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High borrowing costs starting to eat into margins of developers
By Tony Tsang and Jason Ching |
August 24, 2012, Friday
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Print Edition
Print Edition
RECENTLY, investors have increasingly focused on the gross margins of Chinese developers on the backdrop of the proactive price cuts in late 2011 and the first half of 2012. In our view, in addition to the pressure on gross margins, we also need to pay attention to the rising interest costs of these developers.
In the current results season, we noticed remarkable rises in finance costs for most developers, which ate into their net margins. Specifically, those developers that have been relying more on trust loans and other high-yield debts will likely face more pressure going forward.
On our analysis, for those developers that have reported first-half results so far, average borrowing costs during the period rose by about 100 basis points from a year before.
In addition, we noticed a significant difference between the financing costs of the state-owned developers and the non-state-owned developers, at a time when the credit situation in China is tight.
Gap widening
The interest rate gap between state-owned and non-state-owned developers has continued to widen. For example, the average borrowing cost of China Overseas Land and Investment rose by only about 30 basis points to around 3.6 percent in the first half - one of the smallest increases and lowest absolute levels (after the rise) in the sector.
In our view, this significant advantage in terms of cost of financing for the larger state-owned developers such as China Overseas Land, China Overseas Grand Ocean and China Resources Land should allow them to grow at a faster pace in the longer term, especially given the central government's ongoing property market tightening.
In our view, developers that bought relatively more land in Tier-1 and Tier-2 cities in 2009 and 2010 will likely have higher land carrying costs and will, therefore, potentially face higher gross margin pressure; on our analysis, these include Shimao, Sino Ocean, China Vanke and Longfor.
Meanwhile, developers with more higher-cost financing in their debt structure (such as trust loans and high-yield bonds) will also face higher core net margin pressure. Based on our analysis, these include Evergrande, Glorious, Shimao, Sino Ocean, Agile, Country Garden and Vanke.
In our view, for developers with both higher land costs and higher interest costs, strong January-July sales boosted by price cuts might not necessarily be a good thing as these would likely reduce profitability and, given the margin pressure, the motivation.
Tony Tsang and Jason Ching are research analysts with Deutsche Bank. The article was based on a note issued on August 21. The opinions are their own.
In the current results season, we noticed remarkable rises in finance costs for most developers, which ate into their net margins. Specifically, those developers that have been relying more on trust loans and other high-yield debts will likely face more pressure going forward.
On our analysis, for those developers that have reported first-half results so far, average borrowing costs during the period rose by about 100 basis points from a year before.
In addition, we noticed a significant difference between the financing costs of the state-owned developers and the non-state-owned developers, at a time when the credit situation in China is tight.
Gap widening
The interest rate gap between state-owned and non-state-owned developers has continued to widen. For example, the average borrowing cost of China Overseas Land and Investment rose by only about 30 basis points to around 3.6 percent in the first half - one of the smallest increases and lowest absolute levels (after the rise) in the sector.
In our view, this significant advantage in terms of cost of financing for the larger state-owned developers such as China Overseas Land, China Overseas Grand Ocean and China Resources Land should allow them to grow at a faster pace in the longer term, especially given the central government's ongoing property market tightening.
In our view, developers that bought relatively more land in Tier-1 and Tier-2 cities in 2009 and 2010 will likely have higher land carrying costs and will, therefore, potentially face higher gross margin pressure; on our analysis, these include Shimao, Sino Ocean, China Vanke and Longfor.
Meanwhile, developers with more higher-cost financing in their debt structure (such as trust loans and high-yield bonds) will also face higher core net margin pressure. Based on our analysis, these include Evergrande, Glorious, Shimao, Sino Ocean, Agile, Country Garden and Vanke.
In our view, for developers with both higher land costs and higher interest costs, strong January-July sales boosted by price cuts might not necessarily be a good thing as these would likely reduce profitability and, given the margin pressure, the motivation.
Tony Tsang and Jason Ching are research analysts with Deutsche Bank. The article was based on a note issued on August 21. The opinions are their own.
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