OREANDA-NEWS. S&P Global Ratings said today that it revised its rating outlook on Shimao Property Holdings Ltd. to negative from stable. At the same time, we affirmed our 'BB+' long-term corporate credit rating on the China-based real estate developer and the 'BB' issue rating on the company's outstanding senior unsecured notes. In line with the outlook revision, we lowered the long-term Greater China regional scale rating on Shimao to 'cnBBB' from 'cnBBB+' and on the notes to 'cnBBB-' from 'cnBBB'.

"We revised the outlook because we anticipate that Shimao's weak leverage may not recover substantially over the next 12 months due to the company's prolonged destocking process and weak sales execution," said S&P Global Ratings credit analyst Matthew Kong.

In our base case, we estimate the company's debt-to-EBITDA ratio to hover around 5x in 2016 with minimal improvement, which is weak for the rating. Shimao's weaker-than-expected debt-to-EBITDA ratio of 5x in 2015 was a result of lower sales, missed revenue booking target, and eroded margins.

We expect Shimao to maintain a stable operating performance in 2016. However, we estimate that the company's property sales growth will remain at a low single-digit level for the year, compared to substantially high double-digit growth among peers. Its contracted sales for the first half of the year increased 9%, mainly benefiting from increasing average selling price (ASP).

In our view, Shimao's profit margins may slip to 27%-28% in 2016, from 28.5% in 2015. The increase in land price and the destocking in lower-tier cities offset the benefits from improving funding costs and operating expenses. However, the company's margins are still good among developers.

Nonetheless, we see greater potential improvement in Shimao's leverage from 2017 onward. We expect the company's sales to pick up substantially in 2017, given that it will largely complete its destocking while improving its execution capability. This will lead to good recovery in operating cash flows and revenue recognition. We expect its debt-to-EBITDA ratio to improve to about 4.5x in 2017 in our base case.

"We believe Shimao's discipline in land acquisition will support its rating due to a lower reliance on new debt for funding," said Mr. Kong. "The rating affirmation also reflects Shimao's established market position in China and good product and geographic diversity."

The negative outlook reflects our expectation that Shimao's leverage may not improve significantly and remain weak for the rating over the next 12 months. However, we believe that the company can maintain largely stable property sales and profit margins.

We may lower the rating if Shimao's sales performance is weaker than our estimates, such that property sales are materially below RMB70 billion. We could also downgrade Shimao if its debt-funded expansion is more aggressive than we expect, such that the company's debt-to-EBITDA ratio does not improve toward 4x.

We may revise the outlook to stable if Shimao can reduce leverage, such that its debt-to-EBITDA ratio improves significantly toward 4x and EBITDA interest coverage improves to more than 3x sustainably.