China SCE Property Holdings Outlook Revised To Positive On Expected Leverage I #B# Rating Affirmed

Stocks and Financial Services Press Releases Tuesday April 11, 2017 17:26
HONG KONG--11 Apr--S&P Global Ratings

HONG KONG (S&P Global Ratings) April 11, 2017--S&P Global Ratings today said it has revised its outlook on China SCE Property Holdings Ltd. (CSCE) to positive from stable. At the same time, we affirmed our 'B' long-term corporate credit rating and our 'cnBB-' long-term Greater China regional scale rating on the China-based property developer.

We also affirmed our 'B-' long-term issue rating and 'cnB+' long-term Greater China regional scale rating on CSCE's outstanding senior unsecured notes.

We revised the outlook to positive because we believe CSCE's financial leverage will improve significantly in 2017, due to recovery in CSCE's margins. At the same time, CSCE is likely to continue to expand its operating scale, with better geographical diversity and more exposure to higher tier cities.

We anticipate a notable recovery in CSCE's margins in 2017, after a compression over the past two years. The company's gross margin declined to 25% in 2016, from 28% in 2015, as it recognized revenue from some low-margin (or loss-making) projects in smaller cities (such as Nanchang and Anshan) that were sold at discount before 2015. However, margins should improve over the next two years as these low-margin legacy projects wind down and more contribution comes from higher-tier cities. We estimate that CSCE's unrecognized revenue of around Chinese renminbi (RMB) 15 billion at the end of 2016 carries better margins of more than 30%. As a result, we forecast gross margin will recover to over 29% in 2017.

We affirmed the ratings because we believe the pace of CSCE's deleveraging plan still faces some uncertainty, given its fast expansion in top-tier cities. CSCE's capital expenditure (capex) will remain high as it expands in new cities (e.g., Suzhou and Hangzhou). We estimate its land acquisition spending will increase to RMB14 billion-RMB16 billion per year in the next two years, from RMB11.6 billion in 2016.

We believe CSCE has improved its operating scale and geographical diversity over the last few years as it expanded outside its home market. The company's sales increased to RMB23.5 billion in 2016, from RMB14.5 billion in 2015 and RMB11.9 billion in 2014. Its sales contribution from Fujian decreased to 32.6% in 2016 from 73.6% in 2014.

We anticipate that CSCE's sales will increase steadily to RMB26 billion-RMB28 billion in 2017. This is driven by its salable resources of RMB45 billion. The company will have new projects of around 0.7 million square meters gross floor area in 2017, mostly in Beijing, Shanghai, and Tianjin.

CSCE's increased exposure to higher-tier cities with more stable demand enhances its asset quality, in our view. First- and second-tier cities accounted for 80% total land bank by costs in 2016, up from around 68% in 2015 and 58% in 2014.

CSCE still faces some execution risks in its newly expanded cities, including Nanjing, Hangzhou, and Suzhou, which it entered in 2016. Previously, certain projects in new markets initially operated with longer cycles. However, CSCE's past record demonstrates it has generally been able to adapt to new markets over time.

The positive outlook reflects our expectation that CSCE's leverage will improve significantly in 2017 due to material recovery in margins. We also expect the company to manage the pace of its expansion, while maintaining

steady sales growth over the next 12 Months.
We could upgrade CSCE if the company can substantially improve its margins, such that the debt-to-EBITDA ratio improves to below 5x on a sustained basis.

We could revise the outlook to stable if CSCE's debt-to-EBITDA ratio doesn't show clear visibility of declining to below 5x over the next 12 months. This could be due to a weaker recovery in margins than we expect, with gross margin lower than our base case of about 29%.

We could also revise the outlook to stable if CSCE pursues a more aggressive   debt-funded expansion, with significantly higher land acquisition than our base-case forecast of RMB 14 billion.

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