Fitch Ratings has assigned Zhenro Properties Group Limited's (B+/Stable) proposed US-dollar green bonds a 'B+' rating, with a Recovery Rating of 'RR4'.

The proposed notes are rated at the same level as Zhenro's senior unsecured rating because they will constitute its direct and senior unsecured obligations. Zhenro intends to use the net proceeds from the issue mainly to refinance existing debt, in accordance with Zhenro's green bond framework.

Well-controlled land acquisitions and internally generated cash flow have reduced Zhenro's leverage - defined by net debt/adjusted inventory, including proportional consolidation of joint ventures (JVs) and associates - to 41.6% by end-1H20, from 55% in 1H19. However, its small land bank creates some pressure to replenish land and may pose a challenge in keeping leverage at the current level. Fitch forecasts Zhenro can sustain leverage at below 50% in the forecast period, 2020-2024.

Zhenro's ratings are supported by its attributable contracted sales scale, quality land bank, healthy contracted sales growth and low leverage in 2019 and 1H20. The rating is also constrained by its evolving group structure and deteriorated margins.

KEY RATING DRIVERS

Leverage Decline: Zhenro's proportional consolidated leverage declined to 41%-42% in 2H19 and 1H20, from 55% in 1H19, on the back of strong sales and controlled land acquisitions. However, Fitch believes that leverage may edge up from the current level if the company lengthens its land bank life to be in line with 'BB-' peers. Acquiring land at market prices could limit its ability to keep land costs low, especially as it buys more land parcels in Tier 2 cities where there is more intense competition among developers.

Quality Land Bank but Small: Zhenro's land bank life of two to 2.5 years at end-2019 - defined by saleable land bank as of end-2019 divided by expected gross floor area (GFA) sold in 2020 - is shorter than most similarly rated peers at 'B+' and 'BB-' levels. Therefore, we believe the company needs to continually replenish its land bank to sustain contracted sales growth. On the other hand, Zhenro's land bank quality is stronger than most 'B+' peers with an average selling price (ASP) of CNY15,488/sq m in 2019. Its land bank is diversified across China with 36% in Yangtze River Region and 28% in West Taiwan Straits. More than 70% of its land bank is in higher-tier cities.

Larger Sales Scale than Peers: Zhenro's CNY67 billion attributable contracted sales scale in 2019 was larger than most of the 'B+' peers. Its 11M20 total contracted sales was CNY125 billion, or 89% of its full-year target. We expect Zhenro to continue to increase contracted sales in the next two to three years.

Evolving Group Structure: Zhenro's implied cash collection (defined as change in customer deposits plus revenue booked during the year) in 2019 was only CNY23.8 billion, or 35% of the reported attributable sales during the year. This suggests that a large portion of Zhenro's attributable contracted sales in 2019 came from its JVs and associates. A high proportion of land acquisitions were done via JVs and associates in 2017 and 2018, but from 2019 most land acquisitions were made on balance sheet.

The high proportion of off-balance-sheet projects has meant the performance of many projects has not been fully reflected in the company's financials, in Fitch's view. However, Fitch believes Zhenro's financials will gradually reflect the overall performance of projects because recently acquired land is included in the consolidated balance sheet. This transition may lead to short-term volatility in the company's financial metrics, before stabilising.

Margin Edges Lower: Zhenro's EBITDA margin dropped in 2019 and 1H20 yoy, caused mainly by disposal of low-margin projects and lower capitalised interest. Fitch expects the EBITDA margin to stay at 22% in 2020 and edge up slightly in 2021. Zhenro acquired new land at an average cost of CNY5,663/sqm in 1H20, 5% lower than in 2019. Land costs accounted for about 37% of contracted sales ASP. The sold but not yet recognised sales of CNY120 billion carries a gross profit margin of 22%-23% compared with 20% recognised in 2019.

High Non-Controlling Interest (NCI): Fitch expects NCI as a percentage of Zhenro's equity to stay at 40%-45% in 2020-2024, which is higher than the average of 'B+' peers. This reflects Zhenro's reliance on cash from contracted sales and capital contributions from non-controlling shareholders, which are mainly developers, as a source of financing to expand scale. This lowers Zhenro's need for debt funding, but creates potential cash leakage and reduces further financial flexibility because homebuilders with lower NCI can dispose of stakes in projects to reduce leverage.

DERIVATION SUMMARY

Zhenro's proportionally consolidated leverage in 2019 and 1H20 was comparable with that of the 'BB-' peers. Zhenro has a quality land bank, which is shown in its ASP of CNY15,321/sqm, and attributable contracted sales of CNY67 billion in 2019 were comparable with those of 'BB-' peers, such as Times China Holdings Limited (BB-/Stable).

Zhenro's unsold attributable land bank at end-1H20 was equivalent to around two to 2.5 years of GFA sold, which is shorter than that of most 'BB-' peers, such as Risesun Real Estate Development Co.,Ltd. (BB-/Stable). Zhenro's EBITDA margin is also lower than most 'BB-' peers.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Attributable contracted sales of CNY76 billion-87 billion a year in 2020-2024 (2019: CNY67 billion);

0%-4% rise in ASP each year in 2020-2024 (2019: CNY15,488/sqm);

Annual land premium to be maintained at around 2.5 years of land bank life;

0%-2% rise each year in average land costs in 2020-2024 (2019: CNY5,968/sqm);

GFA acquired is 0.9x-1.0x of GFA sold in 2020-2024;

Selling, general and administrative expenses at 3.3%-3.5% of contracted sales in 2020-2024.

Key Recovery Rating Assumptions:

Zhenro to be liquidated in a bankruptcy, as it is an asset-trading company;

10% administration claims;

60% advance rate applied to excess cash (available cash CNY28,369 million - three-month contracted sales CNY16,819 million = excess cash CNY11,550 million);

100% advance rate to restricted cash;

70% advance rate to adjusted net inventory of Zhenro to reflect its 20%-25% EBITDA margin;

70% advance rate to accounts receivable;

60% advance rate to net property, plant and equipment;

40% advance rate to financial instrument;

20% advance rate to investment properties.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

A longer record of leverage (net debt/adjusted inventory) being sustained below 45% with land bank life in line with high-churn peers;

EBITDA margin, after adding back capitalised interest in cost of goods sold, above 20% for a sustained period.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Leverage (net debt/adjusted inventory) above 55% for a sustained period;

EBITDA margin, after adding back capitalised interest in cost of goods sold, below 15% for a sustained period.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Sufficient Liquidity: Zhenro had unrestricted cash of CNY33.6 billion at end-1H20, pledged deposits of CNY423 million, restricted cash of CNY5.8 billion, undrawn bank credit facilities and an unused onshore and offshore bond issuance quota for refinancing, which were enough to cover short-term borrowings of CNY19.0 billion. Funding costs edged down as Zhenro continues to replace its more expensive trust loans with lower-cost financing. The proportion of trust loans declined to 9% in 1H20 from 35.8% in 2018.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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