Fitch Publishes Skyfame's First-Time 'B-' Ratings, Outlook Stable; Rates Bonds 'B-(EXP)'

Skyfame Realty (Holdings)

28/06/2019 09:00

(The following statement was released by the rating agency)


Fitch Ratings-Hong Kong/Shanghai-June 28: Fitch Ratings has published Skyfame 
Realty (Holdings) Limited's Long-Term Foreign-Currency Issuer Default Rating 
(IDR) of 'B-' with a Stable Outlook, and its senior unsecured rating of 'B-' 
with a Recovery Rating of RR4. Fitch has also assigned the China-based property 
developer's proposed US dollar-denominated senior notes a 'B-(EXP)' expected 
rating, with Recovery Rating of 'RR4'. 

Skyfame's ratings are constrained by its scale, which is smaller than rated 
peers, and relatively high leverage of close to 46% at end-2018 following its 
acquisition of a large project in Chongqing, China. Its ratings are supported by 
a growing EBITDA margin because of low land cost. We expect its leverage to 
gradually drop from 2020 given its sufficient land bank to support business 
growth for the next two years.

The proposed notes are rated at the same level as Skyfame's senior unsecured 
rating as they represent the company's unconditional and irrevocable 
obligations. Skyfame intends to use the net proceeds from the proposed notes to 
refinance its existing indebtedness and for general corporate purposes. The 
final rating is subject to the receipt of final documentation conforming to 
information already received.

KEY RATING DRIVERS

Scale Smaller than Peers': Skyfame's rating is constrained by its 
contracted-sales scale. The company had contracted sales of CNY9.4 billion in 
2018 (2017: CNY5.8 billion), smaller than most of its 'B' rated peers' of CNY20 
billion-30 billion and 'B-' rated peers' of CNY10 billion-20 billion. Fitch 
expects Skyfame's contracted sales to expand to CNY12 billion-16 billion in 
2019-2020. In addition, Skyfame has fewer than 10 projects under development. 
However, its ability to significantly reduce its project concentration by 
securing more land is limited by its tendency to acquire large land plots and 
its higher leverage in 2018, which puts the company under pressure to generate 
sales to meet its financial obligations.

Leverage to Remain High: Fitch expects Skyfame's leverage, measured by net 
debt/adjusted inventory, to remain at 45%-55% in the next two to three years as 
we estimate Skyfame will have to spend about 60% on land acquisitions in next 
one to two years. This expectation is based on Skyfame's target of 20%-30% 
annual growth in contracted sales and a land bank life sufficient for four to 
five years of development (end-2018: land bank life of six years). 

The company's leverage rose to 46% at end-2018, from a net cash position in 2017 
and 28% in 2016, as the company accelerated land acquisitions and construction. 
The company spent CNY5.7 billion, or 61% of its contracted sales, on buying land 
in 2018. The land-acquisition-to-contracted sales ratio was 49% in 2017. 
Construction new starts accelerated to 2.5 million square metres (sq m) in 2018, 
from 0.6 million sq m in 2017. 

EBITDA Margin to Improve: Fitch expects Skyfame's EBITDA margin, excluding 
capitalised interest from cost of sales, to remain above 25% in 2019-2020. The 
company's EBITDA margin improved to 30% in 2018, from 22% in 2017 and 15% in 
2016. This was partly due to revenue increasing faster than sales, general and 
administrative expenses and the recognition of more projects with high gross 
margins, such as Skyfame Byland in Guangzhou (an old-town redevelopment project 
with gross margins of 56%-59%). The company has unrecognised contracted sales of 
CNY8.6 billion, which carry a gross profit margin of about 30%, similar to the 
recognised gross profit margin of 31% in 2018. 

Low Land Bank Costs: Skyfame's average land cost was low at below CNY3,000 per 
sq m. in 2018. Land bank cost accounted for only 27% of the cost of goods sold 
on average in 2014-2018, and we expect this to continue to stay below 40% in the 
next few years. The company keeps land costs low by avoiding auctions and 
choosing to acquire sites through M&A, old town redevelopments and preferential 
auctions, in which respective local governments invite developers to offer bids 
to develop land. Skyfame has been the preferred bidder for several plots of 
land, given its focus on developing youth-entrepreneurship communities.

Increasing Scale, Sufficient Land Bank: Fitch expects Skyfame to increase its 
land bank to 6 million-7 million sq m in 2019-2020 from 5.9 million sq m in 
2018. As of end-2018, 6% of its unsold gross floor area was in Tier 1 cities, 
while 81% were in Tier 2 cities. Skyfame is shifting its land bank from mainly 
in the Pearl River Delta towards the Yangtze River Delta and western China. 
Skyfame may also have access to another 19.47 million of land, most of which are 
old urban areas that are planned for redevelopment in the next 10 years. For 
some of these sites, Skyfame has signed preliminary agreements with local 
governments to acquire the land, which need to undergo primary development prior 
to auction. 

DERIVATION SUMMARY

Compared with Sunshine 100 China Holdings Ltd (CCC+), Skyfame has better land 
bank quality with more than 75% of land in Tier 1 and 2 cities. This makes 
Skyfame's contracted sales more predictable compared with that of Sunshine 100. 
Skyfame's churn rate is more than double of Sunshine 100's while their EBITDA 
margins are similar. As a result, Skyfame is rated one notch higher than 
Sunshine 100. 

Both Skyfame and Oceanwide Holdings Co. Ltd. (B-/Stable) had EBITDA margins of 
about 30% in 2018, but Oceanwide had a higher contracted sales of about CNY17 
billion and slightly higher recurring EBITDA-to-gross interest coverage. At the 
same time, Oceanwide's leverage of 70%-80% is higher than Skyfame's 46%. The two 
companies are rated at the same level.   

Xinhu Zhongbao Co., Ltd.'s (B-/Stable) contracted sales were double that of 
Skyfame's in 2018. However, Xinhu Zhongbao's ratings are constrained Fitch's 
expectation that its leverage will remain high at 70%-80% in 2019-2020 after 
reaching 73% at end-2018. In comparison, Fitch expects Skyfame's leverage to be 
45%-55% and have rated the two companies at the same level.

KEY ASSUMPTIONS

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

- Contracted sales of CNY12 billion-16 billion in 2019-2020 (2018: CNY9.4 
billion)

- 60% of contracted sales proceeds to be spent on land replenishment, in order 
to maintain a land bank sufficient for four to five years of development

- EBITDA margin, excluding capitalised interest from cost of sales, at 28% in 
2019-2020 (2018: 30%)

Recovery rating assumptions:

- Skyfame would be liquidated in a bankruptcy because it is an asset-trading 
company

- 10% administrative claims

The liquidation estimate reflects Fitch's view of the value of the inventory and 
other assets that can be realised and distributed to creditors.

- We applied a haircut of 30% to accounts receivable

- We applied a haircut of 25% on adjusted inventory, which is in-line with 
domestic peers with EBITDA margin of 25%-30%

- We applied a haircut of 50% to property, plant and equipment

Our estimate of Skyfame's liquidation value after administrative claims of 10% 
corresponds to a Recovery Rating of 'RR3'. However, Skyfame operates in China, 
which Fitch classifies under Group D of jurisdictions where the law is not 
supportive of creditor rights or there is significant volatility in application 
of law and enforcement of claims. As a result, the Recovery Rating for Skyfame's 
senior unsecured debt is capped at 'RR4'.

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating 
Action

- No positive rating action is expected in the next 24 months, unless Skyfame's 
current business profile significantly improves

Developments That May, Individually or Collectively, Lead to Negative Rating 
Action

- Contracted sales fail to reach Fitch's forecast of CNY12 billion in 2019

- Leverage, measured by net debt/adjusted inventory, sustained at above 65%

- EBITDA margin, excluding capitalised interest from cost of sales, sustained at 
below 20%

- Weakening of Skyfame's liquidity position

LIQUIDITY

Adequate Liquidity: As of end-2018, Skyfame had cash balances of CNY3.1 billion 
(including restricted cash balances of CNY0.7 billion), sufficient to cover the 
debt maturing in one year of CNY2.8 billion. The company had another CNY1.6 
billion of undrawn credit facilities as of end-2018.

Contact: 

Primary Analyst

Jackson Hui

Associate Director

+852 2263 9993

Fitch (Hong Kong) Limited

19/F Man Yee Building

60-68 Des Voeux Road Central 

Hong Kong

Secondary Analyst

Laura Long

Associate Director

+86 21 6898 7989

Committee Chairperson

Su Aik Lim

Senior Director

+852 2263 9914

Summary of Financial Statement Adjustments

-  Capitalised interest is adjusted for cost of goods sold, as disclosed by the 
issuer.

Media Relations: Yee Man Ko, Hong Kong, Tel: +852 2263 9953, Email: 
alanis.ko@thefitchgroup.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: 
wailun.wan@thefitchgroup.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Corporate Rating Criteria (pub. 19 Feb 2019)

https://www.fitchratings.com/site/re/10062582

Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10024585

Country-Specific Treatment of Recovery Ratings Criteria (pub. 18 Jan 2019)

https://www.fitchratings.com/site/re/10058988

Additional Disclosures 

Dodd-Frank Rating Information Disclosure Form 

https://www.fitchratings.com/site/dodd-frank-disclosure/10078919

Solicitation Status 

https://www.fitchratings.com/site/pr/10078919#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

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