Evergrande doom loop intensifies again

Moody’s had downgraded Evergrande, making it a triptych of rating agencies:

Moody’s Investors Service has downgraded the corporate family rating (CFR) and senior unsecured ratings of China Evergrande Group (“Evergrande”), the CFRs of Hengda Real Estate Group Company Limited and Tianji Holding Limited, and the backed senior unsecured ratings of Scenery Journey Limited.

…”The downgrades reflect Evergrande’s heightened refinancing risk over the coming 12-18 months given its weakened funding access and liquidity position. We also expect its profit margins to decline as the company lowers the selling prices of its properties to preserve liquidity,” says Cedric Lai, a Moody’s Vice President and Senior Analyst.

The company’s funding access has weakened, as demonstrated by its highly volatile onshore and offshore bond prices, following reduced investors’ and creditors’ confidence amid continued negative news regarding the company.

The negative outlook reflects Moody’s expectation that the company’s liquidity profile will remain weak over the next 12-18 months.

RATINGS RATIONALE

Evergrande’s Caa1 CFR reflects the company’s nationwide geographic coverage, strong sales execution and low-cost land bank. However, the rating takes into consideration the company’s sizable maturing debt over the next 12-18 months, high proportion of trust loans and moderate credit metrics. In addition, the company’s significant investments in non-property businesses also constrain its credit profile.

Evergrande’s liquidity position is weak. The company’s cash on hand of RMB181 billion as of the end of 2020 was not sufficient to cover its short-term debt of RMB335 billion as of the same date.

Given its weakened access to funding, the company will need to focus on generating internal cash to repay its maturing debts and fund its operations in 2021. The company’s primary objective of generating cash from property sales will continue to squeeze its profit margins. As such, Moody’s expects Evergrande’s gross margin to further decline to 16%-18% over the next 12-18 months from 24% in 2020.

In the first half of 2021, the company’s contracted sales grew 3% from a year ago to RMB356.8 billion, but its average selling price dropped to RMB8,295 per square meter (sqm), compared with RMB8,945 per sqm in 2020 and RMB10,281 per sqm in 2019.

Meanwhile, Moody’s expects that Evergrande will reduce spending on land and control debt growth over the next 12-18 months, given its high debt leverage. Accordingly, Moody’s expects the company’s debt leverage to improve over the next 12-18 months.

On the other hand, its interest coverage will weaken because of the expected decline fall in gross margins. Specifically, Moody’s expects Evergrande’s EBIT/interest to decrease slightly to 1.3x over the next 12-18 months from 1.4x in 2020, while Hengda’s EBIT/interest will reduce slightly to 1.6x from 1.7x over the same period.

Hengda’s credit profile is closely linked to that of Evergrande. In 2020, Hengda accounted for 88% of Evergrande’s revenue and 81% of its reported debt. Specifically, Hengda’s Caa1 CFR reflects the company’s nationwide geographic coverage, strong sales execution, low-cost land bank and focus on mass-market residential properties. However, the rating takes into consideration the company’s sizable maturing debt over the next 12-18 months, high proportion of trust loans and moderate credit metrics.

Evergrande’s Caa2 senior unsecured rating is one notch below its CFR, reflecting structural subordination. This risk reflects the fact that most of the claims are at the operating subsidiaries and have priority over claims at the holding company in a bankruptcy scenario. In addition, the holding company lacks significant mitigating factors for structural subordination. As a result, the expected recovery rate for claims at the holding company will be lower.

Tianji’s Caa2 CFR reflects the company’s standalone credit profile and a one-notch rating uplift, based on Moody’s expectation that Hengda will provide financial support to Tianji when needed.

The one-notch uplift reflects (1) Hengda’s full ownership of Tianji; (2) Tianji’s status as the primary platform for Hengda to invest in offshore property projects and raise offshore funds; and (3) Hengda’s track record of providing financial support to Tianji.

Tianji’s standalone credit profile factors in its moderately large scale, weak liquidity and weak credit metrics.

The Caa2 senior unsecured rating on the notes guaranteed by Tianji considers Moody’s expectation that support from Hengda mitigates the risk of structural subordination.

In terms of environmental, social and governance (ESG) considerations, Moody’s has considered the company’s weak financial management, given that its financial policy favors the use of debt leverage that maximizes returns to shareholders.

The rating also considered the company’s concentrated ownership by its key shareholders, Hui Ka Yan and his wife, who held a 77% stake in the company as of the end of 2020.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

An upgrade is unlikely given the negative outlook.

However, the outlook could return to stable if Evergrande improves its access to funding, and reduces its debt and payables such that its capital structure becomes more sustainable in nature.

On the other hand, Moody’s could downgrade the ratings if Evergrande’s access to funding and liquidity deteriorate further.

More creditors are suing:

In the latest move by a creditor to protect its assets, Leo Group Co. said it filed a lawsuit against Evergrande’s Hengda Real Estate unit to pay for advertisements. It’s asking a Shenzhen court to freeze some of the unit’s assets, including bank accounts, an exchange filing showed Tuesday.

,,,Top Chinese politicians defined Evergrande’s financial problems as “liquidity stress” and not an insolvency, REDD reported Monday, citing two unnamed sources. Evergrande plans to sell around 120 billion yuan ($18.6 billion) in assets and initiated talks with potential buyers such as China Jinmao Holdings Group in early June, REDD cited a third unidentified source as saying.

Evergrande’s primary objective of generating cash from property sales will continue to squeeze profit margins, Moody’s said. It expects the company’s gross margin to further shrink to between 16% and 18% over the next 12 to 18 months from 24% in 2020.

The developer’s sales dropped 13% last month from a year earlier to 44 billion yuan, a filing showed Tuesday. While July is a traditionally slow month for property transactions, it was the biggest decline since February, according to Bloomberg calculations based on the data. Average selling prices stood at 8,055 yuan per square meter in July, below an average 8,295 yuan in the first half.

The stocks was belted again:

Evergrande shares have lost almost two thirds of their value this year

Enterprise value is now approaching 5% of total debt. This is not a “liquidity crisis”. This thing is going down unless rescued. It is another reason to remain bearish iron ore.

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