Cutting debt is best blue-chip passport for China’s developers

The world’s three largest credit-ratings companies have a bit of catching up to do.
Eight high-yield developers listed in Hong Kong should now be investment grade, according to Bloomberg’s default risk model, which uses market inputs such as debt outstanding, interest expenses and operating cash flow to calculate the probability of firms reneging on their obligations in the year ahead.
Country Garden Holdings Co., for instance, has a 0.2 percent chance of defaulting within the coming 12 months, in part because its 31 billion yuan ($4.8 billion) of corporate bonds due by June 2019 is backed by 79 billion yuan of operating cash flow in the year ended September 30. Of Moody’s Investors Service, S&P Global Ratings and Fitch Ratings Ltd., the latter was the only one to upgrade Country Garden in 2017, scoring it BBB- in September.
Ratings firms’ snail’s pace is in sharp contrast to the fast-moving China market, which is transforming top players’ credit profiles for the better.
In 2017, there were 17 Chinese developers with sales of more than 100 billion yuan, versus 12 in 2016. China Real Estate Information Corp. believes the number of 100-billion-yuan firms can expand to 30 by 2020 as the market
consolidates.
China’s largest real estate companies also have every incentive to deleverage, and not just because Beijing wants them to. While share prices have run up, valuations still pale in comparison to Hong Kong blue-chips such as Sun Hung Kai Properties Ltd., especially when earnings growth is taken into account.
Despite faster earnings growth, China’s largest developers are at similar price-to-earnings valuations to their Hong Kong peers.
To be sure, convincing Moody’s et al won’t be easy. S&P last September cut Country Garden’s dollar bonds to BB-, a rung below its score on the company itself. As I noted then, S&P was concerned about developers’ “subordination” risk, or that in the event of a default, offshore investors would have a hard time
accessing mainland firms’
onshore assets.
Another issue clouding investors’ perception is that mainland developers are viewed as nouveau riche, and their actions haven’t helped dispel that notion. Dalian Wanda Group Co. squandered billions buying media assets offshore, while Sunac China Holdings Ltd. somehow decided bailing out Leshi Internet Information & Technology Corp. was a good idea.
In short, for Chinese developers’ stocks to push higher, companies need to deleverage. At some point, the billionaires behind these firms will want to cash out, and the best way to realize their paper fortunes later is to pretty up their balance sheets now.

—Bloomberg

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron’s, following a career as an investment banker, and is a CFA charterholder