In Part 3 of our Hengda (Evergrande) Group series, we explore Evergrande Auto and Healthcare Segment, listed on the Hong Kong Stock Exchange as China Evergrande New Energy Vehicle Group Limited (HKEX: 0708) and known as Evergrande Auto (Chinese: 恒大汽车) for short. Seemingly poised for the future, Evergrande Auto focuses on the healthcare and new energy vehicle industries, two booming sectors that are expected to benefit greatly from China's aging and increasingly wealthy population, as well as the country's shift towards more sustainable energy. However, a deeper look at Evergrande Auto's business model and financials reveal a company with a strong emphasis on real estate development, severe liquidity constraints, a deepening equity deficit, and potentially dubious accounting practices that greatly cast doubts on the entity's ability to continue as a going concern.
In this article, we summarize Evergrande Auto's business model and key financial metrics, in addition to discussing several red flags that arise in the process.
Note: in this article, "Hengda Group" or "Hengda" refers to the Hengda (Evergrande) Conglomerate, the mother (i.e. controlling) company of Evergrande Auto
Hengda (Evergrande) Conglomerate Series
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In 2015, Hengda acquired a media company listed on the Hong Kong Stock Exchange named New Media Group Holdings (Chinese: 新传媒体集团) (HKEX:0708), presumably as part of a shell company acquisition. Under Hengda, the company was subsequently renamed Evergrande Health Industry Group (Chinese: 恒大健康产业集团) and commenced healthcare business operations alongside the original media initiatives.
In November 2017, Hengda disposed of the media business segment, citing the decline of the print industry, before launching its new energy vehicle business to supplement the healthcare segment in June 2018.
In 2020, Evergrande Health Industry Group changed its name to China Evergrande New Energy Vehicle Group, known as Evergrande Auto (Chinese: 恒大汽车) for short.
In this section, we summarize Evergrane Auto's two main business segments.
New Energy Vehicle Segment
Evergrande Auto has developed and designed 14 vehicle models (named "Hengchi"), nine of which have been released. The company has also built several manufacturing bases and launched multiple exhibition centres. Management highlights that they plan to spend more on the research and development of new vehicle models going forward, as well as on various sales and marketing channels including additional exhibition halls and experience centres.
Although Evergrande Auto has "released" new vehicle models, only a few prototypes were allegedly produced in early 2022, while not a single vehicle has yet been delivered to consumers. Moreover, online reports have previously surfaced showing how prototype electric vehicles in the company's exhibition centres lacked proper electrical wiring and needed to be plugged into an electric outlet just to be able to turn the car's interior lights on (see, for example, Weibo source).
In October 2021, following the onset of Hengda's financial meltdown, the Group's founder and chairman Hui Ka Yan stated that the conglomerate would shift its goal to becoming a core electric vehicle maker rather than real estate developer within the coming decade.
Evergrande Auto's healthcare segment includes cosmetic surgery offerings, several hospitals and medical centres, but predominantly comprises of "health management centres" (named "Evergrande Elderly Care Valleys", Chinese: "恒大养生谷") where consumers can purchase Hengda condominiums through a healthcare membership scheme that also includes health insurance products procured by Evergrande Life Insurance (Chinese: 恒大人寿), an associate of Hengda Group (see Part 1), with property management services provided by other Hengda affiliates. During the six months ended June 2021, 25 Elderly Care Valleys throughout China served 450,000 members and customers.
The Rationale Behind Evergrande Auto's Healthcare Segment
Historically speaking, we think that Hengda initiated its healthcare business as a way to obtain land via government auctions more easily. Land in China is centrally owned and allocated to businesses by the government via auctions, while real estate companies have been subject to increasing scrutiny from the Chinese regulators due to (amongst other reasons) their highly leveraged nature and the bubble-like nature of the sector. At the same time, the Chinese government has been increasing its focus on promoting greater access to healthcare and supporting the growth of the healthcare industry in order to meet the needs of the country's increasingly wealthy and aging population. Indeed, bidding for government-allocated land under the guise of developing healthcare projects would pitch Hengda in a much more favourable light than its peers that are blatantly bidding for land for the sole stated purpose of real estate development.
Next, we examine Evergrande Auto through various financial metrics.
As the media segment was disposed of in 2017, we focus our analysis starting in the year 2018 to exclude the media segment from analysis.
It is noted that the new energy vehicle segment is only included for financial reporting purposes by the company from 2019 onwards.
#1: Evergrande Auto's Business Is Characterized By Increasing Revenues But Growing Operating and Net Losses
Evergrande Auto's revenues grew five-fold from RMB3.1 billion in 2018 to RMB15.5 billion in 2020. While total revenue and gross profit are both positive and growing, the company's operating income and net income grew increasingly negative during the same time period due to high administrative expenses (primarily R&D expenditures associated with the new energy vehicle segment) and interest costs from heavy borrowing (discussed later below).
#2: The Sale of Evergrande Elderly Care Valley Projects Accounts For Almost The Entirety of Evergrande Auto's Revenues
The healthcare segment accounts for almost all of Evergrande Auto's revenues.
Turning to a more detailed breakdown of each segment...
The healthcare segment comprises of three revenue sub-segments:
Sales of health and living projects, which refer to the company's Elderly Care Valleys
Medical cosmetology and health management services
Rental income from operating leases
The new energy vehicle segment also comprises of three revenue sub-segments:
Sales of lithium batteries
Provision of technical services
Sales of vehicle components
Evergrande Auto does not provide significant further details about these sub-segments.
*percentages may not add up exactly to 100% due to rounding
Note: revenue from the new energy vehicle segment decreased in 2020 primarily due to the decrease in sales of lithium batteries. Specifically, Evergrande Auto mentions that the company was mainly disposing of current battery inventories.
From the graph above, it is evident that Evergrande Auto relies almost solely on the sales of its Elderly Care Valley projects for revenue. In this sense, the company can be viewed as an extension of the Hengda mother company's core real estate business, rather than a healthcare services provider or new energy vehicle producer.
#3: Evergrande Auto Relies on Repeated One-Off Borrowing To Fuel Its Cash-Intensive Expansion
Evergrande Auto expanded aggressively with heavy investments in PP&E, intangible and right-of-use assets, equity investments in associates and joint ventures, as well as the acquisition of subsidiary companies (as reflected by the large, negative net investing cash flows). The expansion was fueled by large amounts of borrowing (comprising the bulk of the high net financing cash flows), with around half of the company's total borrowings being loans from Hengda Group, followed by one-third comprising of other forms of borrowing such as the use of trust companies and loans from Hengda's joint ventures and associates, while the remaining ten something percent are loans from banks.
The Role of Rent Financing Schemes
To encourage more buyers to purchase Evergrande Elderly Care Valley projects, Evergrande Auto engaged in rent financing schemes (discussed in detail in our Danke series) where the company arranges for buyers to obtain bank financing (at a presumably lower mortgage rate) by serving as a financial guarantor for these buyers. The mechanics of each scheme can differ depending on the specific agreements and regulations (see here), however the key takeaway is that Evergrande Auto would have to repay a buyer's mortgage in the event that the buyer defaults. This can become problematic (as in the case of Danke) when the developer runs into a liquidity problem and is unable to pay for the completion of property construction, resulting in correlated buyer defaults.
As of June 2021, Evergrande Auto has RMB21.7 billion worth of rent financing guarantees outstanding.
#4: Evergrande Auto Borrowed Over RMB100 Billion With A Leverage Ratio of 67% At Its Peak
As alluded to above, Evergrande Auto is a highly leveraged company. From 2018 to 2020 alone, the company borrowed over RMB100 billion with total borrowings outstanding worth RMB73 billion at the peak of its indebtedness.
At the same time, Evergrande Auto's leverage ratio (defined as total borrowings as a percentage of total assets) stood at 67% in 2018 and 2019, before dropping to 48% in 2020. A more thorough look shows that the reduction in leverage comes from a 60% increase in total assets during 2020 due to a RMB31.8 billion increase in properties under development and a RMB10 billion increase in completed properties held-for-sale that year.
Liquidity Support for Hengda Group
Evergrande Auto's total borrowings outstanding halved during 1H2021 from RMB73 billion at the end of 2020 to RMB36 billion in June 2021. While this deleveraging may seem like a positive sign, a breakdown of the company's borrowings raises interesting questions. During the first half of 2021, Evergrande Auto repaid RMB40.5 billion worth of borrowings, the majority of which went to repaying its loans from Hengda Group. Indeed, total borrowings outstanding from Hengda ("shareholder borrowings" in the figure below) decreased from RMB38.4 billion in December 2020 to only RMB6.75 billion in 1H2021, a drop of about RMB31.7 billion. While it is not disclosed whether or not Hengda loans seem to have been given precedence because (the non-current parts of) these loans are next to be due, nevertheless, the timing and disproportionate amount perhaps suggest that Evergrande Auto may have been selectively channelling funds to support and fuel its mother company.
#5: Evergrande Auto Has A Growing RMB73 Billion of Accounts Payable Outstanding
While Evergrande Auto has been paying off some of its borrowings, in contrast, the company's accounts payable ballooned ten-fold from RMB7.3 billion in 2018 to RMB73 billion in 1H2021, mostly comprising of payments to third-party suppliers and contractors. In their most recent (interim 2021) report, management mentions delays in payments to suppliers and construction fees as a result of adverse liquidity problems.
#6: Evergrande Auto Has Insufficient Funds To Meet Its Immediate Liquidity Needs
To capture Evergrande Auto's liquidity standing, we compute the following metric:
(Cash and Cash Equivalents + Accounts Receivable)/
(Current Borrowings + Accounts Payable)
Clearly, Evergrande Auto has far from sufficient funds to meet its short term liabilities, with cash and accounts receivable covering just slightly over 20% of the company's anticipated liquidity needs the coming year.
#7: Evergrande Auto Has a Growing Equity Deficit of RMB12.1 Billion
In addition to the severe liquidity constraints, Evergrande Auto is also facing a widening equity deficit with a total equity of negative RMB12.1 billion in June 2021.
#8: Impairment Losses and Write-Downs
Evergrande Auto has recorded increasing total amounts of write-downs and impairment losses across a wide range of tangible, intangible, and financial asset categories.
*slight differences in total numbers may exist due to rounding
Impairment losses on intangible assets constituted the majority of the company's total impairment losses and write-downs in 2019 and 2020, with an impairment loss on intangible assets of RMB175 million in 2019 related to intangible assets that were "to be used for a terminated project" and an impairment loss on intangible assets of RMB808 million in 2020 due to intangible assets that were "un-utilized and not able to generate future economic benefits". Similarly, a RMB232 million impairment loss on goodwill was also recorded in 2020 due to a "reduction in further economic benefits" from Evergrande Auto's acquisition of a vehicle design and manufacturing company. Following its rapid property expansion in 2020, Evergrande Auto also recorded a RMB435 million write-down on properties under development and completed properties held-for-sale during the first half of 2021.
While the occasional impairment losses and write-downs are not uncommon, the frequency, magnitude, and timing at which such losses and write-downs occur does cast some doubt on the reliability of Evergrande Auto's accounting practices.
Conclusion and Future
On the surface, Evergrande Auto seems like a futuristic company that can thrive on some of China's most prominent macro-trends. On the contrary, a thorough investigation reveals a company that was likely founded to allow its mother group to more easily obtain land, acquire government grants (as evidenced in their financial reports), probably dodge regulatory restrictions on the real estate sector, and obtain additional funding. Evergrande Auto's financial condition has deteriorated to the extent that management has recommended caution in dealing with the company's securities in their interim 2021 report, while we also question the company's ability to continue as a going concern. Company chairman Hui Ka Yan alluded to the intention for Hengda Group to transition to become a core electric vehicle manufacturer within the next decade, but we highly doubt that this will happen. Rather, we think it is more likely that Evergrande Auto will be dissolved (or in a more optimistic case, acquired) as an extension of Hengda Group.
Holistically speaking, we believe that the financial ties between Hengda Group and Evergrande Auto should not be underestimated or ignored, including Evergrande Auto's RMB19 billion of loans outstanding guaranteed by Hengda (i.e. half of the company's total borrowings outstanding in June 2021). Additionally, Evergrande Auto's use of rent financing schemes, as well as the fact that RMB559 million of the company's completed properties were used as collateral to secure borrowing (as of December 2020), may also point to additional complications throughout the resolution process if one arises (see for example, Danke).
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Hengda (Evergrande) Conglomerate Series