OREANDA-NEWS. S&P Global Ratings said today that it had revised its outlook on Hong Kong-based property developer Nan Fung International Holdings Ltd. to positive from stable. At the same time, we affirmed our 'BBB-' long-term corporate credit rating and 'cnA-' long-term Greater China regional scale rating on Nan Fung. We also affirmed our 'BBB-' long-term issue rating and 'cnA-' long-term Greater China regional scale rating on the senior unsecured notes that the company guarantees.

"The outlook revision reflects our view that Nan Fung's earnings quality is improving, supported by growing rental income that is of a stable and recurring nature. We expect the company's rental income to gradually increase and exceed its interest expenses in the coming 18-24 months," said S&P Global Ratings credit analyst Dennis Lee. "At the same time, we anticipate that the company's satisfactory project pipeline will underpin strong contracted sales in fiscal 2017 (ending March 31, 2017) and fiscal 2018. Moreover, we expect the company's large securities investment portfolio to continue to temper the volatility of its property development business and provide the company with significant financial flexibility to meet its financial obligations."

We may raise the rating if Nan Fung's ratio of rental income to interest expenses consistently exceeds 1x in the coming 18-24 months. At the same time, the company's property development business continues to improve with growing contracted sales and good project execution. In our view, the company will also demonstrate disciplined financial management with the maintenance of a highly liquid balance sheet and control of debt-funded expansion.

We could revise the outlook to stable in the following scenarios:We expect Nan Fung's rental income will no longer cover a significant portion of the company's interest expenses. Nan Fung's financial flexibility is severely impaired, which could arise from a material and sustained decline in the size and market value of the company's investment portfolio. Nan Fung's EBITDA interest coverage ratio does not improve, and fails to exceed our forecast of 3.0x in the coming 18-24 months. In assessing the financial leverage of Nan Fung, we include only property-related income in our credit metrics. We also proportionally consolidate the EBITDA and debt of off-balance sheet joint ventures (JVs) and associates in our analysis.

"Nan Fung's balance sheet is highly liquid, in our view. The company has consistently maintained a high cash balance and a large and high-quality securities investment portfolio," said Mr. Lee.

As of the end of fiscal 2016, Nan Fung's cash balance and assets under management in its portfolio of Hong Kong dollar (HK$) 36.7 billion exceeded its reported debt of HK$23.5 billion. We expect the portfolio size to remain relatively stable in the next two years. This is based on our assumption that Nan Fung is not going to largely withdraw assets from the portfolio and that its investment strategy will continue to generate stable dividend and interest income.

Nan Fung's securities investment portfolio provides additional financial flexibility, in our view. The company's financial leverage would substantially improve should it monetize the listed securities to repay debt (it would be in a net cash position in fiscal 2016 if it were to liquidate the portfolio).

We expect Nan Fung's ratio of rental income to interest expenses will continue to strengthen in the coming two years. In our base case, we forecast the ratio will stay at 1.10x-1.30x. We expect rental income to grow 5% in fiscal 2017 and 2018 on positive rental reversion, steady occupancy, and the commissioning of new projects in China.

We also believe Nan Fung's contracted sales will grow significantly in the next two years. The company has a fair mix of high-end and mass-market projects, which should provide some buffer against volatile market conditions in Hong Kong, in our view. Nonetheless, Nan Fung is a midsize developer in Hong Kong with fewer projects compared to larger developers that dominate the market. As such, the company's income and credit metrics could be more volatile and are largely affected by its project completion schedule. We expect the company's weighted average debt-to-EBITDA ratio will be 4.0x-5.0x for the next three years.