Looking for High Yield Real Estate SGD Bonds? Logan Property Could Be Your Best Bet

In a recent article (“Cheaper Valuations Make A Comeback For Asian High Yield”), we reported that valuations have turned attractive in the Asian high yield sector. To venture into this territory, investors have to form an opinion on China’s property developers, which dominate the asset class.

Spooked by rising interest rates, the falling RMB, and Beijing’s deleveraging campaign, investors have sold off Chinese developer bonds to the extent that credit spreads are now above their five-year average (see Figure 1). After the National Development & Reform Commission of China released a statement in late June that imposed more restrictions on Chinese firms’ offshore bond issuances, spreads rose to levels last seen in August 2015.

Figure 1: Credit spreads in the Asian real estate sector have widened significantly since March

While higher cost of funding and tighter government restrictions are likely to put increasing financial strain on domestic developers, especially the higher-geared and smaller-sized firms, they also create interesting opportunities with manageable risk. We highlight one such investment idea in this article—Logan Property’s SGD 2021 bond.

About Logan Property Holdings

Logan Property Holdings Company Limited is a Chinese property developer founded in 1996. The company is listed on the main board of the Stock Exchange of Hong Kong since 2013 and has a market capitalization of HKD54.2 billion (~USD6.9 billion) at Friday’s close. According to a survey by Enterprise Research Institute of Development Research Center of the State Council, The Institute of Real Estate Studies of Tsinghua University, and China Index Academy, Logan is ranked 26th (2017: 29th) among Chinese large-size property developers in terms of overall strength.

Logan focuses on residential property development in China, mainly in the Guangdong-Hong Kong-Macao Greater Bay Area (“GBA”). The company’s products cater mostly to first-time home owners and upgrade buyers.

The founding Ji family members lead Logan’s management team. Mr Kei Hoi Pang—previously known as Mr Ji Haipeng—and his younger brother Ji Jiande head the executive team as chairman and CEO respectively. Mr Kei’s daughter, Ms Kei Perenna Hoi Ting, also sits on Logan’s board of directors as a non-executive director. Together, they control 77.4% of the company shares.

Logan is rated “Ba3” by Moody’s and “BB-” by S&P and Fitch, with a stable outlook on all its ratings.

Revenue growth and margins remained healthy in 1H18

Logan’s revenue for the six months ended June rose 22.4% YoY to RMB 15.2 billion (1H17: RMB 12.4 billion), mostly due to the improved top line from property development (+8.3% YoY to RMB 13.1 billion), which continued to contribute the bulk (86%) of the company’s revenue. The majority of Logan’s property development revenue can only be recognized at completion and upon transfer to the buyer. In 1H18, the company completed eight projects with a total planned GFA of approximately 0.9m sqm.

Revenue growth in 1H18 was also boosted by a new business segment, primary land development, which sells land held for development. The segment contributed RMB 1.1 billion during the period (1H17: nil).

Meanwhile, property leasing continued to make up a small part of Logan’s business, contributing just RMB45.8m of net revenue in 1H18 (1H17: RMB44.8m). While the company’s rental business seems lackluster in relation to its sizeable investment property portfolio (RMB 17.2 billion), we note that around half of the portfolio in terms of GFA is still under development, and may be some time away from generating cash flow.

Gross profit rose 14.8% YoY to RMB 5.6 billion (1H17: RMB 4.9 billion), representing a lucrative gross profit margin of 37.0%, albeit slightly lower than 1H17’s 39.5%. The decline in profit margin was likely because property development revenue in the previous corresponding period comprised a higher proportion of projects in Shenzhen—41.6% in value versus 26.0% in the current period—which carry better margins.

Selling and market expenses fell 8.5% YoY to RMB271m (1H17: RMB296m), but administrative expenses jumped 54.9% YoY to RMB447m (1H17: RMB288m), primarily because of an increase in staff costs. We note that as a percentage of contract sales, Logan’s selling and marketing expenses and administrative expenses improved to 2% (1H17: 3%), implying better margins for its home sales.

Due to a large decline in fair value appreciation of investment properties from RMB 1.8 billion in 1H17 to RMB 1.0 billion in 1H18, Logan’s profit from operations (before finance costs and tax) rose at a relatively slow pace of 4.9% YoY, to RMB 6.7 billion (1H17: RMB 6.4 billion). Adjusting for fair value changes and other items, the company’s core profit¹, which better reflects operating results, climbed 15.1% YoY to RMB 2.9 billion (1H17: RMB 2.6 billion). Core profit margin fell to 19.4% (1H17: 20.6%), though still indicating healthy profitability.

Robust contracted sales growth and unbilled sales provide good income visibility

Logan’s contract sales in the seven months ended July surged 91.9% YoY to RMB 43.81 billion from RMB 22.8 billion in the same period last year. The company’s strong sales growth brought its unbilled contracts to RMB47.4 billion, locking in 90% of its 2018 revenue and providing a bright outlook for this and next year. Based on Logan’s pipeline of unbilled sales (see Figure 2), we are likely to see its full-year revenue jump by 50% in 2018.

Figure 2: Logan has already locked in 90% of this year’s expected revenue

Given the robust sales performance, Logan has upgraded its contract sales target for this year to RMB 70 billion (from RMB 66 billion), which represents an expansion of more than 60% from 2017 (RMB 43 billion). We think the revised sales target is still conservative, as it implies a modest sell-through rate of 46% in the second half of 2018. The company achieved a sell-through rate of 64% in 1H18.

If Logan achieves its 2018 sales target, which we think is comfortably within its reach, the company would lock in 80% of its revenue next year and extend its strong growth to 2019. Logan plans to launch 25 new projects in the second half of 2018, including Stirling Residences in Singapore and Acesite Centrium in Zhuhai.

Leverage improved, but land spending pressures credit profile

Total borrowings rose 17.8% to RMB 48.1 billion from RMB 40.8 billion in the six months ended June, after Logan issued three tranches of senior notes during the period. The company also issued the USD300m LOGPH 7.500% 27Aug2021 Corp (USD) this month, but proceeds from that note were to be used to refinance existing indebtedness and hence should not affect gearing. Cash and bank balances increased 23.2% to RMB 27.6 billion over the same period, sufficient to cover Logan’s short-term borrowings of RMB 17.8 billion.

Reported net gearing (net debt/equity) improved to 66.3% (31 Dec 17: 67.9%). The firm has USD350m (RMB 2.4 billion) of 7% perpetual securities outstanding. Treating those as debt (instead of equity), we find adjusted net gearing similarly improved to 80.0% (31 Dec 17: 83.9%).

In our view, Logan’s aggressive land acquisition plan poses the biggest downside risk to its credit profile. During the six months ended June, the group bought 24 new projects with a total GFA of 6.45m sqm for RMB 15.7 billion, or 44% of its contracted sales in the same period (1H17: 64%). Given that Logan’s land acquisition-to-contracted sales ratio has been consistently high, and the company’s land bank maintained at above five years’ worth of sales, we expect its heavy capital expenditures (“capex”) to continue for the foreseeable future. That will restrain significant improvement in the developer’s credit ratios.

However, we think Logan’s strong growth and profitability should offset its capex needs, and the company should be able to at least maintain its financial health moving forward. Having a huge pipeline of projects provides Logan with the flexibility and maneuver room to slow its land bank expansion, should the company run into tighter financial conditions. The large land bank in place also allows Logan more time to source for new projects at lower costs, by participating in urban renewal and M&A projects, which are highly profitable but take longer time to completion.

Interest coverage is healthy and rising, although borrowing cost is set to become more expensive

Despite the increase in borrowings, Logan’s finance costs (including capitalized interest) fell 7.0% YoY to RMB 1.3 billion (1H17: RMB 1.4 billion). We think this is likely due to the fall in the company’s weighted average cost of borrowing to 5.8% as at 31 Dec 17, from 6.1% a year ago. As a result, we estimate that Logan’s adjusted interest coverage ratio (core profit before interest and tax divided by finance costs), after including distribution to perps, climbed to 4.2x in 1H18 from 3.7x in previous year’s corresponding period.

Going forward, we think the falling trend in Logan’s borrowing cost (see Figure 3) during the past few years is likely to reverse its course. The monetary tightening cycle in the US and other major economies should push the company’s offshore borrowing costs higher, while onshore liquidity remains tight as the Chinese government continues its shift toward deleveraging. The coupon rates on Logan’s three-year USD-denominated bonds issued this year rose steadily to 7.5% in August, from 6.875% and 6.375% in April and February respectively.

Figure 3: Logan’s borrowing cost has likely bottomed out in 2017

Foreign exchange risk is limited as overseas projects provide natural hedge

We estimate that foreign currency borrowings made up about 52% of Logan’s total debt as at 30 Jun 18, or 54% if we include its perps. The company’s foreign currency debt included HKD-denominated bank loans (~RMB 10.0 billion), USD senior notes (~RMB 13.8 billion), and SGD senior notes (~RMB 1.0 billion). Logan does not hedge its foreign currency exposure.

While RMB has declined 5.4% against USD this year through 23 August, we think Logan’s foreign exchange risk is likely low. This is because most of the company’s offshore funding are probably deployed in its Singapore (Queenstown and Hougang) and Hong Kong (Ap Lei Chau) projects, which constituted RMB 27.7 billion or 11% of its saleable resources. These overseas projects provide a natural hedge for Logan’s foreign currency borrowings.

Stellar profitability supported by land cost edge

The earlier mentioned survey by China Index Academy placed Logan as fourth in its 2018 ranking of the top ten Chinese real estate developers by profitability, the same ranking as last year. A quick check of industry statistics corroborates that finding. Among major Chinese property developers (with market cap above USD 5 billion), Logan’s gross profit margin of 34.4% in 2017 ranked fourth, behind only Agile Group (40.1%), China Evergrande (36.1%), and Guangzhou R&F Properties (35.4%). According to Bloomberg data, the company’s five-year average return on invested capital of 10.7% was tops among its peer group.

Industry-wide profit margins are expected to decline in the near future, as Beijing seems intent to persist in its efforts to cool the housing market. Despite the muted industry outlook, we think Logan is likely to retain or improve on its above-average profitability, given the significant cost advantage in its land bank and its concentrated exposure to the GBA. China’s ambition to transform the GBA into a science and innovation hub will encourage investments to flow into the region, pushing real estate prices up. Since the GBA concept first surfaced in 2015, real estate companies have already flooded into the region and housing prices in most bay area cities surged, prompting local authorities to impose property curbs.

Logan’s competitive advantage lies in its first-mover status, as the company invested heavily in the region's home market well before the jump in land prices since 2016. For example, Logan acquired its Logan City project in Huizhou at just RMB300/sqm in 2007. Logan City, which still has more than RMB 30 billion of saleable resources, produced RMB18,444/sqm of revenue in the six months ended June, translating into a gross profit margin of over 60%.

Logan’s average selling price climbed 15.7% YoY to RMB19,642/sqm in July (July 2017: RMB16,974/sqm), nearly five times its average land cost of RMB3,943/sqm (as at 30 Jun 18). Given the company’s established land bank bought at low cost, we think it should be able to enjoy high margins in the next few years.

Strong growth prospects from large land bank and exposure to GBA

As at 30 Jun 18, Logan has a vast land bank with an aggregate gross floor area (“GFA”) of 35.5m square meters (“sqm”), amounting to RMB 416.1 billion of saleable resources. In addition, the company has another RMB 225.1 billion of saleable resources from its merger and acquisition (“M&A”) and urban renewal projects. 72% of its land reserves by land value comprises of projects within the GBA² (see Figure 4).

Figure 4: Geographical breakdown of Logan’s land bank by land value (as at 30 Jun 18)

Logan’s strong pipeline of projects provides excellent growth visibility and support its future sales and profitability. The company’s contract sales target of around RMB 320 billion for 2018-2020 seems ambitious as it implies a five-year CAGR of more than 50%—contract sales in 2016 were RMB 28.7 billion). Viewed from the perspective of its total saleable resources, the goal is actually quite conservative, comprising just 50% of Logan’s land reserves.

In March 2017, Chinese Premier Li Keqiang announced the plan for the “development of a city cluster in the Guangdong-Hong Kong-Macao Greater Bay Area”³. The initiative seeks to build a world-class economic cluster that plays a leading role internationally in technology, innovation, shipping, trade and finance. With one of the largest land reserves in the GBA at 22m sqm, or 72% in value of its land bank, Logan stands to benefit greatly from the government plan.

The Chinese government has reportedly delayed the release of the GBA master plan due to uncertainties from the escalating trade tensions between China and the US⁴. Nonetheless, market participants expect the plan to include favorable economic policies and initiatives on infrastructure, investments, trade and talent to bring about better collaboration among the eleven cities⁵. The developments should boost economic and population growth in the region, which bode well for housing demand.

Even though the official blueprint is still pending, major infrastructure projects to improve regional connectivity are already underway. The landmark project is the Hong Kong-Zhuhai-Macau Bridge, the world’s longest road bridge that costs USD 7.56 billion for just its main section⁶.

Other infrastructure projects, including the numerous high-speed rail and intercity rail lines, and cross-sea bridges Shenzhen-Zhongshan Bridge and the second Humen Bridge, promise better physical integration between the GBA cities (see Figure 5). The improved transportation facilities should channel home demand from heated housing markets such as Hong Kong and Macau to neighboring cities such as Zhongshan, Zhuhai, and Dongguan.

Figure 5: Massive infrastructure investments in the GBA

The flip side to Logan’s large land bank in the GBA is concentration risk, which exposes the company to adverse changes in local economy and policies. That risk materialized in late July, when the Shenzhen government imposed new curbs that aim to restrain housing market speculation. Logan’s land bank exposure in Shenzhen is significant at 22% of the portfolio (excluding M&A and urban renewal projects).

Homeowners in Shenzhen are now prohibited from selling their properties within three years of obtaining their deeds. The local authorities also banned enterprises, institutions and social organizations from buying houses, plugging a popular loophole to bypass purchase restrictions. In addition, newly approved business apartments can only be rented but not sold.

Although the cooling measures are likely to stymie investment demand for residential properties in Shenzhen, we believe real demand will remain resilient in the long run, supported by the city’s stellar economic growth and steady increase in population (see Figure 6). Shenzhen attracts large numbers of skilled migrants each year, but housing supply is constrained by the lack of vacant land. Furthermore, the city’s economic output is growing at a pace that will soon see it overtaking Hong Kong, while its average home price is still a fraction of its illustrious neighbor. These factors suggest there is still much room for further home-price expansion in Shenzhen.

Figure 6: Shenzhen’s economic and population growth

The LOGPH 6.125% 2021 (SGD) offers great value

Overall, we are Neutral on Logan’s credit outlook. We expect the company to continue spending heavily in land investments, which would preclude significant improvement in its credit profile. On the other hand, Logan’s financial health is supported by its strong contracted sales, high margins, and well-established land bank in the GBA.

In our view, the LOGPH 6.125% 16Apr2021 Corp (SGD) offers some of the best value in the SGD-denominated property developer bond market. At their yield to worst of 6.76%, the LOGPH 6.125% ‘21s rank behind only a few bonds of Aspial Corporation and Oxley Holdings, two highly-leveraged Singapore property developers (see Table 1). Compared to other high yield alternatives among the local developers, we think the LOGPH 6.125% ‘21s are very attractive in terms of risk-return, given Logan’s significantly larger asset base and operating scale, and its stronger earnings visibility.

We think the closest comparable to the LOGPH 6.125% ‘21s is the CENCHI 6.250% 02May2020 Corp (SGD) of Central China Real Estate Limited (“CENCHI”), a Chinese residential property developer operating mainly in the Henan province of China. CENCHI has split ratings of “Ba3”, “B+”, and “BB-“ by Moody’s, S&P, and Fitch respectively. We prefer the LOGPH 6.125% ‘21s due to their decent spread pickup, against Logan’s larger scale (Logan’s has total assets of RMB 143.0 billion versus CENCHI’s RMB 76.8 billion), higher profitability, and overall better credit profile.

Table 1: Relative valuation

^{1. Core profit: excluding changes in fair value of investment properties and derivatives and deferred tax and share of changes in fair value of investment properties at an associate.}

^{2. The Greater Bay Area includes Shenzhen, Huizhou/Dongguan, Guangzhou/Foshan/Zhaoqing, Zhuhai/Zhongshan, Heyuan/Yangjiang/Qinyuan, and Hong Kong & Macau.}

^{3. The full text of the Report on the Work of the Government delivered by Premier Li Keqiang at the Fifth Session of the 12th National People's Congress on March 5, 2017, is available at http://english.gov.cn/premier/news/2017/03/16/content_281475597911192.htm}

^{4. He, Huifeng. (2018, June 3). China holds off on Greater Bay Area master plan as trade turmoil clouds outlook. South China Morning Post. Retrieved from https://www.scmp.com/news/china/economy/article/2149002/china-holds-greater-bay-area-master-plan-trade-turmoil-clouds}

^{5. Ronald Sze, Ayesha Lau, Shirley Yuen. (September 2017). The Greater Bay Area Initiative. KPMG. Retrieved from https://www.chamber.org.hk/FileUpload/201710040918418786/The-greater-bay-area-initiative_EN.pdf}

^{6. Sarah Lazarus. (2018, May 16). The $20 billion 'umbilical cord': China unveils the world's longest sea-crossing bridge. CNN. Retrieved from https://edition.cnn.com/2018/05/04/asia/hong-kong-zhuhai-macau-bridge/index.html}

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in LOGPH 6.125% 16Apr2021 Corp (SGD). The analyst who produced this report holds a NIL position in the abovementioned securities.