Rationale
The rating on Evergrande Real Estate Group Ltd. reflects the company's aggressive growth appetite, debt-funded expansion, short operating and financial management track record as a large-scale developer, and weak corporate governance history. Evergrande's high-volume and large-project-size business model could expose the company to execution risk in small markets. The company's large, low-cost, and geographically diversified land bank, competitively priced products, and good execution because of standardized operations temper the above weaknesses. Evergrande develops large-scale residential housing projects in tier-two to tier-four cities, and has a nationwide presence in China. We assess the company's business risk profile as "fair" and its financial risk profile as "significant".
A key risk factor is Evergrande's very aggressive debt-funded growth appetite. The company was on the acquisition trail up to the first half of 2011 despite holding huge land reserves and increasing its debt. As of Dec. 31, 2011, Evergrande's land reserves total 137 million square meters (sqm) in 103 Chinese cities. This is several times larger than that of similarly rated peers. Although, the company has been less aggressive since the second half of 2011, such large holdings may prove a risk if the property market has a sharp downturn. Holding costs (capital) could be heavy and idle land could attract penalties from authorities.
Evergrande's high-volume business model exposes it to intense competition in smaller cities. The company operates in over 100 Chinese cities, some of which are small and have limited demand and affordability. With the government's purchase restriction policy in place in larger cities, more and more developers intend to enter the small markets potentially leading to increased competition.
Evergrande's good cost controls and economies of scale keep its prices competitive. The company also benefits from resilient demand in its target markets of tier-two to tier-four cities, which are less volatile than other markets due to higher owner-occupier demand. Nevertheless, if the competition in these markets intensifies, Evergrande's sales may be affected.
Evergrande's solid sales ability supports the rating. The company's sales performance in 2011 was satisfactory and better than that of similarly rated peers. However, sales slowed down in the first quarter of 2012. Contracted sales were RMB16.45 billion in January-April 2012, compared with RMB25.95 billion for the same period in 2011. In our view, Evergrande has the capacity to accelerate sales given its much enlarged development portfolio, including the more than 200 projects under development in 2012. But the company may have to ramp up sales at the cost of margin if it cuts selling prices aggressively. Because of Evergrande's high debt, any major slippage in the company's sales target could push it closer to our downgrade triggers.
Evergrande's revenue was RMB61.9 billion in 2011, with an EBITDA margin of 25.3%. Debt increased significantly to about RMB52 billion in 2011, from RMB31.28 billion in 2010. Therefore, the debt-to-EBITDA ratio increased to 3.3x from 2.9x despite higher revenue and profitability. We expect this ratio to remain at a similar level in 2012 despite a further increase in debt because Evergrande has locked in a high amount of revenue. We expect property sales to remain flat even though the number of projects has increased, because of a highly uncertain property market outlook.
Liquidity
Evergrande has "adequate" liquidity as defined in our criteria. Our liquidity assessment is based on the following factors and assumptions:
-- We expect the company's sources of liquidity to cover its uses by 1.2x in the next 12 months.
-- We expect sources to cover uses even if EBITDA declines by 15%.
-- Sources of liquidity include about RMB20.08 billion in unrestricted cash as of Dec. 31, 2011, and cash flow from operations.
-- Uses of liquidity include short-term debt of RMB10.23 billion, development costs, and land premiums.
-- We expect capital expenditure on property development to remain large due to a continued ramp-up in property deliveries of between 8 million and 10 million sqm each year in the next one to two years.
Evergrande has limited financial flexibility compared with that of peers. Although the company can scale down construction cost, in particular on new projects, in our view, its liquidity could come under pressure if sales are much lower than we expect.
Outlook
The stable outlook reflects our expectation that Evergrande will likely rein in its aggressive growth strategy and that the company's sales will remain steady. Evergrande's profitability is likely to remain flat or modestly decline due to price cuts to boost sales, in line with peers.
We may lower the rating if Evergrande deviates from its core business, its sales and profitability are materially lower than we expect, and its debt-funded expansion is more aggressive than we anticipate. Downgrade triggers could be a debt-to-EBITDA ratio of more than 5x, EBITDA interest coverage of less than 3x, and unrestricted cash of less than RMB4 billion.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
