OREANDA-NEWS. Fitch Ratings has affirmed Lai Fung Holdings Limited's (Lai Fung) Long-Term Foreign-Currency and Local-Currency Issuer Default Ratings (IDR) at 'BB-'. The Outlook is Stable. The agency has also affirmed Lai Fung's senior unsecured rating at 'BB-'. The full list of rating actions is at the end of this commentary.

The rating affirmation is based on Lai Fung maintaining low leverage and stable growth in rental income. Its ratings are constrained by its small operating scale, with only two investment properties generating rental revenue of over HKD100m per year. These properties are subject to competitive pressures although they are well located. Lai Fung's flagship development project in Hengqin (an island near Macao) does not pressure its ratings, as debt headroom is sufficient to fund the project development. The enlarged scale and improved diversification of its income may enhance its business profile, upon successful completion of this project in 2019.

KEY RATING DRIVERS

Prudent Financial Management: Lai Fung maintained its low leverage, measured using total debt/property assets, at 26%-28% in the first half of financial year 2016 (1HFY16) and FYE15 ending 31 July, as it staggers its property sale to supplement its main business of real-estate leasing. Lai Fung is not active in the land market, with only 6.3 million square feet (sq ft) of attributable gross floor area (GFA) of residential space in its land bank as at January 2016; instead, it progressively sells homes at projects that were mostly acquired several years ago at lower costs. The sale proceeds are used to support the expansion of its investment property portfolio, which the management aims to expand to 6 million sq ft in FY18 from 2.9 million sq ft as 1HFY16.

Concentration of Rental Income: Fitch expects Shanghai Hong Kong Plaza, Lai Fung's flagship investment property, will account for about 50% of Lai Fung's rental revenue in FY17-FY18 as the company completes additional investment properties. Shanghai Hong Kong Plaza has accounted for over 60% of Lai Fung's gross rental revenue since FY11 (FY15: 65%). We also expect the economic slowdown and intensifying competition from online shopping to limit rental upside, though it benefited from a surge in rental income after a new food and beverage area was created in FY14.

Residential Projects in Prime Cities: Fitch estimates the gross profit margin of Lai Fung's development properties (DP) to stay above 40% in the medium term (FY15: 45%), underpinned by its quality DP portfolios. Lai Fung holds residential property projects in Shanghai, Guangzhou and Zhongshan, where the housing oversupply is small. The projects in Shanghai and Guangzhou are situated in prime areas, which lead to satisfactory profit margins. We believe Lai Fung has no intention to expand its property development business substantially, and is likely to sell its inventory gradually.

Hengqin Project a Long-Term Positive: The Hengqin Creative Culture City project will become an important source of recurring income after completion in 1HFY19, and will contribute significant sellable resources from the planned serviced apartment units. We expect the development of this project to increase Lai Fung's leverage to above 30% in the short to medium term, though still below the threshold where Fitch would consider negative rating action. Lai Fung will need to spend around CNY2.4bn for its 80% stake in Phase 1 of the project. The development of the project is on track - construction started in 2HFY15, and the company had signed license agreements with some content providers.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

- Weak growth in China's retail sector, resulting in flat - to low-single-digit percentage rental growth at Lai Fung's Shanghai Hong Kong Plaza.

- Average selling price for its development properties at HKD1,800-2,000 per sq ft during FY16-FY18 (FY15 ASP: HKD4,309/sq ft) with more contracted sales from the high-rise residential project in Zhongshan.

- Hengqin project to complete in 1HFY19 and start to fully contribute revenue from FY20, and presales of the serviced apartments units to begin from FY18.

RATING SENSITIVITIES

Positive rating action is not expected in the next 18-24 months due to Lai Fung's small operational scale. However, developments that may, individually or collectively, lead to positive rating action include:

- EBITDA from investment properties rising above HKD600m (FY15: HKD396m, 1HFY16: HKD193m)

- EBITDA for investment properties/interest expenses exceeding 1.5x on a sustained basis (FY15: 1.3x, 1HFY16: 1.2x)

Negative: Developments that may, individually or collectively, lead to negative rating action include:

- EBITDA for investment properties/interest expenses falling below 1.0x on a sustained basis

- Total debt/property assets exceeding 40% on a sustained basis (FY15: 28.4%, 1HFY16: 26.8%)

- Increase of development assets to above 25% of total property assets (FY15:16.4%, 1HFY16: 14%)

FULL LIST OF RATING ACTIONS

Long-Term Foreign-Currency IDR Affirmed at 'BB-', Outlook Stable

Long-Term Local-Currency IDR Affirmed at 'BB-', Outlook Stable

Foreign-currency senior unsecured rating affirmed at 'BB-'

Local-currency senior unsecured rating affirmed at 'BB-'

CNY1.8bn senior unsecured notes due 2018 affirmed at 'BB-'