A quick read of Evergrande’s long-awaited interim results

Receive first-hand news on the latest bond issues, credit updates and special events when you join us on our Telegram channel at https://t.me/bondsupermart!

Table 1: Evergrande’s Key Credit Indicators

The Interim Results Fall Within Expectations

As expected, Evergrande reported a poor mid-year result, with revenue declining by 16.5% YoY to 222.7 billion yuan. Despite a 120% YoY increase in profit attributable to shareholders (14.4 billion yuan), it was mainly driven by a net gain of 18.5 billion yuan from selling shares of HengTen Networks.

A key point on the income statement highlights that its gross profit margin plunged to 12.9%, the result of continuous discounts and sales promotions in the past few years, directly leading to a loss of 4 billion yuan in the property development business.

Throughout the years, Evergrande fixated on generating sales cash inflows for its projects, essentially paying very little attention to profit margins. It explains why we often hear news about their flats being sold for too low; even affecting sales of other property developers in some regions.

With reference to the three red lines, Evergrande’s latest net gearing improved to 99.8%, turning green in this category. The cash to short term debt and adjusted liabilities to assets ratios also improved to 0.67x and 81% respectively, but still failed to fulfill the requirements. In addition, the non-restricted cash to short-term debt ratio dropped to 0.36x, showing that its actual liquidity is deteriorating.

We note that Evergrande’s cash and cash equivalents stood at 86.8 billion yuan. After deducting the consolidated parts from Evergrande Property Services and Evergrande New Energy Vehicle, there is 65.7 billion yuan remaining for property and other divisions. Its restricted cash increased to 74.9 billion yuan, which should be mainly composed of cash from pre-sale project supervision accounts (used to ensure that the project has sufficient funds for development). Considering past reports about Evergrande misappropriating money in these accounts, we believe the Group may have decided to reallocate the funds in preparation of this interim result. This explains why the restricted cash has increased significantly compared to that of last year-end.

Another point to pay attention to is payables, which includes the commercial paper incidents in recent months. Evergrande’s current liabilities have amounted to 951.3 billion yuan (end-2020: 829.2 billion yuan), and trade payables (where majority of commercial papers are classified) have risen by 7.3% YoY to 666.9 billion yuan. The numbers look poised to increase continuously.

As for land bank and borrowing costs, the Group still owned 214 million sq.m of land reserves at the end of June, as well as 146 urban renewal projects. Although the average borrowing cost has fallen from 9.5% to 9.1%, it is of little importance at this moment.

Evergrande also reported on its progress of asset sales. It is worth mentioning that it sold all 49% of Evergrande Spring’s equity in exchange for 2 billion yuan, and sold interests in five property projects and other non-core assets for 9.27 billion yuan. This may include the football stadium and related apartments in Panyu that have been reportedly sold to Guangzhou City Construction Investment Group. However, the Hong Kong China Evergrande Center transaction with Yuexiu Holdings should be still pending.

Last but not least, there is a statement in the interim result saying that the group "has risks of defaults on borrowings and cases of litigation outside of its normal course of business”. Evergrande did not hold a press conference after, which is considered as an unusual practice.

These should summarize the key points of the interim result. In short, its performance is within our expectations. However, it is obvious that the overall tone has softened a lot, to the point where they no longer offer aggressive rebukes to allegations. In fact, we believe that at this moment, the attitude of Evergrande’s senior management towards its current debt crisis is more important than the above quantitative credit indicators.

Guaranteeing Completion of Residential Projects and Asset Sales Direction

From Evergrande’s recent actions, we can identify that their core development strategy is ensuring the completion of residential projects. The Group even held a pledge-signing ceremony to promise buyers that construction would proceed.

In July and August, Evergrande’s contracted sales were 43.8 billion yuan and 38.1 billion yuan respectively, underperforming its peers. Therefore, the Group must rebuild the confidence of buyers for  sales cash inflows to stand a chance of recovery.

However, our question is, is it a good news for bondholders if Evergrande is prioritizing the completion of residential projects?

If we only look at the situation from the perspective of offshore assets, placing the onshore subsidiary Hengda Real Estate aside, we estimate that China Evergrande’s standalone debt size is about 110 billion yuan, based on the amount of its outstanding offshore bonds. Should Evergrande default, overseas creditors will have the rights to claim against the assets held by the group, including the equity of several listed offshore subsidiaries. These assets will provide some cushion for the recovery value of the bonds. Therefore, although we did mention that selling onshore projects is a worse option in the long run, it may actually be more favorable for USD bondholders.

To our understanding, Evergrande is currently open to negotiations for anything that can be sold. For example, in mid-July, the market circulated a list indicating that the Group is willing to sell its 223 hotels, shopping malls, office buildings and other projects, with a total size exceeding 7 million sq.m. Considering that commercial projects usually look for long-term cash flows, they are not able to provide any immediate relief to their tightened cash flows. Therefore, it is quite reasonable for Evergrande to dispose of them first.

Plans to sell equity is not going smoothly either. After all, capital markets apply the law of the jungle. Rumours are that the offers submitted by potential buyers are too low and completely unacceptable to Evergrande, leading to stalemates. Now, under the coordination of the Guangdong Government, the likely targets of future transactions will still be state-owned enterprises in Guangdong.

At this point, we believe that the Group is still determined to resolve the debt crisis. They have adopted a comprehensive cost cutting and liquidity seeking approach, including the sale of both onshore and offshore assets, as well as a proposal for large-scale layoffs and salary cuts. If Evergrande can successfully prevent debt defaults through sales inflows and liquidating assets, it will be an ideal situation for all stakeholders. However, in any case, investors must know that the final act of this saga will not be determined within a short period.

Recently, major shareholder Joseph Lau and his wife sold their stakes in Evergrande; some also reported that Group CEO Xia Haijun is also going to resign from his position. We treat this as a sign that even key insiders are uncertain about Evergrande’s fate.

Meeting Future Debt and Bond Strategies

Last week, REDD Intelligence interviewed people familiar with the matter, reporting that the Guangdong Government is discussing whether to form an Evergrande creditor committee. It also included other important information. Firstly, top Guangdong officials have differing opinions on Evergrande’s debt issue, while governor Ma Xingrui intends to offer a rescue plan. Secondly, Evergrande failed to repay a 300 million yuan trust loan on time in August, but promised to pay it within the 10-day grace period. Thirdly, the Government asked Yuexiu Holdings to suspend its acquisition of Evergrande’s Hong Kong headquarters.

Although we are unable to confirm if the above information is factual, the creation of the creditor committee is not all bad news. While it is true that a creditor committee is typically responsible for debt restructuring, we also consider this is as a way to ‘centralize’ the creditors. Major creditors of Evergrande such as banks and trust firms are consolidated in the committee, allowing Government to issue instructions for them to provide relevant supporting measures, including debt extension and rate reduction.

Meanwhile, the Group’s bondholders comprises a wide variety of individuals, who are unlikely to "receive and follow instructions" as seamlessly as financial institutions, so it is not quite possible to apply a similar approach. If the above rumour turns out to be true, what’s more likely to happen is that unless Evergrande defaults on a public bond, it may not enter into a debt restructuring process.

Evergrande does not have any bonds due for the remainder of this year, and the next one is an 8.2 billion yuan onshore bond that is puttable in January 2022. However, the bond coupons repayable by the Group in September and October are approximately 3.8 billion yuan. Although the amount is not large, we still have to closely monitor the development of the situation, to see if it has sufficient funds to repay the interest.

The price of its shortest tenor USD bond “EVERRE 8.250% 23Mar2022 Corp (USD)” has now fallen below $40, showing that markets have already priced in the risks of default and haircut. Although the probability of any debt restructuring involving maturity extension and haircut is increasing, we believe that the current price is already reflecting the maximum haircut level. Therefore, the incentive to sell the bond now is quite low, and investors will miss the opportunity for a possible rebound.

At this point, we still think Evergrande has the resilience to survive for a longer period. Therefore, the risk of short-term bonds is slightly lower than that of long-term bonds. However, if it really gets into any legal process, it may take a long time to come up with a recovery plan for the relevant bonds. Investors should also take time value into consideration.

Please stay tuned as we continue to provide credit updates on Evergrande.

Our podcast series, Yield Hunters, is available on Spotify, iTunes Podcasts and Google Podcasts. We share our thoughts on new bond issues and hold discussions on the fixed income space. Listen to our latest episode below and follow us!