S&P: Jingrui Holdings Ltd. Assigned 'B' Rating; Outlook Stable

S&P Global Ratings today said it has assigned its 'B' long-term corporate credit rating to Jingrui Holdings Ltd. The outlook is stable. Jingrui is a China-based property developer, which recently refocused its strategy in higher tier cities in the Yangtze River Delta.

The rating reflects Jingrui's small operating scale, small market share, weak competitiveness in its core markets, lower profitability than its peers, and our expectation that the company will increase its leverage to replenish its small land reserves to expand and refocus in higher-tier cities. In our view, the company has largely completed its strategic transition and inventory clearance in the past few years. We anticipate its profitability will gradually recover and move toward the lower end of the market average. Jingrui also demonstrates good control of its funding costs relative to similar peers.

Given the company's small operating scale and that it has only started to rebuild its presence in higher-tier cities in recent years, we believe Jingrui will experience higher execution risk than peers with established market positions in land acquisitions, particularly at more reasonable cost. In addition, homebuyers in higher-tier cities also have much higher standards with regard to product quality, while Jingrui will also need to operate under tighter market policies. In our view, Jingrui's improved performance in the past one to two years was partly due to favorable market conditions, and it still lacks the proven ability and brand reputation to operate in the competitive higher-tier cities in different cycles. Its ability to set premium pricing in these cities is limited, due to its lack of an established brand, while its small scale limits its financial ability to acquire quality land amid fierce competition in the land market. However, we note that Jingrui has expanded cooperation with other developers and set up fund structures for project development to reduce capital needs. Jingrui also attempts to improve product quality by providing customized interior design to potential buyers in some of its projects to differentiate itself from its competitors.

Jingrui has undergone a significant strategic change in the past few years, moving its focus and market exposure away from lower-tier cities to high-tier cities, where Jingrui has more than 80% of its land reserve now. However, the company had quickly cleared its inventories at below market price to recoup its financial resources for land replenishment in higher-tier cities in the past two to three years, thus resulting a material margin decline and substantial weakening in profitability.

We believe the strategic transition is largely complete. The lingering effect from projects in lower-tier cities is diminishing, but it is still having some impact. In addition, considering the effect of higher land costs and tightening government policies despite stronger housing demand in higher-tier cities, we believe that Jingrui's profitability will gradually restore to the lower-end of the market average with an EBITDA margin at around 20%.

To achieve its sales growth of about 20% each year, we believe Jingrui's current land bank is running low, and will need considerable land purchases. Indeed, we estimate that the company's current land reserves of 4.4 million square meters (sqm), or 2.5 million sqm on an attributable basis, are only sufficient for development in the next two to three years. As such, we expect that its debt to EBITDA ratio will increase to about 8x in 2018 and 2019, from 5.5x in 2017. At the same time, EBITDA interest coverage will tighten to around 1.8x-2.0x, from 2.5x in 2017.

In our view, Jingrui has competitive funding costs and fair funding access compared to other developers of similar size. Over the past years, Jingrui has experience in tapping onshore and offshore debt markets and offshore equity placements. It reduced its average funding costs to around 7% in 2017 from 8.5% in 2016. We believe the competitive funding rates and access to funding channels is a result of the favorable market conditions in recent years as well as Jingrui's long operating record and history of tapping various funding channels.

The stable outlook reflects our expectation that Jingrui will grow its contracted sales moderately while maintaining satisfactory project execution in the next two years. We expect the contracted sales gross profit margin will improve to around 23%-25%. We also expect the company's financial leverage will remain high, despite a meaningful improvement in 2017.

We could lower the rating if Jingrui's leverage deteriorates or its debt servicing ability worsens beyond our base case. This could be indicated by a debt-to-EBITDA ratio of above 8x, or EBITDA interest coverage of less than 1.5x in the next 12 months. This could happen if (1) the gross margin fails to recover significantly from the low level in the past two years, or (2) the company's debt-funded expansion from land acquisitions is more aggressive than we anticipated.

The rating upside is limited in the next 12 months. A significant improvement in its scale and profitability combined with debt-to-EBITDA ratio staying below 5x on a sustainable basis could lead to an upgrade.

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