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Research Report

08/04/2020 17:32

China developers' results reveal strains before COVID-19

[ET Net News Agency, 8 April 2020] The release of most Chinese developers' 2019 results
show many firms were facing margin compression well before the COVID-19 outbreak hit,
according to a report titled "China Developers' 2019 Results Expose Strains Before
COVID-19 Crisis Hit", which was published today by S&P Global Ratings.
The event simply amplified strains underway before this crisis. Tepid sales and tighter
margins should drive the ratings on China developers in 2020, particularly as U.S. dollar
funding dries up.
S&P maintained its baseline view, which assumes a 5%-10% drop in national contracted
sales for 2020.
"Chinese developers have grown steadily in recent years, with almost all lifted by the
rising tide of surging property sales. Most rated entities seemingly built meaningful
buffers through this flush period," said S&P's credit analyst Aeon Liang. "However, the
business disruptions triggered by the COVID-19 pandemic have exposed vulnerabilities in
weaker firms that didn't use the good years to bolster their financial strength."
About two-thirds of rated developers reported 2019 revenue below S&P's original
forecasts, resulting in about a 2% gap on an aggregate basis. The worst is 30%-35% below
S&P's expectations.
The number of joint ventures that contribute to the growth in developers' total
contracted sales has grown more than S&P anticipated. This has resulted in a shortfall
between revenue booking and contracted sales registration since far fewer of these JV
projects were consolidated.
Revenue increased by an average of 28% in 2019, of the Chinese developers S&P rates.
This compares with a 51% increase, year on year, in contracted sales two years ago. Two
years is an approximate average life cycle for residential projects in China. S&P believes
a lengthening construction cycle--to stretch out spending--explains this gap.
At its essence, this is a case where some firms grew aggressively during the boom times,
and have now been caught out by an abrupt slowdown triggered by the outbreak. Firms
increased their exposure to joint-venture projects to accelerate expansion and grappled
with challenging delivery execution as the scale of their projects grew ever more
Gross margins have declined markedly. Higher land costs, prolonged price caps, and
deeper price cuts--particularly in lower-tier cities--have driven this margin drop. The
average gross margin of the 40 developers the agency rates that had reported results as of
April 3, 2020, decreased by about 3 percentage points in 2019 to about 30%.
More than 45% of developers suffered a margin decline of over two percentage points,
while a quarter weathered a margin drop of five percentage points or more. S&P expects
this trend to continue.
"Developers lost roughly two months of construction in 2020 due to the COVID-19
outbreak, which has involved stringent nationwide containment measures. Revenue
recognition in 2020 may face greater slippage as the delivery of projects slated for this
year creeps into 2021," said S&P's credit analyst Christopher Yip. (KL)

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