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Zhenro Properties Group Ltd. Assigned ‘B’ Rating With Stable Outlook

          SINGAPORE (S&P Global Ratings) May 7, 2018--S&P Global Ratings today assigned its 'B' long-term issuer credit rating on Zhenro Properties Group Ltd., a China-based property developer that listed on the Hong Kong stock exchange in January this year. The outlook is stable. The rating on Zhenro reflects the company's high leverage stemming from its quick expansion and aggressive growth target. 
          The rating also reflects Zhenro's limited record of prudent financial management and high reliance on funding from nonbank financial institutions. The company's growing operating scale, good geographic diversity, and satisfactory margins temper these weaknesses. Further support for the rating comes from the company's execution capability in building quality products that capture upgrade demand.
          We expect Zhenro's leverage to remain high over the next two years with a debt-to-EBITDA ratio of 8x-10x in 2018 and 2019, compared with 8.2x in 2017. Continuously high land premium payments and construction expenditure will likely offset benefits from improving sales and delivery, given the company's aggressive growth appetite. We also believe that Zhenro's land bank of 15.3 million square meters (attributable: 12.1 million) at the end of 2017 could support growth for less than three years. Therefore, the company will need to continuously source land to support its medium to long-term development.
          We expect Zhenro's land acquisition costs to reach Chinese renminbi (RMB) 31 billion in 2018, close to 50%-60% of its attributable contracted sales, and further grow by 25%-30% in 2019. At the same time, we anticipate that the company will increasingly source projects through mergers and acquisitions and cooperation with other large developers, such as Country Garden Holdings Co. Ltd.,
          China Resources Land Ltd., and CIFI Holdings (Group) Co. Ltd. In 2017, Zhenro acquired 18 out of 41 land parcels through jointly controlled entities, compared with only three projects in 2016. In our view, Zhenro's high reliance on short-term financing from nonbank financial institutions is a credit risk, mainly because of the company's limited record in the capital markets. As of the end of 2017, the company derived 55% of its borrowing (excluding corporate bonds and perpetual securities) from trust loans, asset management plans, and other nonbank financial institutions.
          Zhenro has weaker financing flexibility than its peers, which are generally listed companies with long repayment records in the capital markets. Although these alternative funding routes have less restrictions on the use of proceeds, they are generally costly and of short duration. The weighted average maturity of the company's borrowing is less than two years as of the end of 2017. However, we expect Zhenro to gradually improve its maturity profile as a recently listed company, if it demonstrates a good repayment record, sound governance, and transparent information disclosure.
          In addition, Zhenro's revenue stream is dominated by residential property development and its rental income is still minimal. Its properties are significantly skewed toward the residential market, with sale of commercial properties contributing around 20% of total property sales. Given Zhenro's strategy and land bank exposure, we believe recent price restrictions on residential units in higher-tier cities may affect the company. Under government policy, selling prices generally cannot be higher than that of similar properties in the same area. That could limit the company's ability to convert its premier quality and design into a price premium, thus affecting margins. We believe that Zhenro will be able to continue its good sales execution in residential property development, targeting mainly demand for upgrades. The company started its property development business in Jiangxi, and later expanded into Fujian, the Beijing-Tianjin-Hebei region (Jing-Jin-Ji), and Yangtze River Delta.
          Zhenro's properties have a strong focus on design and quality, and are generally well perceived by customers. This allows the company to achieve better pricing and sell-through ratios than its peers'. Its brand has also improved as the company speeds up its scale expansion. In 2017, the China Index Academy ranked the company 20th among the country's property developers in terms of overall strength. We believe Zhenro can maintain its good project and geographical diversity throughout its scale expansion. At the end of 2017, the company had 91 projects in 18 cities widely spread across the Yangtze River Delta, the mid to western China, the Bohai Economic Rim, and Western Taiwan Straits Economic Zone. Its land bank is also balanced, with no single city accounting for more than 15% of the land bank. Such diversity makes slippage in a single project or market changes in a single city more manageable.
          We expect the company to selectively enter more cities following its scale expansion, including the Greater Bay Area in southern China. We expect Zhenro to further expand its operating scale over the next two years, supported by the good quality of its land bank in higher-tier cities. As of the end of 2017, over 80% of the company's land bank is located in tier-one or tier-two cities including Shanghai, Nanjing, Hefei, Suzhou, Wuhan, Xian, Tianjin, Changsha, Zhengzhou, and Fuzhou. We believe this reach could protect the company's cash generation because demand in these cities is more solid, supported by good economic growth and low inventory months. We also expect project delivery to pick up over the next two years following strong growth in contracted sales. The company's revenue of RMB20 billion in 2017 was only 43% of the attributable contracted sales in the same period. We estimate revenue will reach RMB27 billion-RMB29 billion in 2018 and RMB40 billion-RMB43 billion in 2019.
          We estimate Zhenro's margins may stabilize at low levels in 2018 under the current price restrictions. The company's gross margin dropped to 21% in 2017, compared with 22% in 2016. We expect the company's margins will stabilize at 20%-22% in the next two years. The stable outlook reflects our view that Zhenro will maintain high growth in contracted sales and revenue in the next 12 months, without a material deterioration in its currently high financial leverage. We also expect the company's margins to stabilize owing to its increase in scale.
          We could lower the rating if Zhenro's debt-to-EBITDA ratio, on a consolidated or proportionate basis, significantly deteriorates from our base case, which may be due to weakened sales execution or more aggressive debt-funded expansion than we anticipated. We could also lower the rating if the company's liquidity weakens and the weighted average maturity is less than two years. An upgrade is less likely in the coming 12 months due to Zhenro's high leverage and short record of operating on a larger scale.           
          Nevertheless, we could raise the rating if: (1) the company adopts a more conservative financial policy and significantly improves its leverage; and (2) it improves its capital structure, such that its debt-to-EBITDA ratio improves significantly toward 5x.