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Rating Action:

MOODY'S ASSIGNS FIRST-TIME PROSPECTIVE (P)Baa3 RATINGS TO CHINA OVERSEAS LAND & INVESTMENT; OUTLOOK STABLE

13 May 2005
MOODY'S ASSIGNS FIRST-TIME PROSPECTIVE (P)Baa3 RATINGS TO CHINA OVERSEAS LAND & INVESTMENT; OUTLOOK STABLE

Hong Kong, May 13, 2005 -- Moody's Investors Service has assigned a prospective (P)Baa3 rating to the proposed senior unsecured bonds to be issued by China Overseas Finance (Cayman) I Limited and guaranteed by China Overseas Land & Investment Ltd (COLI). At the same time, Moody's has assigned a prospective (P)Baa3 issuer rating to COLI. The ratings outlook is stable. This is the first time that Moody's has assigned a rating to COLI. The rating agency expects to confirm these ratings upon completion of the bond issuance. The bond proceeds are to be used to refinance existing debts and fund future capital expenditure requirements.

The (P)Baa3 ratings reflect the following key credit strengths of COLI: (1) strong local knowledge and project management expertise support the company's position as one of the leading property developers in China, (2) possession of low-cost and sizeable landbank enables business flexibility; (3) diversification into second-tier cities should lower exposure to a few core markets, and (4) strong credit metrics with large cash holding.

At the same time, the ratings reflect the following key credit challenges: (1) cash flow being susceptible to volatility in the property development business, (2) the uncertain operating environment of the evolving China property markets, which are vulnerable to regulatory and policy changes, (3) the low level of stable recurring income, and (4) the company's ability in managing its expanding business through property cycles in China is yet to be proven.

COLI is a leading residential property developer in China and has strong brand equity in the industry. Its long presence of over 10 years in the Mainland and good relationship with local governments through its close ties with its ultimate parent, China State Construction Engineering Corp (CSCEC) -- which is the largest construction company in China directly under the central government -- have enabled it to build up a profound understanding of domestic market conditions and regulatory requirements. This, coupled with the CSCEC group's expertise as a leading construction contractor in the Mainland, has allowed COLI more effective cost control and project management of its Mainland residential property developments, one of the key operating challenges in China.

COLI has established strong presences in its four core markets: Shanghai, Shenzhen, Guangzhou and Beijing. It has, recently, begun diversifying into other large provincial cities, such as Chengdu, Xian, Suzhou and Nanjing in view of possible overheating in some of its core markets. Moody's believes that this strategy entails some business and execution risks, but COLI's selective approach and local knowledge will help mitigate these. Such a strategy, if successfully implemented, will offer geographic diversification to its income and asset in the medium term, as these cities exhibit decent economic growth and their property markets are generally less competitive than COLI's 4 core ones.

The (P)Baa3 ratings further reflect Moody's concern about the highly cyclical and unpredictable China property markets -- a result of their developing nature and changing regulations and policies -- although Moody's acknowledges that long-term housing demand prospects remain favorable, driven by continued economic growth and urbanization trend in China.

Operating in this high business risk environment, COLI's cash flow is subject to higher volatility than its peers in other regions. Furthermore, the company's ability to manage its expanding business and demonstrate strong cash flow generation in China is yet to be proven, as the China property markets have been on the uptrend in past years.

Countering this high business risk, the (P)Baa3 ratings factor in the agency's expectation of COLI's commitment to diligently managing its borrowings, containing its leverage below 30% over the medium-term and maintaining minimum cash equivalent to 10% of total assets. Moody's further expects the company to maintain strong discipline in its future property developments and infrastructure investments.

Moody's takes comfort that COLI's current large and low-cost landbank, due to the company's early entry and good local relationships, could provide some degree of business and operational flexibility to help weather a down-cycle. Its 9.5 million m² landbank is sufficient for about 4-5 years of development. In addition, COLI has good access to the bank loan market -- even in face of China's tightened lending to the property sector -- supported by its established and extensive relationships with banks in Hong Kong and China. Moody's expects that any further tightening of property financing or policies in China will not materially interrupt COLI's funding access, given its healthy financial profile and established market position.

COLI is seeking to optimize its income mix over the medium term while continuing its core development business in order to lower the impact on its cash flow of property development cyclicality and reduce the risk of exposure to a single market. Aside from expanding into selected provincial cities, it seeks to raise the level of more stable income accruing from its infrastructure projects and property investments to 30% of EBIT (excluding EBIT from the construction business which is to be spun-off) over the next 5 years from 13% in FY2004. While this measure introduces a degree of event risk, Moody's expects that the diversification will be progressive and investments will focus on completed and income-generating assets with reasonable returns.

Leverage is projected to peak in FY2005 at mid-30% and Moody's expects debt service ratios to improve afterwards with expected strong cash inflow from properties sale beginning in 2007, given its development completion schedule. As a result, leverage is anticipated to trend down to mid-20% in FY2007-2008 while Operating cash flow (OCF)+Int/Int should remain above 10x on average over the next few years.

The level of contingent liabilities with respect to counter indemnities for construction projects is expected to reduce. This is because COLI intends to spin-off its Hong Kong construction business into a separate company for listing on the Hong Kong Stock Exchange. Moody's understands that most of the surety bonds for construction projects will be taken over by the new company and it will also counter-guarantee any remaining bonds issued by COLI. Taken this into consideration, adjusted leverage is projected to be at mid-30% by FY2007-2008.

Moody's considers the proposed spin-off of COLI's construction business and the listing of 79%-owned China Overseas Property Group (COP) on the Shanghai A-share market, while introducing a certain degree of structural complexity, as neutral to COLI's credit ratings.

COP holds property developments and investment operations in Beijing, Shenzhen, Changchun and Nanjing. It is COLI's intention to retain a majority interest and management control of COP after its listing and as such, COP's performance and financials will continue to be fully reflected in COLI's consolidated financial statements.

The ratings could experience upward pressure if leverage were maintained at below 20% and OCF+Int/Int at above 15x on a sustainable basis. This could stem from (1) successful diversification of property development business into second-tier cities, (2) significant increase in absolute level of stable recurring income from infrastructure investments, and/or (3) achievement of project development and sales as projected by the company. In addition, COLI has to exhibit the ability to effectively manage its financial profile over the property cycle in China.

On the other hand, the ratings could undergo a downgrade if COLI's key financial metrics did not show improving trend after 2005 which could be a result of (1) a significant downturn in China's property market and no counterbalancing actions were taken by COLI, such as de-leveraging, or (2) an aggressive land acquisition plan or a capex plan for infrastructure investments that did not provide adequate returns, such that leverage > 30% and OCF+Int/Int < 8x across the cycle.

China Overseas Land & Investment Limited (COLI), a majority-owned subsidiary of the state-owned China State Construction Engineering Corporation (CSCEC), is one of the largest property developers in China. Its principal businesses are residential property developments, property investments and management and infrastructure project investments.

Hong Kong
Kasemsak Charoensiddhi
Analyst
Corporate Finance Group
Moody's Asia Pacific Ltd.
Telephone: 852-2509-0200
Facsimile: 852-2509-0165

Hong Kong
Clara Lau
Senior Vice President
Corporate Finance Group
Moody's Asia Pacific Ltd.
Telephone: 852-2509-0200
Facsimile: 852-2509-0165

No Related Data.
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