We expect Yuzhou to continue to improve its sales execution and product mix
over the next 12 months. The company's property sales in the first 11 months
of 2012 were better than we expected as it cut prices moderately and adjusted
its product mix to cater more to first-time home buyers. Yuzhou's contracted
sales were Chinese renminbi (RMB) 6.16 billion, exceeding the full-year target
by 23.2%. The company's sales execution improved as contributions from new
markets outside of Xiamen increased.
The company's low-cost land bank and its good market position in Xiamen will
likely continue to support its profitability. Yuzhou's average land costs were
about 15% of the contracted average selling price in the past three years. In
our view, the company's operating track record, brand recognition, and the
good location of its land bank in Xiamen will continue to support its
above-average pricing there.
Yuzhou's profitability weakened somewhat until recently as the company
expanded outside of its home market and adopted a more flexible pricing
strategy. Nevertheless, we believe Yuzhou's profitability will start to
recover given the company has no pressure on meeting annual property sales
target. We expect Yuzhou's EBITDA margin to remain satisfactory at about 35%
in the next one to two years.
We expect the company's financial performance to improve moderately in 2012.
In our base-case scenario, we expect Yuzhou's 2012 credit metrics to improve
as higher property sales offset lower margins, and stronger cash flows result
in a more stable leverage. Our key forecast assumptions for the year are that:
(1) Yuzhou's contracted sales will reach RMB5 billion, compared with RMB4.3
billion in 2011; (2) its EBITDA margins will weaken to about 35% from 42%; and
(3) its borrowings will increase moderately to RMB6.5 billion to fund working
capital and capital spending. As a result, we expect Yuzhou's adjusted
debt-to-EBITDA ratio to be 4x and EBITDA interest coverage 3x by the end of
Yuzhou's liquidity is "adequate," as defined in our criteria. We estimate that
the company's liquidity sources will exceed uses by 1.2x or more in 2012. Our
liquidity assessment incorporates the following expectations and assumptions:
-- Liquidity sources for 2012 include an unrestricted cash balance of
RMB1.4 billion (as of Dec. 31, 2011), new loan drawdowns of RMB1.5 billion in
the first half of 2012, and expected cash proceeds of RMB5.3 billion from
-- Liquidity uses include short-term debt of RMB1.3 billion, land
premiums payable of RMB1.3 billion, and estimated construction costs, working
capital needs, and dividend distributions of RMB4 billion.
-- We expect net sources of liquidity to remain positive even if EBITDA
declines by 15%.
-- As of Dec. 31, 2011, the company was in compliance with financial
covenants on its outstanding bonds and notes. In our view, Yuzhou has limited
headroom to increase its offshore debt against the EBITDA interest coverage
covenant of 3.0x on its US$200 million senior unsecured notes due 2015.
Yuzhou has undrawn onshore banking facilities of RMB2.9 billion (as of June
30, 2012). Nevertheless, we do not include these facilities in our liquidity
assessment because they may not provide timely liquidity support. This is
because loan drawdowns depend on credit availability and case-by-case approval.
The stable outlook reflects our expectation that Yuzhou will maintain
satisfactory property sales and consistent financial management for the next
12 months at least. We also expect the company to have adequate liquidity
while expanding outside of its home market.
We may lower the rating if Yuzhou's property sales and profitability in the
next 12 months are significantly weaker than we expected or its debt-funded
expansion is more aggressive than we anticipated. This may lead to a more
leveraged capital structure and weaker credit metrics than we expected. We
consider total debt to total capitalization of more than 60% and EBITDA
interest coverage of less than 2x as indicators of such weakness.
The upside to the rating is limited until the company improves its operating
scale and project diversity, and maintains satisfactory profit margins.
Furthermore, we may raise the rating if Yuzhou shows financial discipline and
a record of prudent expansion.