China Aoyuan stands out with strong 2018 results

Last week, China Aoyuan Group Limited (“Aoyuan”) signed an agreement with the Fengxian District government to develop an exhibition center and headquarters in the Oriental Beauty Valley. These commercial property developments would likely cost Aoyuan RMB 12.5 billion and could mark Aoyuan’s first foray into the suburban districts of Shanghai. Aoyuan is likely to fund the developments using existing cash or draw from its RMB 31 billion credit facility.

The Oriental Beauty Valley is located near Shanghai and is an area designated by the Chinese government to convert its farmland into Asia’s largest health and beauty industry center, possibly rivalling the Cosmetic Valley in France and the Saito Life Science Park in Osaka, Japan.

Management did not provide any projections about the new projects’ investment profits but the scale of the RMB 12.5 billion developments are quite significant in comparison with its previous property projects (see the “estimated land cost” column in Table 1). This could be the start of a change in business direction away from its core property development expertise. Last year, the company announced plans to diversify into other areas such as cultural tourism, commercial operation, property management, health, and cross-border e-commerce as part of its long term business plan. The firm also changed its name from "China Aoyuan Property Group Limited" to "China Aoyuan Group Limited".

About China Aoyuan

With its land bank size of 34.1m square meters, China Aoyuan Group Limited is one of China’s fastest growing property developers. The company’s revenue increased to RMB 31 billion in 2018 from RMB 19.11 billion in 2017, achieving a compound annual growth rate of 62% over the last three years. Net income increased 50% last year from RMB 1.95 billion to RMB 2.9 billion, while gross profit margin improved to 31.1% in 2018 from 26.7% in the preceding year. The group’s contracted sales grew to RMB 91.8 billion from RMB 45.59 billion during the same period and management is expecting to achieve a contracted sales target of RMB 114 billion this year.

Nearly 94% of Aoyuan’s properties reside in onshore China, with a majority in Guangdong province—home to the Greater Bay Area (“GBA”). As shown in Table 1, which breaks down the developer’s onshore projects by city, Aoyuan expects to earn at least RMB 105 billion of revenue for projects in Guangdong.

The GBA is part of China’s blueprint to establish an economic area to become a global innovation and financial hub. GDP in the GBA has grown 14 percent annually between 1980 and 2017, and residential demand in the area could increase. Nonetheless, management expects to recognize the largest margins from real estate developments in Jiangxi, Guizhou, Anhui and Liaoning—cities classified as Tier 2 and below. We suspect this is because economic growth in China's lower-tier cities are increasing and consumers in these cities are becoming richer and more eager to spend, thereby driving greater real estate demand and higher residential property prices.

Table 1: Aoyuan’s onshore land bank by region and land cost

Credit profiles of Chinese real estate developers

Compared to other similar sized real estate developers and using results from fiscal 2018, Aoyuan is less geared, has a higher interest coverage ratio, and a larger proportion of free cash flow to debt. Aoyuan’s debt-to-total asset ratio is close to the industry average of 31.5%, but slightly higher than larger developers like Country Garden and Greenland Holdings.

The group’s revenue-to-debt ratio in 2018 is, however, lower than the industry average and significantly less than the larger developers, which suggests that the firm may not be realizing enough revenue from its debt borrowings. As disclosed in its 2018 annual report, Aoyuan offered customers discounts on some of their properties in order to get customers to agree to pay the balance of the consideration early while construction was still ongoing. That may have offset the sales potential of the projects but increased cash flow to the firm.

With regard to the company’s other credit metrics, Aoyuan’s ability to cover interest expense by more than 22x exceeded the industry average as well as some of the large developers’ EBIT-to-interest expense ratios. Its free cash flow (“FCF”)-to-debt ratio was also notably the highest within the column (see Table 2) as it topped industry averages such as the FCF-to-debt ratios belonging to China Evergrande, Country Garden, and Greenland Holdings.

Table 2: Peer comparison analysis

Aoyuan’s liquidity profile at a glance

From Table 3 and according to our estimates, China Aoyuan realized RMB 7 billion of free cash flow in 2018 (and recurring FCF of RMB 8.3 billion) from RMB 31 billion of revenue. The reversal from a negative RMB 8.3 billion in 2017 is largely due to an increase of RMB 22 billion from contract liabilities, which could be a result of property discounts. Add the fair value of its completed properties—RMB 20.7 billion—to the RMB 31 billion of liquid assets and the company still falls short of its RMB 64 billion of total borrowings (loans and bonds).

However, we estimate free cash flow to at least double to approximately RMB 16 billion in 2019 as revenue tends to lag contracted sales by two years. With this in mind and looking at its debt maturity profile for the next few years (see Table 4), we think that its present rate of cash flow generation should help the firm meet its obligations for the next two to three years.

Table 3: An assessment of Aoyuan’s liquidity position

Table 4: Aoyuan’s contractual liabilities as of 31 Dec 18 (including interest and principal cash flows)

This year, Aoyuan raised RMB 8.2 billion through three bond offerings, and a bank loan with Nanyang Commercial Bank, Hang Seng Bank, Bank of East Asia, and Industrial Bank Hong Kong. Creditors are more cautious in 2019 and borrowing rates have increased this year, particularly for Chinese real estate developers.

According to Reuters, small Chinese property firms have struggled to raise money from the offshore bond markets. Aoyuan’s filings showed that the company refinanced its 6.525% 25/4/2019 note with a similar sized offering but at a higher coupon rate of 7.95%. The company’s HKD loan rates also increased from between Hong Kong Interbank Offered Rate (“HIBOR”) plus 0.95% to HIBOR + 4.5% last year, to HIBOR + 4.95% this year, which is evident from its HKD1.131 billion three year term loan facilities announced in April. Looking ahead, Aoyuan may not raise more money in the offshore bond market for the remainder of 2019 as the company has maxed out its National Development and Reform Commission foreign debt quota.

Notes on Aoyuan’s individual bonds

Despite the slight rise in borrowing cost and considering its credit performance together with our financial projections, we are still positive on China Aoyuan Group’s credit quality. The issuer has a better than average credit profile that is nearly on par with the large developers.

We forecast cash flows to improve in 2019, doubling to at least RMB 16 billion this year and exceeding RMB 16 billion in 2020. We assume that Aoyuan will maintain a gearing ratio matching the industry average with a debt-to-asset ratio of 25% to 35% moving ahead. The downside risks to our view are customer defaults accelerate and the company’s contracted sales fall short of RMB 114 billion this year. We would also be concerned if the group’s diversification efforts into other sectors such as health and tourism hurt cash flows and weaken its liquidity profile substantially.

Aoyuan’s corporate bonds have been trending upwards recently (see Figure 1). Most of them are trading near their call prices, possibly in response to the company’s positive earnings in fiscal 2018. There is a risk that the firm may call their bonds with the ample liquidity it has, or if there are no investment opportunities and management would like to lower their debt amount.

We prefer the CAPG bonds with shorter maturities as there is greater visibility on the firm’s debt maturity profile till 2022. However, given the strong rally in the bond prices this year, we think the CAPG curve looks too tight at the moment as compared to other single-B rated Chinese property developer credits. We are hence either underweight or neutral on Aoyuan’s USD and SGD notes (see Table 5).

Figure 1: Prices of Aoyuan’s Singapore-listed bonds

Table 5: Aoyuan’s outstanding bonds

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in EVERRE 7.500% 28Jun2023 Corp (USD), EVERRE 8.250% 23Mar2022 Corp (USD), and LOGPH 6.125% 16Apr2021 Corp (SGD). The analyst who produced this report holds a NIL position in the abovementioned securities.