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March 7 (The following statement was released by the rating agency)
Fitch Ratings has assigned China Resources Land Ltd's (CR Land; BBB+/Stable) USD1,000m 4.675% notes due 2016 a 'BBB+' rating. The notes are rated at the same level as CR Land's senior unsecured rating because they constitute direct and senior unsecured obligations of the company.
CR Land's ratings are supported by its business model of maximising operating cash flow from its development properties to support the expansion of its investment property portfolio. CR Land enters major Tier-2 cities in China selectively, in line with its model of operating investment properties in prime locations nationwide. CR Land's strategy fits into its parent China Resources (Holdings) Company Limited's (CRH) aim to be an influential conglomerate that taps China's growing affluence.
KEY RATING DRIVERS
Stable Cash from Development: Fitch expects CR Land to generate positive cash flow from operations (CFO) as the company shifts its development property strategy to focus on stability and profitability instead of high growth. CR Land generated HKD8.7bn in CFO in 1H13, continuing the positive trend set in 2012 and reversing from 2011's negative CFO. The company likely generated positive CFO in 2H13 when it had contracted sales of CNY32.6bn, around the same level as the CNY33.7bn in 1H13, even as land acquisitions likely fell in 2H13 from the CNY20.4bn in 1H13.
CR Land's contracted sales had a 44% compounded annual growth rate for 2010 to 2013, but the company aims to move towards maximising cash generation with projects in higher-tier cities or in city centres that enjoy both strong demand and firm pricing. This is reflected in the higher land cost of CNY5,122 per square metre (sqm) for new land acquired in 1H13, compared with CNY2,283 per sqm for land acquired between 2010 and 2012.
High-Yielding Investment Properties: CR Land's investment properties are in prime locations in China's Tier 1 and wealthier Tier 2 cities. CR Land maintains an 80/20 split between retail and office by rental income. The strength of this portfolio is seen in the net rental yield of 4.9% that it fetched in 1H13, higher than the average of 3.5% among large Hong Kong and Chinese property investment companies. CR Land's strong reputation in investment properties helps to support sales of its development properties that are linked to its investment property projects.
Parental Assistance: CR Land's business profile is strengthened by the operational benefits it enjoys as a core subsidiary of CRH. CRH supports CR Land in preparing prime land and large parcel lands for eventual injection into CR Land for development. These additional land parcels augment CR Land's own existing land bank. CR Land has an edge in securing prime land in new cities given state-owned CRH's government linkage as well as its proven track record in developing city centre commercial property projects. CR Land also enjoys lower funding costs from borrowings with affiliated companies.
Financial Headroom Supports Expansion: Fitch has focused on investment property credit metrics in its analysis as CR Land's development property business is moving into a stable state. The agency allocates all cash and debt supporting 30% of properties under development (net of presales proceeds) to the development business, in-line with the trends for large Chinese homebuilders.
Residual debt is then allocated to the investment business. With this adjustment, the key measure used to assess CR Land's development business is the churn rate as measured by contracted sales/ gross debt of the development business. This ratio has been improving, rising to 1.7x in 1H13 from 1.2x in 2012 and 1.0x in 2011.
For its investment property business, leverage, as measured by debt/recurring EBITDA for the segment, stood at 3.7x (annualised) in 1H13 and EBIT net interest cover (NIC) was 6.5x. These ratios are comparable to similarly or higher rated Hong Kong property investment companies. CR Land is making heavy investments that will more than double its investment property assets over the next three years. As a result, CR Land's credit metrics are likely to weaken, although they would still remain healthy with EBIT NIC for investment property trending towards 3.0x and leverage heading towards 7.0x.
Rapid Expansion Constrains Ratings: CR Land's high capex is partially debt funded and the resulting higher leverage is a rating concern. Fitch expects CR Land to open an average of seven new investment property projects or an equivalent GFA of almost 900,000 sqm per year between 2014 and 2016. This compares with its existing GFA of 2.3m sqm as of end-1H13. The agency projects that a constant increase of more than 20% in newly added GFA will create pressure on CR Land's credit metrics.
Positive: Positive rating action is unlikely in the next 12 to 18 months, but stabilisation of the investment property operation at a substantially larger scale may lead to positive rating action.
Negative: Future developments that may individually or collectively, lead to negative rating action include:
- investment property debt/recurring EBITDA sustained above 7.0x;
- investment property EBIT NIC sustained below 2.5x;
- contracted sales/development properties gross debt sustained below 1.8x;
- sustained negative CFO