Among the many financial markets developments the previous year, Hengda (China Evergrande) Group's debt crisis undoubtedly stood out as one of the most concerning to investors. Previously in our Hengda series (here), we analyzed the Evergrande conglomerate's financials to reveal an extremely highly leveraged and indebted company that only had sufficient liquid assets to cover 22% of its short term financial liabilities. In this special report, we analyze and compare the financial standing of China's five largest (predominantly residential*) real estate companies (namely Hengda and other peers) to evaluate the sector's status quo.
Hengda (China Evergrande) Group (恒大集团)
Sunac China Holdings (融创中国)
China Vanke (万科集团)
Country Garden (碧桂园)
Greenland Holdings (绿地控股)
Additionally, we also examine the "three red lines" (Chinese: 三道红线) - regulatory requirements imposed by the Chinese regulators in August 2020 to curb excessive risk-taking and promote better financial discipline in the domestic real estate market, including analyzing how each developer is progressing in meeting these requirements, and discussing what the future may hold for the Chinese real estate industry.
*China's real estate industry is dominated by the residential sector
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We first walk through a series of profile summaries for each of the real estate companies.
Hengda (China Evergrande) Group (恒大集团) (HKEX: 3333)
Hengda is a private (i.e. non-state owned) real estate company founded in 1996 that markets itself as a diversified conglomerate with supplementary non-core businesses including property management, healthcare, electric vehicle manufacturing, cultural tourism, and a wealth management platform, as well as two key associate companies Shengjing Bank (Chinese: 盛京银行), the largest bank in northeast (东北) China, and Evergrande Life Insurance (Chinese: 恒大人寿保险), previously the Chinese joint venture arm of Singaporean finance and insurance company Great Eastern. As of December 2020, Hengda had 798 real estate development projects with 231 million square metres of land reserves throughout China, while property development accounted for 97% of the Group's total revenue.
Note: all of the real estate companies discussed in this article are engaged in, or market themselves as being engaged in, diversified businesses, albeit with a heavy reliance on property development and/or construction as core revenue drivers. Some of the supplementary businesses are legitimate initiatives, while others may potentially be indirect ways to obtain more land and government grants for real estate development (for example, see our discussion of Hengda's corporate governance failures here).
During summer 2021, rumours surfaced online that Hengda was experiencing liquidity difficulties and had written a letter to the Guangdong (where the company is based) provincial government warning of potentially large scale adverse consequences on third-party creditors (including a large number of local contractors and suppliers), home buyers and employees, if the company's liquidity issues were to deteriorate further.
In December 2021, Fitch Ratings downgraded Hengda’s credit rating due to a subsidiary company’s non-payment of coupons for an offshore bond.
Sunac China Holdings (融创中国) (HKEX: 1918)
Sunac is a private real estate company founded in 2003 that has since expanded nationwide with a "real estate plus" model that greatly resembles the Evergrande conglomerate. Specifically, although more than 90% of Sunac's revenue is derived from property development, the company also has property management services, conference and exhibition centres, in addition to a myriad of additional businesses including cultural tourism, medical and healthcare initiatives, as well as intellectual property investments to develop animated movies and dramas. As of June 2021, Sunac is engaged in 964 property development projects with a gross floor area (GFA) of 416 million square metres and total land bank of 278 million square metres.
Sunac's shares were suspended from trading on the Hong Kong Stock Exchange on 1 April 2022 due to the company's failure to publish its 2021 financial results within the required time period. The following month, Sunac released an announcement stating that the company had defaulted on interest payments totalling US$29.5 million for its October 2023 senior notes. Additionally, Sunac had also missed interest payments totalling US$75 million for the company's April 2023, April 2024, and October 2024 senior note issues.
China Vanke (万科集团) (HKEX: 2202) (SZEX: 000002)
Vanke is an initially private real estate company founded in 1984 that focuses on China's three major economic circles (Chinese: 三大经济圈, see below) and key cities in the midwest region (e.g. Chengdu, Chongqing, and Wuhan).
China's three major economic circles refer to:
The Pearl River Delta area - e.g. Guangzhou, Foshan, Shenzhen cities
The Yantze River Delta area - e.g. Shanghai city, and surrounding Zhejiang and Jiangsu provinces
The Bohai Sea coastal area - e.g. Beijing city, Tianjin municipality, and Shandong province
In 2017, Shenzhen Metro Group Company (Chinese: 深圳地铁), became Vanke's largest shareholder, resulting in a mixed private-public ownership structure.
Note: Shenzhen Metro Group Company Limited (SZMC) is a state-owned enterprise under the commission of Shenzhen's city government. SZMC develops and operates Shenzhen's rail transit system, but is also engaged in property development and public construction.
More than 90% of Vanke's revenue comes from property development and sales, although the company has expanded its scope of business to include property management services, retail property development and operations (e.g. malls), logistics warehousing, rental housing, and education (i.e. small scale schools).
As of December 2021, Vanke has an estimated GFA under construction of 103.67 million square metres and a GFA for planned projects of 45.2 million square metres.
Country Garden (碧桂园) (HKEX: 2007)
Country Garden is a private Chinese residential property developer founded in 1992 that describes itself as a diversified technology company whose businesses include property development and construction, property investment, hotel development and operations, as well as other initiatives related to smart construction, robotic catering, new retail, and modern agriculture. In spite of Country Garden's seemingly diversified business model, 97% of the Group's revenue is generated from property development, followed by the rendering of construction services contributing just under 2% of revenue, while the remaining 1% comprises of the company's miscellaneous businesses and rental income.
As of December 2021, Country Garden has 3,216 projects across mainland China with a total landbank (including those of the Group's joint ventures and associates) of 253 million square metres, of which 158 million square metres are GFA under construction, 86 million square metres are acquired land for projects which have not commenced construction, while the remaining 9 million square metres are completed projects.
Greenland Holdings (绿地控股) (SHA: 600606)
Greenland Holdings is a mixed-ownership holdings company originally founded in 1992 by the Shanghai local government as a state-owned developer focusing on real estate and infrastructure projects. Over time, the company expanded its scope of business to include additional initiatives such as hotel development and operations, financial services, energy-related businesses, and automobile dealerships, while also going through a restructuring process that resulted in a mixed private-public ownership structure with the Shanghai local government indirectly holding a majority 46% share of the company and former and current employees owning approximately 29%.
In 2021, infrastructure projects and construction services (including construction for residential and related buildings) constituted 57.6% of Greenland's total revenue, while generic real estate development accounted for 37.9%. Combined, infrastructure projects, construction, and real estate development comprise 95.5% of Greenland's total revenue.
Note: for the sake of clarity, construction services refer to the actual physical provision of construction (i.e. building) services, whereas real estate development refers to oversight of the broader development process from inception (e.g. acquiring raw land and obtaining the necessary permits) to project completion. As part of the real estate development process, physical construction may be carried out in-house or by outsourcing to a third-party contractor.
As of December 2021, Greenland has 4,395 property development projects under construction across China spanning a GFA of 152 million square meters, in addition to 17 million square meters of acquired land (with a planned GFA of 31 million square meters) that has yet to commence construction, and 78 million square meters in GFA of completed properties.
In May 2022, Greenland negotiated a one-year maturity extension for the company's US$488 million worth of senior notes outstanding that were originally scheduled to mature the following month.
The Three Red Lines
In August 2020, the People's Bank of China and the Ministry of Housing and Urban-Rural Development (Chinese: 住房和城乡建设部) issued a series of regulatory requirements for real estate companies commonly known as the "three red lines" (Chinese: 三道红线).
The three requirements are:
A Net Debt/Total Equity ratio below 100% by 30 June 2021
A Cash/Short-Term Debt ratio above 1x by 31 December 2021
A Total Liabilities/Total Assets ratio (excluding advance receipts from customers) below 70% by 31 December 2022
The first and third ratios capture each company's level of leverage, while the second is a measure of liquidity.
In this section, we delve further into each of the three requirements and examine the evolution of these regulatory ratios for the five major real estate companies.
Note: Hengda and Sunac have yet to release their full year 2021 report, while financial information for Greenland Holdings is only available for the year 2014 onwards. Greenland Holdings went public in 2015 via a shell company acquisition, although some of Greenland's individual subsidiaries were publicly listed prior to this.
#1: A Net Debt/Total Equity Ratio Below 100% (Deadline: 30 June 2021)
The net debt/total equity ratio is defined as:
(Short- and Long-Term Interest-Bearing Liabilities - Cash and Cash Equivalents)/Total Equity
While the companies under consideration also subtract all restricted cash to reach net debt, we compute a more conservative measure by only including the restricted cash that has specifically been identified as serving as guarantee deposits for bank loans, as opposed to other forms of restricted cash such as restricted cash from property pre-sale proceeds (where a certain propotion of sales proceeds are required to be kept as bank deposits in accordance with local regulations) or guarantee deposits for banker's acceptances. It is noted that the official regulatory announcement does not specifically mention the treatment of restricted cash.
Note: Vanke management attributes the company's drop in 2014 ratio to "a substantial increase in cash and cash equivalents"
Looking at the five real estate companies, we see that Country Garden and Vanke have consistently maintained net debt/total equity ratios below 100% both prior to and following the launch of the three red lines. In contrast, Hengda, Sunac, and Greenland had relatively high net debt/total equity ratios throughout the past decade. Greenland's net debt/total equity ratio was in the 200% range around the time the company went public, before decreasing over time to be in compliance with the regulatory requirement by the end of 2021. In contrast, Hengda's and Sunac's net debt/total equity ratios started off lower than Greenland's but increased significantly towards the middle to latter half of the past decade, reaching record highs of 240% and 229% respectively in 2017.
#2: A Cash/Short-Term Debt Ratio Above 1X (Deadline: 31 December 2021)
The cash/short-term debt ratio is defined as:
(Cash and Cash Equivalents)/(Short-Term Interest-Bearing Liabilities)
Comparing the five companies, Country Garden, Vanke, and Greenland have consistently maintained their cash/short-term debt ratios to be above the 1X threshold over the entire time period, while Sunac met the threshold in every year except 2012 and 2019. Hengda's cash/short-term debt ratio was significantly lower than the 1X threshold in almost every year, with particularly alarming magnitudes in the second half of the past decade. Specifically, Hengda's cash balance could only cover 36% to 47% of its short-term debt due each year during 2017 to 2020.
Note: as above, we compute a more conservative metric by only including the restricted cash that has specifically been identified as serving as guarantee deposits for bank loans, as opposed to all restricted cash. Again, the official regulatory announcement does not specifically mention the treatment of restricted cash.
#3: A Total Liabilities/Total Assets Ratio Below 70% (Deadline: 31 December 2022)
The total liabilities/total assets ratio is defined as total liabilities on the balance sheet divided by total assets, excluding the cash provided by advance payments from customers and the associated contract liabilities on both sides of the fraction, i.e.
(Total Liabilities - Contract Liabilities)/(Total Assets - Advance Payments From Customers)
The five companies show less variation with regards to their total liablities/total assets ratios than with the other two red line metrics. Specifically, during the past five years, all of the companies maintained a total liabilities/total assets ratio in the mid-70% to mid-80% range. However, as of the end of 2021, only Vanke is able to meet the 70% regulatory threshold, and it remains to be seen whether the company's peers will be able to deleverage in time for the December 2022 deadline. Country Garden is more likely to succeed with only a 5.7% drop in leverage needed, while the already in-distress Hengda, Sunac, and Greenland are arguably less promising.
The Issue of Liquidity
We focus more on liquidity in this section by expanding the second red line requirement (i.e. cash/short-term debt) to compute a more comprehensive ratio that captures the extent to which each developer's current liquid assets are able to cover its current financial liabilities due the same year. Previously, in our analysis of Hengda (here), we discovered that whilst the Group's short-term debt and total borrowings declined from 2019 to 1H2021, the debt reduction was offset by accumulating payments due to suppliers and contractors which eventually resulted in an accounts payable balance (including lease liabilities) of nearly RMB1 trillion by June 2021. We argue that accounts payable are an important component of current liabilities that should not be ignored. Indeed, comparing the two diagrams below shows that companies' accounts payable balances can significantly exceed their levels of short-term debt outstanding.
Note: Greenland's data starts in the year 2014 in both this diagram and below
Note: the accounts payable for Hengda during 2019-2020 in this article are slightly different from the numbers used in our Hengda series. This is because Hengda is the only company among all five under consideration to report lease liabilities as part of accounts payable. Consequently, for the sake of comparison, we have removed lease liabilities from Hengda's accounts payable data used in this analysis, whereas the accounts payable data used in our Hengda series are the reported numbers inclding lease liabilities in 2019 and 2020.
Consequently, we compute a financial liability coverage ratio defined as:
Liquid Current Assets/(Short-Term Debt + Accounts Payable)
Liquid current assets are defined as all current assets which can be easily converted into cash (including marketable securities and accounts receivable, but excluding illiquid current assets such as property inventory).
While all of the companies except Hengda (and to a lesser extent, Sunac) satisfy the cash/short-term debt requirement (reproduced below for the sake of comparison), none of the companies have sufficient liquid current assets to cover their short-term debt and accounts payable in 2020. During boom times when developers can quickly sell their illiquid inventory properties at relatively high prices this may not be a problem, but once demand and housing prices drop developers may find themselves struggling to meet their liquidity needs. Indeed, this was the case with Hengda, which reported increasing volumes of property inventory and low clearance sale prices leading up to its descent into distress.
We conclude this article by summarizing some final thoughts.
The Evergrande Conglomerate Is Not An Outlier
Hengda is more indebted than its peers in terms of the amount of debt and trade balances outstanding, but it is by no means an outlier in terms of leverage or liquidity levels. Although Hengda does have a substantially lower liquidity coverage ratio than its peers, none of the five companies we examined have sufficient liquid current assets to cover their financial liabilities due within a year, reflecting a common reliance on liquidating inventory for short-term cash flow needs which subjects the firms to a significant degree of market risk.
Trade Balances Should Not Be Ignored
As highlighted in our Hengda series article (here), from a regulatory perspective, trade balances including accounts payables due to third-party entities should not be ignored. Although traditional regulatory metrics such as the three red lines use debt-based measures of liquidity, it is clear that real estate developers can accumulate massive trade balances that even exceed borrowings by a significant amount (including total borrowings, such as in the case of Country Garden and Vanke below). While delaying or missing payments to suppliers and contractors may have less severe consequences for a firm relative to missing debt payments, such actions can still be socially detrimental especially when the firm has far more market power than its contractors (as is often the case in the Chinese real estate sector, for example, see our article on Hengda's corporate governance failures here).
The Future of China's Real Estate Industry
Needless to say, China's real estate industry is and will be undergoing a period of major changes and overhauls. Though useful, the three red lines were implemented rather late, while additional regulatory enhancements will likely be needed in the future to ensure a healthy, functioning industry. Developers also face a long road ahead with significant deleveraging milestones to reach and liquidity improvements to make, while those companies in distress will likely need to draw up resolution plans with the regulators in order to forge a way out. Although Hengda's debt crisis is unique in terms of its colossal size and scale, the correlated, smaller scale distress faced by other firms can potentially put a strain on the local regulators already working with distressed developers and affected parties to find a socially optimal solution (read our Concluding Evergrande article here for further information). All in all, a sector-wide collapse is highly unlikely, but we do anticipate tough times ahead for the industry.
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