HONG KONG (S&P Global Ratings) Sept. 4, 2023--Declining margins and soft sales will continue to hit Chinese property developers' earnings over 2023 and 2024. S&P Global Ratings has warned of developers' eroding profitability over the past few years. This phenomenon is again reverberating in interim results for 2023. Many distressed developers recorded losses again in this period, after material losses in 2022.
"Persistent earnings weakness will no doubt drive the sector's leverage higher," said S&P Global Ratings credit ratings analyst Oscar Chung.
S&P Global Ratings believes industry leaders and players with a diverse business mix such as rental and service incomes can better withstand declining development margins.
"The leverage of these developers will be on a rising trend, but many still have some leeway to manage by trimming land spending or spinning off commercial property assets," Mr. Chung said.
S&P Global Ratings currently estimates the median debt-to-EBITDA ratio of its rated developers to moderately rise to 5.0x in 2023 and 5.2x in 2024, from 4.9x in 2022.
GONE IS THE ERA OF OUTSIZED PROFIT
What supported developers' fat profit margins in prior years--strong property price growth--is a thing of the past. Instead, home prices in 70 major cities on a month-to-month basis fell for 16 months straight from September 2021 till the end of 2022. Prices are extending a decline that began in June after a brief uptick in the first five months of 2023. In contrast, home prices grew at an average of 9% throughout 2015-2020.
Based on 13 rated and 24 unrated developers' interim results, weighted average gross margin during the first half of 2023 fell to 13%, 2 percentage points down from the full year of 2022. Gross margins of the sampled developers averaged 25% back in 2020.
Lower-margin projects presold in 2021-2022, and early 2023 to a less extent, will hit developers' profit in 2023-2024 upon project delivery. Developers acquired most of these projects in an overheated land market before the recent slump.
Chart 1
SALES COLLECTION OVER PROFITABILITY FOR CASH-STRAPPED DEVELOPERS
Developers have been sacrificing margins to boost sales and recoup investments. Margin declines are more prominent for developers scrambling for cash for debt servicing and timely project deliveries.
Country Garden's (unrated) swing to a net loss of Chinese renminbi (RMB) 51.5 billion in the first half of 2023 is a case in point. The company operates mainly in lower-tier cities where demand is generally weaker, and resorted to offering steep price cuts to meet huge liquidity needs.
Falling prices likely contributed to Country Garden's huge RMB40 billion inventory impairment and squeezed gross margin (excluding impairment) to 7.1%, from 13.7% a year ago. Importantly, in its interim results Country Garden flagged losses, a large maturity wall, and falling sales as material uncertainties on its ability to continue as a going concern.
Country Garden is not the only one. Out of the 37 sampled developers releasing their interim results, 14 developers reported net loss in the first half of 2023, mainly due to diminishing gross profit or inventory markdowns. Many of these are privately owned developers who have constrained financing channels or players with heavy exposure to lower-tier cities.
DIVERGENT TREND STILL EXISTS
Not all is lost. The profitability of individual developers can vary substantially. We believe developers with state ties or better funding access will be more resilient to margin decline. This is because these developers can avoid fire sales of assets and the sacrifice of margin for cash flow safety during industry downturn. Consider China Overseas Land & Investment Ltd. (BBB+/Stable/--). Its margins have held up relatively well at 22.6%, from 23.5% for the same period last year.
Stable recurring income sources will also be a key differentiator, as property development margins wane. China Resources Land Ltd.'s (BBB+/Stable/--) overall gross margin fell just 1.2 percentage points in the first half of 2023, thanks to higher contribution from rental and property management segments, which more than offset a 5.8 percentage points drop in its property sales margin.
Cuts in land investments will also help rein in leverage. Rated developers' land acquisitions as a percentage of sales fell to an average of 26% in the first half of 2023, from 28% in 2022 and more than 30% in 2021. This has driven a reduction in their reported debt by 4% over the past six months.
"A continuation of this trend in the next two years will be important to counterbalance slower return on capital from 10% in 2022 to 9.4% in 2023 and 9.2% in 2024 that we forecast for our rated developers," said Mr. Chung.
Potential equity financing and spin-off of investment properties as REITs, can further reduce debt levels and improve balance sheet health.
HOME PRICES ARE SLIPPING BUT SO ARE LAND PREMIUMS
Ever-rising housing prices are no more. Since the downturn surviving developers are focusing more on asset quality and exercising more stringent returns requirements. Competition in the land market has generally moderated. The average premium in 100 major cities--percentage paid over the auction opening price--has eased from 14% between 2020-2021, to an average of 4% since 2022.
Some developers are now indicating margin guidance of about 20% or more for some of their newly acquired projects with more favorable land cost. These will likely remain exceptions limited to well located projects by better-managed firms, rather than the rule for the entire sector, until a meaningful broader sales recovery is in place.
Related Research
- Bulletin: China Overseas Land & Investment Leverage To Improve With More Bookings, Disciplined Spending, Aug. 30, 2023
- Bulletin: Longfor To Counter Sector Weakness With Balanced Portfolio, Aug. 22, 2023
- Credit FAQ: Will Country Garden's Woes Further Hobble China's Property Market?, Aug. 16, 2023
- China Property Watch: Peripheral Pain, May 22, 2023
Editor: Lex Hall
This report does not constitute a rating action.
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| Primary Credit Analyst: | Oscar Chung, CFA, Hong Kong +(852) 2533-3584; oscar.chung@spglobal.com |
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