Idea of the Week: Shui On Land—Defying Industry Downturn and Shanghai Lockdown

It was an unprecedentedly tough time for the Chinese property developers in 1H2022, as the average contracted sales of the top 100 developers plunged by 50%. Particularly, developers whose property projects mainly situated in Shanghai face a much harder situation due to the over one-month lockdown derived from the pandemic. To our surprise, Shui On delivered an incredible result amidst such a bleak environment, with contracted sales surging by 54.2% YoY to RMB 18.7 billion in 1H2022, of which about 95% came from sales of Shanghai projects. So how did Shui On grasp the nettle?

On the one hand, Shui On released more sellable projects in 1H2022, including Shanghai RHXC Ocean One and Shanghai RHXC Park Vera. On the other hand, housing demand in Shanghai remained vast, and property sales picked up, with a high sell-through rate after the reopening of Shanghai. Data from CRIC depicted that the sell-through rate averaged 68% for newly released projects in June. Benefitting from the favorable location, Shui On’s Shanghai RHXC Park Vera was sold out on 9 June, the first selling day, marking approximately RMB 9.6 billion of contracted sales. Given that Shui On will unveil more projects in the second half of this year, we expect the excellent performance to persist. It is worth pointing out that Shui On announced an annual sales target of RMB 25 billion at its interim results meeting, which shows the company's determination, whilst most developers are ceasing to set sales targets right now.

However, Shui On’s operation was somewhat affected by the pandemic. During the lockdown of Shanghai, the deferral in the handover of property projects, such as Taipingqiao Ville V and Shanghai Panlong Tiandi, resulted in the recognized revenue from property development shrinking by 76% to RMB 2.5 billion for 1H2022.

Commercial Property Performance Came in above Expectation

The pandemic not only drags down the handover of residential projects but also the operation of commercial property. For Example, the occupancy rate of Shanghai Xintiandi dropped to 91% from 100% in the same period last year, and the occupancy rate of Xintiandi Style II dropped to 62% from 79%. We thus assumed the relevant revenue will experience a significant decline in the first place. However, benefitted by the launch of a shopping mall in Wuhan, the rental income of Shui On grew by 8% to RMB 1.5 billion in 1H2022, which is much better than expected.

All in all, the total revenue Shui On recorded in 1H2022 amounted to RMB 4.4 billion, down 63% YoY; Gross profit dropped 42.9% to RMB 2.8 billion, but gross margin climbed to 63.9% after the increase in the percentage of rental revenue. We expect the revenue to further improve along with the resumption of construction and the recovery of the occupancy rate in Shanghai.

Liquidity Weakened but is Still Manageable 

From the perspective of credit profile, as of June 2022, the total interest-bearing debt rose by 8.1% to RMB 34.4 from the end of 2021, of which the short-term debt totalled RMB 11.4 billion, and cash and cash equivalents after deducting the restricted part were close to RMB 10.9 billion, translating into a near 1x adjusted cash to short-term debt ratio. It suggests that the liquidity materially contracted, in comparison to that of 2.7x in end-2021. The main reason why liquidity weakened was because of the redemption of the USD 600-million perpetual bond in June. In practice, in the midst of the capital crunch, most developers would rather pay a higher coupon than redeem perpetual bonds, for example, CIFI chose not to redeem a perpetual bond in August.

The redemption of perpetual also pushed up the net gearing ratio from 30% in 2021 to 48% in mid-2022, but it still remained at a low level in the real estate industry. Additionally, Shui On's off-balance sheet credit metrics did not change significantly in 1H2022 compared to the previous year, and the off-balance-sheet debt Shui On faces is relatively insignificant, as its reported debt amount is almost matching the real debt amount.

Table 2: Credit Metrics of Shui On

Smooth Access to Refinancing

We noticed that most developers cancelled interim dividends due to the market downturn, but Shui On still declared an interim dividend of HKD 0.036 per share, unchanged from the same period of last year. To a certain extent, Shui On’s action demonstrates the company's confidence in its liquidity. We also believe that the smooth access to refinancing enables the company to have strong assurance.

In February, Shui On signed a RMB 10 billion Memorandum of understanding with the Shanghai Branch of Shanghai Pudong Development Bank on Real Estate M&A Finance and ESG and sustainable finance. Then it signed another RMB 10 billion Memorandum with Shanghai Bank in March. As a matter of fact that only a few non-SOE Chinese developers with a good credit profile, such as Country Garden, CIFI, and Midea Real Estate, have ever been granted M&A finance, it indicates that the market is optimistic about Shui On's credit.

From the past track record, a large portion of the refinancing of Shui On comes from banks in Hong Kong. As of June 2022, Hong Kong's syndicated loan amounted to RMB 14.4 billion, accounting for 41.8% of total debt, which stood at RMB 34.4 billion. Given by Shui On’s stable operation and Hong Kong background, we expect the company to be able to continue to raise funds in Hong Kong and overseas markets. To sum up, the company has a decent fundraising capability and liquidity in the near term, and overall credit risk is insignificant. 

Bond due in November 2023 is Worthy of Consideration 

Four bonds issued by Shui On are available for transaction on our platform, with investment horizons ranging from 1 to 4 years. Below are the specifications:

Table 3: Bonds of Shui On

As mentioned above, we think Shui On’s credit will remain resilient in the near term but might deteriorate if the recovery of the Chinese property market is belated. Investment-wise, investors can consider short-duration bond, like the bond due in November 2023, which is currently trading at around $90, offering investors an attractive return of around 14% in a one-year investment horizon.

Corporate Risk

Despite Shui On faces a rather good operation and credit, investors should be mindful of the following risk. Firstly, the company is exposed to foreign exchange risk. As of 30 June 2022, HKD-denominated and USD-denominated debt amounted to RMB 27.2 billion, representing 78.9% of the total debt. As the company operates in China and its revenue is denominated in RMB, which depreciated remarkably recently, the debt repayment amount might be amplified and the financial strength might thus be dampened.

Secondly, Shui On mainly engaged in the development of luxury properties in China. Compared with traditional residences, luxury properties require a longer time to develop and have a lower market demand. As a result, it might lower the capital turnover and worsen the solvency to a certain extent.

Conclusion

Shui On’s Contracted sales soared over 50% for 1H2022 amid the market downturn. Income from rental marked an 8% YoY decline, a better-than-expected performance. Credit metrics weakened, with a decreasing cash balance and increasing leverage. Yet compared with traditional Chinese property developers, Shui On retains a rather decent fundraising capability, and its liquidity looks solid in short term. Bond price shows resilience, with short-duration bonds trading around $90. Investors can consider the bond due in November 2023, which is yielding approximately 14% in a one-year investment horizon.