E-House Downgraded To 'BB-' On Faster Debt Expansion, Slower Revenue Growth Amid COVID-19; Outlook Stable

  • We expect E-House (China) Enterprise Holdings Ltd.'s debt leverage to increase, following recent property acquisitions, and 2019's slower operating cash flow recovery and non-core business spending.
  • Furthermore, the real estate service provider's revenue growth in 2020 will be largely constrained by the COVID-19 outbreak, likely causing a drop in property sales and its agency fees.
  • On March 25, 2020, S&P Global Ratings lowered its long-term issuer credit rating and issue ratings on E-House to 'BB-' from 'BB'.
  • The stable outlook reflects our expectation that the company's leverage will stabilize at a debt-to-EBITDA ratio of 2.5x-3.0x over the next 12-24 months. We expect its revenue to resume mild growth in 2021, underpinned by a large project pipeline and its strong market position.
HONG KONG (S&P Global Ratings) March 25, 2020--S&P Global Ratings today took the rating actions listed above.
We downgraded E-House to reflect a spike in leverage that will unlikely turn around substantially in the next one to two years. This is partly due to the blow from the COVID-19 outbreak on E-House's primary real estate agency business and debt expansion that is faster than we had expected.
Our downgrade also reflects our expectation that E-House's operating cash flow continued to be negative in 2019. We expect the deficit to be mainly due to the company's investment into its network brokerage business "Fangyou" via advance commission payments to network participants and high "concession money" it pays to developers to secure projects.
We expect E-House's spending on shareholder-friendly measures, non-core businesses, and investment in fixed assets to weigh on its leverage. After almost US$100 million in share repurchases in 2019, the company recently acquired various buildings and office spaces in Shanghai for employee training and education for Chinese renminbi (RMB) 1.6 billion. We estimate at least half of that amount will be debt funded. We therefore project its leverage to deteriorate to 2.2x-2.4x in 2019 and 2.7x-2.8x in 2020, from only 0.7x in 2018.
We believe E-House's primary agency business is likely to decline 10% in transaction volumes in 2020, in line with our view on the property sector. Its Fangyou business will also be constrained by the coronavirus outbreak and lower its growth to 20%-25%. This compares with our previous assumption of 4%-5% growth in E-House's transaction volumes and 35%-40% increase in Fangyou's business. Therefore, we expect E-House's revenue to only increase 4%-5% in 2019 and 6%-8% in 2020.
In our view, E-House will maintain its lead in most of its business segments, especially in primary agency and Fangyou. For instance, we estimate its primary agency's market share to have increased to 4.5%-5.0% by end 2019, from 3.5% the year before. As of June 2019, E-House had a total project pipeline for primary agency services of more than 280 million square meters. This solidly supports its earnings stability over the next five to six years, in our view.
We expect E-House's operating cash flow to turn positive this year, given the company is taking measures such as customer base diversification and its focus on projects with timely commission payments. With developers facing tighter liquidity, accounts receivable days will likely increase slightly again in 2020 but its impact on operating cash flow should be mild. This is because we expect the concession money paid to developers will not increase and Fangyou business growth to slow.
We see no imminent liquidity risks because we estimate short-term debt to be at most about RMB1.5 billion, versus RMB3 billion–RMB4 billion in cash, as of end-2019.
The stable outlook reflects our expectation that the company will maintain good profitability over the next 12-24 months and its revenue will mildly rebound. We also do not expect leverage to further deteriorate; its debt-to-EBITDA ratio should stay at 2.5x-3.0x. E-House's working capital management should also improve such that operating cash flow turns positive from 2020.
We may lower the rating if E-House: (1) pursues more significant debt-funded investments than we expect; or (2) has lower revenue and profitability than we currently estimate due to intensified competition, such that its debt-to-EBITDA ratio rises to above 3.0x over the next 12-24 months without signs of improvement.
We may also downgrade E-House if the company demonstrates weaker working capital management than we expect, such that its operating cash flow does not substantially improve in 2020 or 2021.
Rating upside is limited in the next 12 months unless E-House can control its debt growth and further repay its onshore or offshore financings. At the same time, it will need to demonstrate stable business growth leading to a sustained positive operating cash flow. A debt-to-EBITDA ratio remaining below 2.0x with an operating cash flow-to-debt ratio of above 20% would be indicative of such an improvement.
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