(The following statement was released by the rating agency)
Dec 18 -
Summary analysis -- Kerry Properties Ltd. ------------------------- 18-Dec-2012
CREDIT RATING: BBB-/Positive/-- Country: Hong Kong
Primary SIC: Subdividers and
Mult. CUSIP6: 492469
Credit Rating History:
Local currency Foreign currency
16-Nov-1998 BBB-/-- BBB-/--
31-Oct-1997 BBB/-- BBB/--
The rating on Kerry Properties Ltd. reflects the Hong Kong-based diversified property company’s steadily increasing recurring income, established brand name in China through key investment properties, and good funding flexibility. Rating weaknesses include: (1) Kerry’s mixed record of sales execution in China; (2) the company’s capital-intensive business model, which gradually generates cash flow but requires large upfront capital outlays; and (3) its growing exposure to the volatile Chinese real estate market and policy risks in Hong Kong. The property development market is cyclical. Kerry’s limited number of project launches adds to the volatility of its property sales business.
We assess Kerry’s business risk profile as “satisfactory”. the company has more diversified businesses than its rated Chinese property development peers. Kerry generates recurring income from its rental properties in China and Hong Kong, and from its logistics operations. These businesses support a fair level of cash flow and operating performance stability, offsetting the volatility in property sales cycles.
We expect Kerry’s rental income to grow over the next two years as the company opens new large-scale properties in Shanghai and other cities. The company’s leading market position in logistics and warehouse rentals in terms of revenue in Hong Kong should also continue to contribute recurring income. We expect Kerry to maintain a ratio of recurring income to interest coverage at 2x-2.5x over the next two years, which was weaker than the level it sustained in 2011. Higher interest expenses in 2012 and beyond will likely temper the higher rental and logistics income.
We expect Kerry’s recurring rental income to meaningfully improve in the next two years, following the addition of Shanghai Jing An Center and phase 2 of Shenzhen Kerry Plaza. Jing An has a total gross floor area of 450,000 square meters, accommodating “grade-A” offices, retail space, service apartments, and the Shangri-La hotel. Pre-leasing is satisfactory, with more than 90% of the retail space and more than half of office space pre-committed at good rents. Once fully operational, this project alone should be able to generate more than Hong Kong dollar (HK$) 600 million in annual rental revenue, which compares with a total of HK$900 million from all the company’s Chinese investment properties in 2011. We expect Kerry’s existing rental portfolio to continue to grow organically, both in Hong Kong and China.
In our view, the execution risk is higher for Kerry when it expands into second- and third-tier cities in China because the company adopts a high-end strategy in these markets. Affordability levels and commercial demand are lower in these cities than in tier-one cities.
Kerry’s property sales are volatile, reflecting its project development schedule and the market conditions. In 2011, Kerry’s sales from China were limited because the government’s policy tightening targeted high-end projects. Given the strong pipeline of properties for sale and stabilizing market conditions in China, we expect property sales to have improved from China in 2012. Kerry achieved about HK$3 billion in contracted sales from China for 2012 against only HK$1 billion for the same period a year earlier. Kerry accelerated sales in Hong Kong; its contracted sales until November 2012 exceeded HK$6 billion, mainly coming from Lions Rise, Altitude, Island Crest, and Primrose Hill.
Kerry’s sales execution in China will be one of key rating factors in the next three years because the company’s development portfolio weighs more in that market. Also, following the introduction of stamp duty for buyers in October this year in Hong Kong, demand may dampen and therefore depress sales in the territory. Kerry will become increasingly dependent on property sales from China, given the dominance of large properties in China in its land bank. Nevertheless, we expect Kerry’s diversified business model, in particular its recurring income, to temper these risks.
Kerry’s logistics segment continues to perform steadily. We expect this segment to grow at less than 10% in the next two to three years due to a slowdown in exports and the economy in China. This growth rate is down from over 20% in the past couple of years.
Kerry’s financial risk profile is “intermediate,” in our view. The company’s financial management is conservative and consistent, resulting in consistently positive cash flow from operations. Kerry has a track record of matching its capital expenditure with its cash flow. When sales are slow, the company tends to scale back construction and land acquisitions.
We expect Kerry’s financial performance to improve from that in 2011. The company’s results for the first six months were strong due to the high recognition of property sales. In the second half, we expect the profit contribution from property sales to decline. As a result, on a full-year basis, the credit ratios will be weaker than in the interim results but better than a year earlier.
In our base case, Kerry’s debt-to-EBITDA ratio is likely to be about 5x-6x in 2012-2014 to support the company’s property development activities and land replenishment program. This levels compares with about 4x on an annualized basis for the first six months. Nevertheless, we believe Kerry will execute its land replenishment plan with caution, given the management’s continuous adherence to strict leverage and investment-return policies. As a result, the company is likely to maintain a ratio of debt to capital of below 30% and positive cash flow from operations.
We believe Kerry’s liquidity is “adequate,” as defined in our criteria. The company’s sources of liquidity, including cash and available facilities, are likely to exceed its uses by 1.2x or more over the next 12-18 months. Our assessment of Kerry’s liquidity profile incorporates the following expectations and assumptions:
-- We believe Kerry has adequate sources of liquidity to cover its needs in the next 12-18 months, even in the unforeseen event that EBITDA declines by more than 15%.
-- Kerry’s liquidity sources include a cash balance of HK$13.26 billion as of the end of June 2012, undrawn committed bank facilities of HK$5.6 billion in Hong Kong, and cash flow from operations. We do not account for bank facilities in China in our liquidity calculation due to their uncommitted nature. Nevertheless, they do provide financial flexibility.
-- Uses of liquidity in the next 12 months include debt maturities of about HK$2.4 billion and outstanding land premiums.
-- Kerry’s financial covenants have sufficient headroom. The company’s typical bank loan covenants do not have any financial undertakings related to its EBITDA; they are mainly balance sheet focused.
-- The company can absorb low probability, high impact shocks because of the good conversion of EBITDA to discretionary cash flow.
The positive outlook reflects our expectation that Kerry’s recurring income will meaningfully increase over the next two years as the company completes more investment properties in mainland China. The outlook also factors in a likely improvement in Kerry’s sales performance in China due to its enlarged property portfolio and stabilizing conditions in the property market. We believe the company is likely to maintain adequate liquidity and an intermediate financial risk profile, based on disciplined financial management.
We may raise the rating if:
-- Kerry ramps up Jing An, such that the project contributes meaningful rental income;
-- The company’s sales performance strengthens in China, with more contracted sales year over year in 2013 and at reasonable margins; and
-- Its recurring income coverage improves toward 2.5x.
We may revise the outlook to stable if Kerry’s execution of Jing An or property sales in China are well below our expectation or if the Hong Kong property market deteriorates. We could also revise the outlook if Kerry’s growth appetite increases materially, such that its land acquisitions are more aggressive than we expect and a materially higher-than-anticipated increase in debt resulting in higher leverage.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008