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Jan 14 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned China-based property developer Modern Land (China) Co., Limited’s (Modern Land; B/Stable/RR4) proposed yuan-denominated senior unsecured notes an expected rating of ‘B(EXP)’ and recovery rating of RR4.
The notes are rated at the same level as Modern Land’s senior unsecured rating as they represent direct, unconditional, unsecured and unsubordinated obligations of the company. The final rating of the proposed notes is contingent upon receipt of documents conforming to information already received.
Limited Scale: Modern Land’s limited scale in terms of land bank, contracted sales as well as geographical coverage leaves the company susceptible to greater volatility in earnings. Modern Land’s contracted sales of CNY4.4bn for 2013 (2012: CNY2.8bn) and its current land bank of about 1.8 million sqm (excluding presold properties) as at the end of 1H 2013 is commensurate with homebuilders rated in the ‘B’ category (those rated ‘B+', ‘B’ or ‘B-').
Low Leverage Gives Flexibility: The company is in a net cash position as at end-June 2013. It has unrestricted cash of CNY1.10bn and unutilised onshore credit facilities of CNY1.06bn (against total debt of CNY856.30m). Fitch expects contracted sales to increase to around CNY4bn-CNY6bn per annum over the next two years. The rating also takes into account Fitch’s expectation that as the company ramps up its scale with more land acquisitions, net debt/adjusted inventory will likely hit 30% (2012: 9%) with contracted sales/gross debt moderating to around 1.5x (2012: 2.48x) in 2014. A slower asset turnover, however, would weaken the company’s leverage ratio and pressure its credit metrics - although this is not in Fitch’s rating case.
Product Mix May Dilute Margin: Modern Land has been generating strong EBITDA margin of 25%-33% over the past three years, a level higher than Chinese mass market homebuilders in general. This is due to a combination of high-end products in Beijing, its product differentiation strategy and the company’s comparatively lower land cost. Modern Land is likely to maintain its margin at the current level for the next two years, boosted by continuing sale of high-end products. However, the EBITDA margin would likely moderate to around 20%- 25% over the medium term because of its increasing exposure to the mid-end and mass market segments in lower-tier cities as well as higher land costs (end-1H13: CNY859/sqm versus recent land acquisition in Nan Chang at approximately CNY4,000/sqm).
Longer Gestation Period for Niche Product: Modern Land’s market positioning as a niche homebuilder that provides energy-efficient homes needs a longer gestation period because it will take time for the company to make its products known, particularly in the second- and third-tier cities that the company has recently entered. Gross profit margins for initial launches are likely to be lower (20%-30%) and the company is only likely to be able to raise prices in subsequent launches after obtaining market acceptance following the handover of the initial projects.
Sales Geographically Concentrated. Modern Land currently has six projects under development in six cities across five provinces. While the majority of its land bank is in lower-tier cities such as Xiantao (36.6%) and Changsha (27.6%), the company’s contracted sales for the next two years would likely be still driven by projects in Beijing and Taiyuan, which have higher value and margins. In Fitch’s view, meaningful geographical diversification will occur when Modern Land’s operations in lower-tier cities mature and it is able to sustain its profit margins over the medium term even though a smaller proportion of sales come from Beijing and Taiyuan.
Positive rating action is not expected in the next 18-24 months due to Modern Land’s small operational scale. However, future developments that may, individually or collectively, lead to positive rating action include:
- Contracted sales sustained above CNY7bn without compromising leverage
- EBITDA margin sustained above 25%
Negative: Future developments that may, individually or collectively, lead to negative rating action include
- EBITDA margin sustained below 20%
- Contracted sales/gross debt sustained below 1.0x
- Net debt/adjusted inventory sustained above 40%