OREANDA-NEWS. China's Xinyuan Real Estate Co., Ltd. (Xinyuan; B/Stable) has adequate land bank for the next two years of development, following aggressive acquisitions in 2016, but sustaining its land bank quality while improving leverage is crucial to maintaining its rating, says Fitch Ratings.

Xinyuan has announced acquisitions of CNY3.6bn in China and the US so far in 2016, after not making any acquisitions in 2015, with a cash outlay of CNY2.6bn after accounting for returned land deposits and prepayments. Xinyuan's total sellable gross floor area (GFA) of 2.56 million square metres (sq m) at end-June 2016 in China and US will last two years, based on 2016 expected sales. Its land bank remains low compared with 'B' rated peers, but in April the company completed its land bank replenishment needs in Beijing and Kunshan for 2016, mitigating further land-price surges.

Robust housing sales in Xinyuan's core markets of Zhengzhou, Kunshan, Jinan and Tianjin led to the homebuilder increasing its contracted sales by 55.3% yoy to CNY4.9bn (USD754m) in 1H16, beating Fitch's expectations and meeting around half of its original CNY9.5bn-10bn sales target. Fitch believes Xinyuan can achieve its revised sales target of CNY12bn in 2016, with rising average selling prices (ASP) in second-tier cities and the planned launch of six new projects in Zhengzhou, Beijing and Kunshan in 2H16.

Sturdy contracted sales have created significant land replenishment pressure for homebuilders in China, especially as China's land sales remain subdued. Homebuilders' strong liquidity and easier funding access allows them to compete aggressively for new land deals and drive the rapid rise in land prices. Fitch expects Xinyuan's leverage to hover around 45%-50% in 2016-2017 (1H16:44.8%, 2015:45.0%), assuming a moderate acquisition pace at higher land prices, with cash-land-premium-paid/contracted-sales at 40%-45%.

Apart from normal public auctions, Xinyuan pays advance deposits to local government or industry partners, mainly in the Tier 2 cities of Zhengzhou, Jinan and Xi'an, to secure a large part of its land bank. The homebuilder has secured around 2 million sq m of land bank in Zhengzhou and 0.2 million sq m in Xi'an via deposit as of end-June 2016. This acquisition strategy creates uncertainty about Xinyuan's land bank. Fitch expects some deposits to be returned as big developers march into less-heated Tier 2 cities and drive up land prices.

China Jinmao Holdings Group Limited (BBB-/Stable) make its first land purchase in Zhengzhou on 18 August 2016, paying CNY3.5bn, which represents an average GFA price of CNY36,920/sq m. If the land price surge spreads across Zhengzhou, it will drive up average selling prices for Xinyuan's existing projects and enhance its margins over the next two years, but would also endanger the homebuilder's potential land parcels, agreed at CNY2,000/sq m-3,000/sq m when paying the deposits.

Fitch expects Xinyuan's gross margin to recover from 2H16 into 1H17, in line with surging ASPs in its core cities and recognition of the Oosten project in US. This follows a slight decline to 27% in 1H16, after adding back capitalised interest, from 28% in 2015, due to recognition of low-margin projects in Suzhou, Jinan and Kunshan. The homebuilder's EBITDA margin improved to 15.2% in 1H16, from 14.7% in 2015, due to management's continued efforts to reduce selling, general and administration costs. However, the improvement in Xinyuan's gross margin could be jeopardised from 2H17 if land acquisition costs sprint ahead of the rising ASPs.