Inside Running

China Developers' Best Blue-Chip Passport

Companies will need to deleverage before share prices push higher.
Photographer: DuKai photographer/Getty Images

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.

Everybody Loves an Upgrade

Bloomberg's default risk model shows that companies from Country Garden to CIFI Holdings deserve an investment-grade ranking

Source: Bloomberg

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 Sept. 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.

Winner Takes All

China's property market is going through a consolidation, benefiting the largest players, which are mostly listed in Hong Kong

Source: Citi Research

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.

Not There Yet

Despite faster earnings growth, China's largest developers are at similar price-to-earnings valuations to their Hong Kong peers

Source: Bloomberg

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.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Shuli Ren in Hong Kong at sren38@bloomberg.net

    To contact the editor responsible for this story:
    Katrina Nicholas at knicholas2@bloomberg.net

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