Fitch Revises Outlook on China Logistics to Stable on Reduced Refinancing Risk; Affirms ‘B-‘
Fitch Ratings has revised the Outlook on China-based warehouse developer China Logistics Property Holdings Co., Ltd’s (CNLP) Long-Term Foreign-Currency Issuer Default Rating (IDR) to Stable from Negative, and affirmed the IDR at ‘B-‘. Fitch has also affirmed CNLP’s senior unsecured rating at ‘B-‘ with a Recovery Rating of ‘RR4’.
The Outlook revision takes into consideration CNLP’s reduced refinancing risk following refinancing activities in 2020, including issuing convertible bonds and a bond exchange. The rating affirmation reflects gradual improvement in CNLP’s financial profile, with recurring EBITDA interest coverage rising to 0.78x in 2020 despite Covid-19, and trending towards 1x in 2021 in Fitch’s estimate. CNLP’s ratings are supported by a robust business profile, with a quality investment portfolio valued at CNY20 billion as of end-2020.
KEY RATING DRIVERS
Reduced Refinancing Risk: Fitch believes CNLP’s refinancing risk in the next one to two years is manageable. CNLP dealt with two capital market maturities in 2H20, mainly through asset disposal proceeds, internal cash and issuing USD100 million in convertible bonds to Bain Capital. CNLP also extended the maturity of USD150 million of its USD162 million senior notes due September 2021 by 14 months to November 2022, through an exchange offer in November 2020. The only short-term capital market maturity CNLP faces in 2021 is USD12 million due September 2021.
Weak but Improving Interest Coverage: CNLP’s reliance on debt-funded expansion has resulted in EBITDA interest coverage sustained below 1x since 2013. CNLP’s interest coverage was at 0.78x in 2020, lower than our expectation of 0.93x due to larger capex than we estimated and a slower ramp-up than we expected of its logistics properties, despite a higher profitability with its EBITDA margin improving to 58% (2019: 56%).
We think coverage will trend towards 1x in 2021 and stand at 1x and above from 2022, considering the steady ramp-up of logistics parks and lower funding costs, after CNLP repays the costly US dollar bonds issued in previous years. Moreover, the implementation of an asset-light strategy will help company improve its financial profile.
Robust Business Profile: CNLP’s business profile remains robust and is commensurate with an entity rated ‘B+’ or ‘BB-‘. It had CNY18 billion of completed investment-property (IP) assets at end-2020, which have a stable occupancy rate of 90% and a high retention rate of above 80%. CNLP has quality assets in terms of clients and geographic diversification in core Tier 1 and 2 cities in China. About 40% of its logistics parks by gross floor area was in the Yangtze River Delta, where the economy is more vigorous and demand for logistic facilities is stronger.
Concentrated Customer Base: Its tenants include well-known customers with online retailer JD.com being the largest. Third-party logistics providers and e-commerce companies contributed around 87% of CNLP’s rental revenue in 2020. However, it has a concentrated customer base, as its top-10 customers consistently account for more than 50% of revenue (2020: 54.3%; 2019: 52.8%).
Evolving Asset-Light Strategy: CNLP has adopted an asset-light strategy since end-2018 by selling stakes in its mature projects to core funds or through developing new projects under funds co-established with institutional investors. It has set up three funds and sold equity stakes in nine projects, through which the company recycled CNY1.8 billion until end-2020. CNLP continues acting as asset manager for these funds. The area under management was 1 million sq m at end-2020, with assets under management of CNY5 billion at end-2020.
Fitch believes that either recycling cash from selling equity stakes in mature assets or inviting investors into the development stage of new projects would help the company reduce liquidity pressure. In addition, the proceeds from asset disposal provide an ongoing source to fund expansion. The company does have potential institutional investors interested in its quality assets. However, the strategy carries high execution risk and CNLP has yet to establish a solid execution record.
CNLP’s rating is constrained by its financial profile, although the company’s quality high-end warehouses and robust industry demand support a business profile that is in line with a ‘B+’ or ‘BB-‘ rating. The sustained weakness in recurring EBITDA interest coverage (2020: 0.78x) means CNLP is reliant on debt to finance its capex and operating cash flow. CNLP at end-2018 started exploring an asset-light business model similar to that of industry leader GLP Pte. Ltd. (BBB/Stable), but progress has been slow.
CNLP and Lai Fung Holdings Limited (B+/Negative) have similar asset scales and both have an IP value of around USD2.5 billion, which generate EBITDA of about USD50 million, before the impact of the pandemic. Lai Fung’s IP EBITDA interest coverage of 0.8x in FY20 was comparable with CNLP’s 0.7x-0.8x. Fitch expects Lai Fung’s coverage to trend towards 1.0x in FY23, once the new office buildings in Shanghai and Guangzhou are completed. Fitch believes the asset quality of Lai Fung’s IP assets as stronger, as they consist of offices and shopping malls in high-tier cities. Fitch also sees better funding access for Lai Fung than for CNLP, as Lai Fung has some support from the parent company and has an adequate record in obtaining offshore bank consortium loans. The stronger business profile and stronger funding access of Lai Fung supports the two-notch difference in ratings compared with CNLP.
Fitch’s Key Assumptions Within Our Rating Case for the Issuer:
– Rental income to increase by 20%-25% in 2021-2022;
– EBITDA margin to edge up to 60% in 2021-2022;
– Annual capex of CNY1.2 billion-1.3 billion during 2021-2022;
– Average borrowing cost at 6.8%-7.0% during 2021-2022.
KEY RECOVERY RATING ASSUMPTIONS
The recovery analysis assumes that CNLP would be liquidated in bankruptcy
We have assumed a 10% administrative claim.
The liquidation estimate reflects Fitch’s view of the value of balance sheet assets that can be realised in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors.
Advance rate of 0% applied to cash and 100% to restricted cash, respectively.
The 50% advance rate applied to net property, plant and equipment, and investment properties, is supported by CNLP’s quality logistic parks which generating rental yield of above 3%.
Advance rate of 75% applied to account receivables.
The allocation of value in the liability waterfall results in recovery corresponding to ‘RR1’ recovery for onshore and offshore senior unsecured debts. However, the Recovery Rating for senior unsecured debts is capped at ‘RR4’ because under Fitch’s Country-Specific Treatment of Recovery Ratings Criteria, China falls into Group D of creditor friendliness, and instrument ratings of issuers with assets in this group are subject to a soft cap at the issuer’s IDR.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Recurring EBITDA/interest coverage sustained above 1x;
– Unrestricted cash/short-term debt sustained above 1x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Recurring EBITDA/interest coverage fails to improve materially;
– Aggressive expansion leading to deterioration in liquidity.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
LIQUIDITY AND DEBT STRUCTURE
Improved Liquidity: CNLP’s liquidity improved by end-2020, with the cash/short-term debt ratio recovering to 1.2x from 0.5x at end-2019, after the company’s management of its debt structure through issuing convertible bonds and exchanging US dollar senior notes in 2020. CNLP had CNY1 billion in unrestricted cash on hand, and CNY0.8 billion in unused bank facilities at end-2020, sufficient to cover CNY0.9 billion of short-term debt, including USD12 million of senior notes due September 2021.
Fitch expects that CNLP’s liquidity position will be weak during 2021-2022, considering the company’s large capex plan, despite our assumption of a certain amount of proceeds from asset disposal each year. Liquidity coverage – measured as (available cash + undrawn portion of committed facilities + free cash flow)/short-term debt – would be at around 0.6x in our forecast (end-2020: 0.5x) during 2021-2022.
SUMMARY OF FINANCIAL ADJUSTMENTS
Depreciation of right-of-use assets and interest on lease liabilities was excluded in the EBITDA calculation; interest on lease liabilities was excluded from cash interests; total debt was adjusted for face value of convertible bonds.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
Source: Fitch Ratings