Photographer: Qilai Shen/Qilai Shen

Stockholders Ride China's Developer Wave Despite Warning Signs

  • Sunac, Evergrande take on debt to fund great China land-grab
  • Key will be how quickly developers turn assets into profits

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For all the headlines on China’s deleveraging and actions to damp a hot property market, there’s still plenty of exuberance around.

Two growth-consumed developers, Sunac China Holdings Ltd. and China Evergrande Group, have shown in recent months that piling on debt is no concern for stockholders. Their shares have more than tripled in the past year, vastly outpacing the broader market. While bondholders have suffered, the equity market is betting that up-sizing will pay off as China’s urbanization and property upgrading continue.

Sunac, which this week agreed to buy a portfolio of hotels, land and projects for 63.2 billion yuan ($9.3 billion) in China’s largest property deal, showcased the degree of unconcern. Despite warnings from ratings agencies and an unusual financing package behind the deal that features a loan from seller Dalian Wanda Group Co. amounting to almost half the price, Sunac is up about 15 percent since the announcement.

In the debt market, Sunac’s position isn’t so rosy. The Tianjin-based company has seen its dollar notes maturing in 2019 drop almost 6 cents on the dollar in the past year, touching the lowest since February 2016 this week. Fitch Ratings cut Sunac deeper into junk territory after the deal, while S&P Global Ratings put its own sub-investment grade for the issuer on negative watch, and Moody’s Investors Service said the transaction raises financial risk.

"Both stock and bond investors reacted rationally -- for equity investors, they care about growth potential, while for bond investors, they care more about Sunac’s ability to repay debt," said Hong Hao, chief strategist at Bocom International Holdings Co Ltd. Even so, "it is worrying to see a Chinese company’s gearing ratio jump all of a sudden when credit growth is slowing down on the mainland and regulators are tightening in the financial markets."

China’s policy makers have steadily tightened regulations on the property market over the past year or so to prevent a bubble, though new-home sales still climbed 13 percent in May from a year before, and prices of new apartments jumped more than 10 percent in Beijing, Shanghai and Guangzhou.

This isn’t the first cycle of lending, purchasing and development rules being tightened for property, however, and some predict that officials will ease up when economic growth slows, stoking the market all over again. Meantime, developers are in the middle of a shakeout, with smaller operators being swallowed up.

Read more about the great Chinese land-grab here.

"In retrospect, buying land banks with an aggressive attitude in the past few years allowed some Chinese developers to emerge as consolidators," Oscar Choi, an Asian property analyst at Citigroup Inc. in Hong Kong said in an interview earlier this year. "This overturned the view held by some market watchers that high leverage is nothing but sinful.”

Stockholders may still face a test. Top Chinese financial regulators set to gather at a quinquennial meeting starting Friday to establish financial-policy priorities for the coming five years may re-emphasize the priority of reining in leverage -- after debt soared to 258 percent of the economy’s size by 2016. They have already stepped up scrutiny of some of the opaque areas of Chinese finance, such as wealth-management products and the funding behind the overseas acquisitions of several big conglomerates.

Smaller Cities

What’s benefited some developers, including one of the most aggressive -- Country Garden Holdings Co. -- is the spread of momentum in the property market to China’s lower-tier cities, according to some analysts. And so far, the outlook has left them able to keep raising funding.

Evergrande lived up to its status as the world’s most-indebted developer three weeks ago, pulling off the biggest-ever dollar bond sale from a junk-rated issuer, with $6.6 billion raised. The move showed how the company is still in expansion mode, after it had reduced its gearing earlier through a stake sale in a unit and redemptions of perpetual bonds.

Sunac broke new ground in funding its purchase of a package of dozens of hotels, theme parks and other assets by having seller Wanda take out a 29.6 billion yuan loan for the deal. It was unusual to see such magnitude for vendor financing, observers said. Jackson Hui, Hong Kong-based analyst at China Merchants Securities HK Co., said "bond investors may raise eyebrows when they see Sunac’s soaring gearing ratio and get worried about its debt-repayment capability."

Sunac said in an emailed response to questions that its "sound sales performance will continue to provide ample cash flows for the company, and safeguard the stability and security of its finances." Evergrande didn’t respond to a request for comment.

"This is more like an equity-friendly deal as it could be a growth story -- but it’s not so rosy for creditors," said Christopher Yip, Hong Kong-based analyst at S&P Global Ratings. The leverage is "manageable" for now, but the volume of assets acquired is huge, and further funds will be needed to develop them. "It’s all about timing -- how quickly they can turn those assets into profits."

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— With assistance by Chris Anstey, Emma Dong, Amanda Wang, Jeanny Yu, Denise Wee, and Dingmin Zhang

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