China Evergrande’s Rhythm of Deleveraging

Why did this happen? In 2020, most developers were delivering properties sold in 2017 to 2018. This coincided with large-scale measures implemented by many cities to curb the overheating price during that period, resulting in many developers failing to sell the houses at their desired price despite having spent large sums on land acquisition. This caused the profit margins of many projects to drop sharply, and some of them even recorded a loss.

In recent years, we have been seeing more sales promotions in the industry, and many developers are lowering prices to stimulate sales. We expect that the overall gross margin in the next few years will remain low, and may no longer maintain an average level of 30%.

In fact, Evergrande holds an advantage in this regard. As of end-2020, its average sales price was approximately RMB 8,944/sqm, about 4.2 times higher than its average land cost (RMB 2,122/sqm). With its scale advantages and a large number of renovation projects, the average cost of the 140 new land parcels added by Evergrande last year was as low as RMB 1,992/sqm. Given the low cost of land compared to its peers, the Group has more flexibility to launch discounts and promotions, all while maintaining a profitable margin that can meet its interest expenses.

Improved Credit Indicators Compared to June, Despite the Insignificant Improvement

Credit-wise, we saw Evergrande’s credit indicators deteriorate significantly in June last year, with the results of its deleveraging efforts becoming more apparent at end-2020. Total debt was reduced by about RMB 120 billion from June, and its net gearing ratio improved to 153% (see Table 2).

Table 2: Evergrande’s Key Credit Indicators

(billion RMB)	December 2020	June 2020	December 2019	3 Red Lines Requirement
Total Debt	716.5	835.5	799.9	/
Cash Balance	180.7	204.6	228.8	/
Net Gearing (%)	153%	199%	159%	< 100%
Cash to Short-Term Debt (times)	0.54x	0.52x	0.61x	> 1.0x
Adjusted Liabilities to Assets (%)	83%	85%	83%	< 70%
Short Term Debt Ratio (%)	47%	47%	47%	/
Borrowing Cost (%)	9.49%	9.14%	8.99%	/
Land Bank (million sq.m)	231	240	293	/
Source: Annual Results, Interim Results, iFAST Compilations Data as of 31 December 2020

Although its leverage level has improved, we saw that its average cost of borrowings has further deteriorated to 9.5% after exceeding the 9% danger level, reflecting that its financing capacity has become tighter. On the other hand, the Group's cash to short-term debt ratio remained at 0.54x, which means its short-term liquidity was still insufficient.

In spite of that, this is not the first time Evergrande has faced the pressure of repaying huge amounts of short-term debt. In the past four years, its short-term debt ratio has not changed significantly (see Chart 1), and the group has managed to overcome its debt pressures eventually.

Chart 1: Evergrande’s Debt Distribution in Last Four Years

In short, Evergrande’s year-end credit indicators are slightly better than that of June’s, despite the insignificant improvement. However, does this mean that the Group's overall solvency has not changed at all?

Sales and Cash Inflow Hitting New High; Strong Guidance on Deleveraging

In 2020, Evergrande’s contracted sales amounted to RMB 723.3 billion, up 20.3% YoY and better than the industry average. As one of the top sellers in the market, the Group definitely achieved an impressive sales growth.

In the first quarter of 2021, the Group recorded contracted sales of RMB 153.2 billion, an increase of 3.9% YoY, which seems to lag behind its peers. In fact, Evergrande recorded a 108% YoY sales growth in February last year through the launch of its online sales platform, and thus will not benefit from a low base effect this year.

Previously, Evergrande announced its 2021 sales target of RMB 750 billion, up 3.7% against last year's sales. Therefore, the Group's current sales progress is generally in line with expectations. Last year, Evergrande recorded a cash inflow from sales of RMB 653.2 billion, with a collection rate of 90% (2019: 78%), which was 1.7x more than its debt due within one year (RMB 335.5 billion). We believe its sales inflow will be sufficient to deal with its short-term debt.

By the end of March, Evergrande’s total debt was further reduced to RMB 674 billion, and sales inflow in these three months continued to increase by 17% YoY to RMB 133 billion. In other words, it is likely that the sales inflow/total debt will exceed 1.0x this year. With progressing sales figures and cash inflow, its debt-servicing ability has in fact improved even though the leverage level does not change.

After the results announcement, Evergrande’s bond prices reacted positively, which is somehow attributable to the clear deleveraging guidelines given by the management. We saw clear timetables for achieving the goals towards the total debt size, as well as the Three Red Lines (see Table 3).

Table 3: Evergrande’s Deleveraging Guidance

Guidance	Timeline
Total Debt Size	June 2021: Below RMB 590 billion June 2022: Below RMB 450 billion June 2023: Below RMB 350 billion
Three Red Lines	June 2021: Net Gearing Below 100% December 2021: Cash to Short Term Debt Over 1.0x December 2022: Adjusted Liabilities to Assets Below 70%
Land Bank	2021: Reduce 15 million sq.m 2022: Reduce 15 million sq.m
Source: Result Announcement Press Conference, iFAST Compilations Data as of 1 April 2021

So, does Evergrande have the capability to achieve such an aggressive deleveraging plan?

Possible to Achieve the Goal with Ample Saleable Resources and Reduced Land Expenses

During the press conference, Evergrande’s Vice Chairman and CEO Mr. Xia Haijun said that the Group’s total saleable resources would reach 137 million sq.m in 2021. To achieve the sales target, an approximate 60% conversion rate should suffice.

Despite the ample saleable resources, it is necessary for the Group to maintain the size of its land bank in order to support future development. Last year, Evergrande added 69 million sq.m of land with a total cost of RMB 137.2 billion.

We roughly estimate that the Group has to purchase a similar amount of land this year, so that the land bank can be reduced by 15 million sq.m under a 60% conversion rate. Fortunately, Evergrande has 100 renovation projects on hand that are not included in the reported statement yet, of which 78 are located in Greater Bay Area, and 58 are located in Shenzhen. These projects will serve as the key assets in the Group’s upcoming land reserve. Thus, the management predicts that the Group can save RMB 30 billion each year on land acquisition.

In 2020, Evergrande recorded RMB 48.1 billion cash outflow under a reduction of RMB 90 billion net borrowings. All things equal, if the Group can improve sales inflow by RMB 50 billion, and reduce land expenses by RMB 30 billion, it is actually possible for Evergrande to shrink another RMB 120 billion debt using internal capital, without affecting cash on hand.

Strategic Investment Issues Are Resolved; Huge Asset Portfolio Can Help Maintain Cash Flows

In September last year, Evergrande caused market panic in the "leaked letter” incident. At that time, there were rumors that the Group had difficulties in repaying a one-off RMB 130 billion strategic investment, and thus had to seek for a bailout from the Guangdong Government.

Later on, the Group made an open statement to clarify that the letter was purely fabricated. Two months later, the Group announced that strategic investors holding equity interests of RMB 125.7 billion (about 97%) had signed supplemental agreements, agreeing not to require the repurchase of their equity interests.

Over the years, the market was highly concerned about this part of “hidden debt”, but the case is finally closed. It is definitely a positive piece of news for bond investors since they no longer have to worry about this repayment of strategic investment.

One last point to note is Evergrande’s huge asset portfolio. Since last March, the Group has raised a total of HKD 88.8 billion through the public offering, placement and strategic investment of its subsidiaries such as Evergrande Property, Evergrande New Energy Vehicle, HengTen Network, and Fangchebao. For example, the Group raised HKD 16.4 billion last month from selling and placing Fangchebao’s shares to strategic investors. Evergrande still owns about 70% equity in the company after the transaction, and is also expected to raise more funds through an initial public offering in a year.

Therefore, we believe that even though the Group's debt financing channels are limited, it still has the ability to make use of the asset portfolio in exchange for cash flows, and the risk of any abrupt default in the short term is low.

Better to Consider the Bonds Due on or before 2023

The Group is still caught in a vicious cycle of rising borrowing costs, which will affect its long-term debt servicing. Therefore, we believe that bonds with a shorter tenor offer better value, especially when it comes to highly leveraged issuers like Evergrande.

Considering that the Group has improved its credit status, we think the bonds with around two years to maturity are more attractive. Currently, the USD bonds due in 2023 or earlier (see Table 4) are offering a YTM of 12% to 14%, which is quite attractive for investors.

Table 4: Evergrande's USD Bonds due in 2023 or Earlier

Bond Name	Years to Maturity	YTM
EVERRE 8.250% 23Mar2022 Corp (USD) (Available on Bond Express)	0.94	12.605%
EVERRE 9.500% 11Apr2022 Corp (USD)	0.99	12.831%
EVERRE 11.500% 22Jan2023 Corp (USD)	1.78	13.600%
EVERRE 10.000% 11Apr2023 Corp (USD)	1.99	13.852%
EVERRE 7.500% 28Jun2023 Corp (USD)	2.20	13.715%
Source: Bondsupermart Data as of 19 April 2021

Corporate Risks

Despite our positive view on the Evergrande’s outlook, it is an undisputed fact that it is still a highly leveraged issuer. If the Group cannot achieve its expected sales conversion rate, it will lead to a tightened cash flow and affect its overall solvency.

Evergrande’s financing cost last year dropped significantly. One of the factors is the RMB appreciation against USD over the period, which reduced the Group’s payment for both principal and interest of its offshore debts. On the contrary, if RMB begins to weaken in the future, financing-related expenses may rebound.

Since Evergrande has a large scale of non-standard financing which is less transparent, it will be more difficult and complicated to analyze the actual debt structure of the Group.

Conclusion

Evergrande’s earnings performance in the second half of 2020 was similar to that of the first half. The decline in gross margin was slightly better than its peers, and its credit indicators were better than that of June, despite the insignificant improvement.

With sales figures and cash inflow hitting new highs, the overall solvency of the group has in fact improved. The deleveraging guidance given by the management is optimistic, although we believe that the target can be achieved from cash flows given its adequate saleable resources and reduced land buying expenses.

Concerns about strategic investments have now been resolved, and the huge asset base will help maintain cash flows. With an improvement in its overall credit profile, we believe the bonds due on or before 2023, which are offering YTM of 12% to 14%, are attractive for investors.

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