Evergrande's debt burden just keeps on growing, squeezing shareholders

Shengjing Bank Co

05/09/2016 24:00

(Repeating story first sent on Sunday to additional 
subscribers) 
    By Clare Jim and Umesh Desai 
    HONG KONG, Sept 4 (Reuters) - Building up the second-biggest 
corporate debt pile in China does come at a cost.  
    China Evergrande Group  333.HK , the nation's No.2 real 
estate developer reported last week that its borrowings grew to 
$57 billion by the end of June, including so-called perpetual 
bonds. Only state-owned Petrochina  0857.HK  owes more. 
    The crushing impact of that burden became clear in its 
first-half results as despite reporting a 12.6 percent jump in  
sales, Evergrande said that income attributable to shareholders 
slumped 74 percent to 2.46 billion yuan ($368 million). That was 
mainly because of a 60 percent rise in payments on the  
perpetual bonds as well as a surge in marketing costs. 
    The aggressive leveraging of Evergrande's balance sheet by 
its founder and major shareholder Hui Ka Yan shows that while 
investors and economists have been largely focused on the 
mountains of debt being built up by China's state-controlled 
sector, the private sector has also been on a borrowing binge, 
fuelled by the availability of cheap money. 
    With a stock market value of just $8.5 billion, its critics 
say that Evergrande, which is a household name in China because 
of its development of many thousands of apartments for middle 
class buyers, would be rocked badly if there was a major  
decline in China's home prices or a further downturn in an 
already shaky Chinese economy. 
    "Evergrande's stretched balance sheet, due to active land 
purchases, high dividend payments and expansion into new 
businesses should keep its net gearing at a very high level," 
said Bank of America Merrill Lynch analyst Raymond Ngai "We 
think the stock should trade at a discount valuation, with its 
high financing risk." 
    Hui and the company declined to comment for this article. 
    Evergrande's shares have fallen 7.5 percent since the 
results were announced late last Tuesday. They ended last week 
at HK5.33. Hui expects further declines and has a target price 
of HK$3.90. 
     
    CRITICS PARTIALLY MUZZLED  
    For credit analysts, the debt picture appears far from 
sound. 
    "We are concerned about Evergrande's high leverage and 
liquidity risks," said Moody's analyst Franco Leung. 
    It is by no means the first time that there have been alarm 
bells rung, though Evergrande has also been able to have some of 
its fiercest critics at least partially muzzled. 
    High-profile short seller Andrew Left, of California-based 
Citron Research, published a report in 2012 arguing the group 
was insolvent. Evergrande denied the accusations and Left was 
recently found culpable of market misconduct by a tribunal in a 
case brought by the Hong Kong securities regulator. 
    Left, who declined to comment on Evergrande for this 
article, says he is considering an appeal. 
    Moody's itself was reprimanded by the regulator and fined  
HK$11 million for alleged failures in producing a critical 
report on Evergrande.  Moody's is appealing.  
    Evergrande does have its supporters in the analyst 
community, who see it taking advantage of the troubles faced by 
rivals in a weaker economy. 
    "Evergrande is good at buying land and quickly turning it 
into cash by selling properties - so this strategy is a good 
one. In a sector slowdown, there is lot of room to swallow less 
efficient players," said David Ng, Macquarie's Head of China & 
Hong Kong Research. 
    Meanwhile, Hui has, if anything, speeded up his debt-fueled 
purchases in recent years. 
    In the past eight months, Evergrande has splurged $4 billion 
on banks, construction companies and stakes in rivals. The 
company also bought 80 plots of new land spread across 57 cities 
in the first half of the year. 
    A lot of the acquisitions are add-ons that the company's 
supporters say reinforces its market position, including a 
supply chain that can stretch from financing to construction and 
sales. 
    But Evergrade has also expanded into other areas. It grabbed 
headlines in 2010 when it bought the main soccer in its home 
town of  Guangzhou. Evergrande also owns a variety of other 
assets, including an insurance company, a bottled water company, 
and a New Zealand dairy, and is making a big push into 
hospitals, tourist projects, movie houses and has become an 
Internet provider. 
     
    INSPIRED BY DENG 
    Little is known about Hui. Local media reports have said he 
was born in central China's Henan province in 1958 to a poor 
family, and he moved south to Shenzhen because he was inspired 
by then Chinese leader Deng Xiaoping's visit to the city in 1992 
that played a crucial role in accelerating China's economic 
reforms. He now has many of the trappings of a top business 
owner, including a private jet, a yacht and two Rolls-Royce 
vehicles, according to the reports. 
    His most controversial recent move has been Evergrande's  
$2.2 billion investment in China's largest real estate developer 
Vanke  2202.HK , putting Evergrande in the middle of the 
country's messiest-ever corporate battle. This has triggered 
speculation among analysts that it could be considering a costly 
play for all of Vanke. 
    "Its purchase of Vanke's stakes will undermine Evergrande's 
efforts to control its debt growth and raises financial and 
investment risk," said Moody's Leung. 
    Evergrande has characterised the Vanke purchase as an 
investment and has not elaborated - even to Vanke, whose 
officials said they were perplexed.  "We have been asking them 
about their intention in buying our shares but they have never 
replied," Wang Wenjin, executive vice president of Vanke, said 
last week. L3N1B32HZ] 
    It has increasingly been using perpetual bonds, which on 
average pay an interest rate of 9 percent, and are counted as 
equity rather than debt because they have no maturity date.  
During the first six months of the year, the amount on issue 
soared 53 percent to 116 billion yuan. 
    Yield-hungry investors in China have been happy to amp up 
the party. Evergrande's bonds due 2020  XS116514648=TE  were 
sold last year at a yield of 12 percent but now yields are a 
mere 3.6 percent despite a CCC-plus rating from ratings agency 
Standard & Poor's that puts well into junk territory and only 
five notches above default levels. 
    Even before the Vanke stake purchase, its net debt to core 
earnings soared to a ratio of 14.8 at the end of 2015, according 
to research provider CreditSights, up from 2.1 five years ago. 
That means it would take nearly 15 years to repay its debt at 
the current rate of profit generation. 
    In a group of 40 real estate developers examined by rating 
agency Standard & Poor's, only three had higher ratios. 
    In February, the company indicated it was prepared to get 
even more aggressive when it gained the approval of bondholders 
to make its covenants more flexible to "pursue additional 
business opportunities and further business growth." 
    That means leverage will likely rise, says S&P Global 
analyst Matthew Kong: "We are not confident the company can 
deleverage, despite the strong sales."  
 
 (Additional reporting by Tris Pan in HONG KONG; Editing by 
Clara Ferreira-Marques and Martin Howell) 
 ((clare.jim@thomsonreuters.com; +852 2912 6653; Reuters 
Messaging: clare.jim.thomsonreuters.com@reuters.net)) 
 
Keywords: EVERGRANDE DEBT