Small Developers Suffer Quietly In Shadows Of Evergrande, Country Garden

Key Takeaways:

• Shares of smaller developers like Yuzhou and Aoyuan have plunged this year under similar, if not bigger, liquidity pressures to those faced by giants like Evergrande and Country Garden
• Moody’s downgraded its outlook for China’s entire property sector to ‘negative’ last month

By Warren Yang

China’s cash-challenged property developers are stuck between a rock and a hard place as Beijing tries to figure out what to do with this important, yet struggling, piece of its $18 trillion economy. As that happens, the nation’s many smaller privately-owned developers have had to cope outside a global spotlight that has been squarely focused on the woes of giants like Evergrande (3333.HK) and Country Garden (2007.HK).

Such concerns are prominently reflected in precipitous declines this year for shares of developers like Yuzhou Group Holdings Co. Ltd. (1628.HK), Times China Holdings Ltd. (1233.HK) and China Aoyuan Group Ltd. (3883.HK), which have all become nearly worthless.

As such, any equity investors without an extremely strong appetite for risk are probably avoiding such stocks, making fundraising through new share issues out of the question. Debt investors are probably keeping their distance as well, particularly after Moody’s downgraded its outlook for the sector to “negative” last month, just four months after an upgrade to “stable” when it looked like things were improving.

Yuzhou shares are down 68% so far this year, while Times China has fallen 74%. Both stocks trade well below HK$1 and have nearly meaningless price-to-sales (P/S) ratios of about 0.03. China Aoyuan shares are faring better with “just” a 40% loss so far this year.

China’s real estate sector has faced a reality these past three years that differs starkly from the boom it enjoyed for the previous two decades. The stress many developers are now feeling first burst into view in 2020, when Beijing started to rein in reckless borrowing by the debt-heavy group.

That decision dealt a huge blow to the sector by largely cutting off the debt financing that fueled its previous rapid expansion. The move was risky for policymakers since it significantly dampened real estate development that was a key component to China’s recent economic growth. The apparent thinking back then was that it was better to fix problems at that earlier stage rather than wait until things spiraled out of control into a full-blown crisis.

But then the Covid-19 pandemic shut down economies around the world, including China’s. Life was already becoming hard for real estate companies in the country even before that as the property market cooled after two decades of explosive growth. Then, the new borrowing restrictions coupled with pandemic limitations didn’t help.

China’s economic reopening with the receding pandemic fueled hopes that things would start looking up for the sector, and indeed there were signs of a broader economic rebound at the start of the year. But that momentum quickly fizzled, dashing any hopes for a quick fix to developers’ problems.

For starters, the government’s cap on debt makes it harder for them to refinance their debt and also finance new projects. Declining home prices are also keeping many buyers on the sidelines, depriving developers of their most important revenue source and adding to their liquidity stress.

That’s produced a destructive cycle where developers have difficulty finishing their projects, which in turn makes potential homebuyers even more anxious, leading to further delays in property development due to lack of cash. At the same time, developers are also having trouble raising new funds from stock and bond buyers who used to be another one of their most important cash sources.

Gloomy Prospects

All that brings us back to the smaller developers, which are suffering just as much – if not more – than the big boys due to their more limited resources.

Yuzhou is a case in point, now working on a debt restructuring plan after defaulting on some of its dollar-denominated bonds last year. The company actually managed to slightly boost its revenue in the first half of this year from a year earlier, according to its latest earnings report released at the end of August.

But its cost of revenue increased by a far higher 11%, leading to an 85% plunge in its gross profit. The increase in the company’s cost of revenue owes partly to downward adjustments in fair value of properties upon delivery, which probably means that they didn’t fetch as much money as Yuzhou had budgeted when it started construction.

Similarly, Yuzhou booked a massive loss on its property investments, as well as a huge write-down related to its properties under development and a large impairment on its receivables. The company’s finance costs also swelled in the first half as it reduced its unpaid interest. When all those charges and costs were factored in, Yuzhou booked a net loss of 9 billion yuan ($1.2 billion) for the period, reversing a profit of 353 million yuan a year earlier.

As its finances deteriorated, Yuzhou’s gearing ratio – or the ratio of its debt to equity – more than tripled to 356% in the first half of this year from a year earlier. This raises further questions about its ability to pay its debt, especially since its debt coming due soon increased in the first half of this year.

It’s more or less the same story for Times China. China Aoyuan looked slightly better, managing to boost its gross profit in the first half of the year. But that only helped it to narrow its net loss to a still-substantial amount during the period as the company remained deeply in the red.

Beijing eased the borrowing restrictions for some property companies this year and rolled out other measures, such as relaxing home purchasing curbs in some cities, to try to reinvigorate the property market. But those steps haven’t produced significant results, at least not yet.

Prices for new residential properties fell at the fastest pace in 10 months in August. That same month, Fitch Ratings also lowered its forecast for new home sale transactions in China for this year, now expecting a 10% to 15% decline, versus its previous projection of a 5% drop.

Beijing has been known for its ability to pull rabbits out of its hat to solve big problems at difficult times in the past. But the ones plaguing the property sector now seem too complex for any quick fix. That darkens already-gloomy prospects for property companies, and will continue to pressure smaller names like Yuzhou, China Times and Aoyuan as they live in the shadows of headline-grabbers like Evergrande and Country Garden.