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Yield Spread
Published on May 17 2019
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- Kaisa Group Holdings Ltd. has moderate geographic concentration, high debt leverage, and weaker interest coverage than peers'.
- The China-based property developer's increasing operating scale, high-quality land bank replenishment from urban renewal projects (URPs), and likely deleveraging over the next 12-18 months temper these risks.
- On May 16, 2019, S&P Global Ratings assigned its 'B' long-term issuer credit rating to Kaisa.
- The stable outlook reflects our view that Kaisa will control its leverage over the next 12-18 months. We also expect the company to maintain satisfactory profitability supported by its low-cost land bank.
HONG KONG (S&P Global Ratings) May 16, 2019
The rating on Kaisa reflects the company's moderate geographic concentration, high debt leverage, and weaker interest coverage than peers'. Kaisa's increasing operating scale, high-quality land bank replenishment, and likely deleveraging over the next 12-18 months temper these risks.
We believe Kaisa will continue to focus on the Greater Bay Area (GBA) and on higher-tier cities in China. The company's strong market position and knowhow in Shenzhen and other key cities in the GBA should provide downside buffers. These markets have growing and resilient demand. In 2018, the GBA accounted for about 60% of Kaisa's contracted sales and 54% of land reserves. The company's home base of Shenzhen makes up about 33% of sales. Kaisa has in recent years expanded into other higher-tier cities outside the GBA, with 56 projects in 45 cities.
Kaisa's geographical concentration makes it vulnerable to regional policy changes. However, the geographic diversity has improved in recent years, with the company's presence in cities such as Huizhou and Guangzhou in the GBA, as well as in Chongqing and Chengdu outside of the GBA. These areas, including Shenzhen, accounted for about 65% of contracted sales in 2018. However, Kaisa's record outside of the GBA is not fully established and could be tested in a downturn, in our view.
Kaisa's involvement in URPs exposes it to regulatory uncertainty and a much longer development cycle. This is true for other developers in the segment too. Tier-1 cities such as Shenzhen, Guangzhou, and Shanghai have their own city renewal regulatory frameworks; each city has different policies and procedures. Apart from increased uncertainty associated with policy changes, URP projects are more difficult to execute and come with higher operating risks. In addition, resettlement negotiations with villagers, zoning approvals from local governments, and other non-commercial factors (such as change of key government officials) may result in a much longer development cycle than originally anticipated. This could add volatility to Kaisa's sales execution and cash flow.
Kaisa's large pipeline of URPs and proven project execution outweigh these risks. The company has more than 20 years of experience in executing URPs and has a satisfactory record of conversion. At the end of 2018, Kaisa had about 30 million square meters (sqm) of URP site area, 99.5% of which was in the GBA, where Shenzhen and Guangzhou each accounted for about one-third. By site area, Kaisa is the largest URP player in the region. It also has the longest operating history. Over the past decade, the company has been able to convert on average 940 thousand sqm gross floor area (GFA) annually into its land reserves. We anticipate it will be able to continue to convert 800 thousand-1 million sqm per year over the next two years.
Kaisa's first-mover advantage in URPs helps build barriers to entry and supports profitability. The company's large URP pipeline also provides a higher level of visibility of converting URPs into saleable resources. Kaisa therefore gets an extra source of land supply in high-tier cities at a comparatively low cost. In 2018, Kaisa's average land cost per sqm was about 20% of contracted average selling price, with URPs contributing about 30% of total sales.
We expect Kaisa's leverage to remain high over the next 12 months, although the debt-to-EBITDA ratio should gradually improve to 7.2x-7.6x in 2019, from 9.0x in 2018 and 11.0x in 2017.
The high leverage is due to the recent normalization of sales and operations since a debt restructuring and exchange completion in 2017, and investments for strong growth.
We believe Kaisa will be able to control its growth in gross debt over the next 12-24 months. As the land market in China is heating up again, Kaisa can afford not to chase land due to its sufficient land bank.
The company has set a contracted sales target of Chinese renminbi (RMB) 90 billion in 2019 and is eyeing further growth in 2020.
In our view, Kaisa's total saleable land resources worth about RMB464 billion are sufficient to meet that target. We expect Kaisa's land acquisitions, including spending on URPs, to reach RMB24 billion-RMB27 billion in 2019, close to 30% of expected attributable contracted sales. This should allow for mild deleveraging.
Kaisa has higher funding costs than its peers', partly because it has had no previous issuance in onshore capital markets, and due to its debt restructuring. The company's blended funding cost of 8.4% in 2018 was partly due to its significant proportion of offshore financing. This, combined with high debt, results in Kaisa's EBITDA interest coverage being weak relative to peers'. The coverage was 1.3x at the end of 2018, and could improve to about 1.6x over 2019 due to some deleveraging.
These weaknesses are partly due a series of credit events starting in January 2015, when the company announced an offshore bank loan default. This was followed by a debt restructuring, including exchange offers. As such, Kaisa did not issue bonds in the domestic market during the issuance boom from late 2015. Although the financial restructuring and the following exchange processes were completed in June 2017, the company may need extra time to regain investor confidence.
Kaisa's capital structure compares well with that of peers at a similar rating level. The company's weighted average maturity of debt was about 3.2 years at the end of 2018, thanks to the 2017 refinancing that extended offshore maturities. Non-bank financing accounted for 22% of total debt, although the majority matures in 2019.
The stable outlook reflects our expectation that Kaisa's leverage will remain high but improve over the next 12-18 months, supported by strong sales growth and a disciplined approach to land acquisitions.
We may lower the rating if Kaisa's debt-funded acquisitions are more aggressive than we expect or if the company's contracted sales and sell-through rate drop substantially. EBITDA interest coverage falling below 1x over the next 12 months could indicate such a deterioration.
We could also lower the rating if the company's liquidity weakens. A significant drop in the ratio of liquidity sources to liquidity uses would indicate such weakening.
We may raise the rating if Kaisa continues to expand, such that its operating scale and diversity improve to be comparable to larger peers'.
We may also raise the rating if the company: (1) improves its funding cost such that its EBITDA interest coverage stays above 2.0x; and (2) significantly reduces leverage, such that its debt-to-EBITDA ratio improves to about 6.0x on a sustainable basis.
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