S&P Lowers Outlook on Xinyuan Real Estate (XIN) to Negative; Sees Material Leverage Rise in 2014
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Standard & Poor's Ratings Services said that it had revised the rating outlook on China-based property developer Xinyuan Real Estate (NYSE: XIN) to negative from stable.
At the same time, we affirmed our 'B+' long-term corporate credit rating on Xinyuan and our 'B+' long-term issue rating on the company's outstanding senior unsecured notes. As a result of the outlook revision, we lowered our long-term Greater China regional scale rating on Xinyuan and its notes to 'cnBB-' from 'cnBB'.
"We revised the outlook to reflect our view that Xinyuan's leverage is likely to rise materially in 2014 because of a decline in margins and the company's aggressive debt-funded capital expenditure to expand scale," said Standard & Poor's credit analyst Dennis Lee. The company's cash flow protection measures, such as debt-to-EBITDA ratio and EBITDA interest coverage, are therefore likely to weaken in 2014 before recovering marginally in 2015.
We expect Xinyuan's debt-to-EBITDA ratio to weaken to more than 5x in 2014. However, the company's financial performance could improve in 2015 because sales are likely to ramp up owing to the enlarged scale; we also expect a slight recovery in margins. In addition, we anticipate that Xinyuan will manage its balance sheet and land bank with discipline, given the company's history of prudent financial management.
The company's profit margin has deteriorated beyond our expectation so far this year. We attribute the decline to increased production costs, higher expenses related to newly launched projects in new markets, and payment of project bonus to senior management.
We forecast that Xinyuan's margins will improve starting from the second half of 2014 because expenses for the geographical expansion and new launches are likely to gradually decrease. We also anticipate that the company will increase selling prices as it launches subsequent phases of its existing projects. In addition, Xinyuan plans to launch some projects in upper-tier cities in late 2014 and 2015. We believe these projects have higher margins than the existing ones.
We anticipate that Xinyuan's debt will remain high over the next two years to finance the company's fast expansion. In the first six months of 2014, the company spent about Chinese renminbi (RMB) 4 billion to acquire land, including in new cities such as Xi'an, Shanghai, Changsha, Sanya, and Xingyang. The geographic expansion could stretch Xinyuan's resources and increase its execution risk. Moreover, construction expenditure on the company's new projects is likely to remain high in 2014 and 2015. In our base-case scenario, we estimate the total capital expenditure for land acquisitions and construction to increase to RMB10 billion in 2014 and remain at a similar level in 2015. Growth in sales over the period will temper the impact of the increase in debt.
We could lower the rating if: (1) Xinyuan's profitability doesn't improve from the level in the first half of 2014; or (2) the company's debt-funded expansion is more aggressive than we expect, such that the debt-to-EBITDA ratio remains above 5x with no sign of improvement.
We could revise the outlook to stable if: (1) Xinyuan's financial management is disciplined while the company expands its scale, in particular for investments in land bank; and (2) the company's sales and margins recover in line with our expectation and improve its cash flow protection measures in 2015.
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