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Sunac China Holdings Ltd. Outlook Revised To Positive On Stronger Visibility On Deleveraging Trend; ‘B+’ Rating Affirmed

          HONG KONG (S&P Global Ratings) Sept. 24, 2018--S&P Global Ratings today raised its outlook on Sunac China Holdings Ltd. to positive from stable. At the same time, we affirmed our 'B+' long-term issuer credit rating on the Chinese developer. We also affirmed our 'B' long-term issue rating on Sunac's senior unsecured notes. 
          The outlook revision reflects our view that Sunac's deleveraging trend is likely to continue in the next 12 months based on strong sales execution, solid margins, and controlled spending. In our view, the company is unlikely to pursue aggressive debt-funded acquisitions to expand its scale, given it has become one of the top developers in China and has built up a sizeable land bank to support its growth over the next few years. 
          Sunac could continue to deleverage with the ratio of debt to EBITDA lowering towards 5x (both consolidated and proportionally consolidating its joint-venture projects) over the next 12 months. The company's financial leverage improved significantly in the first half of 2018, with a rolling consolidated ratio of debt to EBITDA of about 8.2x. On a proportional consolidated basis, this ratio fell to about 7.2x, from about 15x at the end of 2017,
          We anticipate Sunac's total sales will reach Chinese renminbi (RMB) 450 billion (of which about 70% attributable) in 2018, with RMB190 billion already achieved in the first six months of 2018, and saleable resources estimated at RMB490 billion in the second half. The company's diverse land bank and good geographic positioning--with about 85% of developments in tier-one and tier-two cities--provide healthy support for its growth, despite a softening market environment. 
          We expect Sunac to switch to a more prudent land acquisition pace. In the first six months, the company's outlays for land purchases was about 30% of cash collected from sales, significantly lower than about 80% in 2017. We forecast that the company will maintain a ratio of land purchases to cash from sales of 30%-40% in the next 12 months, reflecting its expectation of a softening market, its existing abundant land reserves, and a more controlled growth. 
          At the same time, we believe Sunac has a strong earnings trajectory, thanks to strong sales growth achieved in the past few years. At the end of June 2018, the company had unrecognized revenue of about RMB480 billion, underpinning a strong top line growth in the next one to two years. This trend is likely to continue in our view, given the company's competitive products and geographic positioning. 
          Profitability is also improving, with Sunac's reported gross margin rising to 24.7% in the first half of 2018, from 20.7% in 2017. The company's first-half adjusted gross margin was a higher 34% if the impact of amortization of revaluation gains is excluded in the cost of goods sold. We believe the adjusted margin is a more reasonable assessment of profitability because we do not include business combination gains of mergers and acquisitions at the time of purchase in our EBITDA calculation. We therefore view Sunac's profitability of about 27% EBITDA margin as in line with the industry average, compared with below average assessed previously.
          Nevertheless, in our view, Sunac remains opportunistic and may make unexpected acquisitions, which could strain its financial positions. The company investment in China-based Leshi companies in 2017 resulted in material write-downs and rise in leverage. In our view, the company's has yet to establish a track record of conservative financial management. 
          The positive outlook reflects our view that Sunac's financial leverage could continue to improve over the next 12 months, supported by strong sales execution, sustainable profitability, and lower acquisition spending.
          We could raise the rating if the company can demonstrate a more consistent track record of financial prudence and improve its financial leverage. A debt-to-EBITDA ratio, on proportional consolidated basis, of below 5.0x on a sustained basis could indicate such improvement. 
          We may revise the outlook to stable if Sunac's financial leverage improvement is weaker than our expectation or if we believe the lower leverage position is not sustainable. This could be due to a lack of financial discipline or weaker-than-expected cash generation. A debt-to-EBITDA ratio of more than 6.0x on a proportional consolidated basis, could indicate that the company's leverage will not be materially improving.