In the first half of the year it generated $44bn of revenues and $4.5bn of profits, paying out half in dividends. It has $98bn of debt, $44bn of it due within the next twelve months.
Any first-year business and accounting student can tell you it is highly unsustainable. $4.5bn profits and you pay out half in dividends. The amazing thing is that for 1H2018, it paid out $4.2bn in interest payments!!! If it had no debt, net profits would have doubled.
(owner, Hui Ka Yan)
Assuming you do the same for the second half of 2018, you have $4.5bn to cover the $44bn due over the next 12 months. That's provided the $4.5bn is real net positive cash flow and not gains on revaluation of assets.The key here was that Evergrande has recorded NEGATIVE CASH FLOW every year since 2010!!! Every bloody year. It has been running on fumes. As long as property markets there remain speculative and robust, the fumes will not be so toxic... but...
So what triggered the calamitous view? Read below:
The owner, Hui Ka Yan, had to put in $1.8bn of his own money to subscribe to the new company fund rasing bond. The coupon rates were 11%-13% p.a. ... where on earth do you get a company bond with that coupon rate??? I mean, one of the largest listed stock in China/HK.
It means, no banks want to lend any more, they have maxed out usual suspects for fundraising. Look at their net profit ratio to revenue, they barely make 10%. That would not be sufficient to pay the coupon rate even.
Why Care About Evergrande
- It is the largest China property company by revenue.
- It is also the most indebted developer there.
- It still has a market capitalization of $30bn, the potential domino effect should it fail will be catastrophic.
- An implosion of the country's largest developer will see a lot of its property holdings for investments being sold, which will further flood the marketplace. Any signs of weakness in the leader will further exacerbate other property developers in terms of their borrowing cost.
- We may see a "who can get out fastest" among the developers soon.
Evergrande's assets, as suggested above, are large. For instance, its current land reserve, which spans 822 projects, covers a mammoth 305m square meters, close to 120 square miles, a touch below the size of Malta.
We thought we'd turn our attention to a corner of that expanse, $23bn worth of investment properties. According to one equity analyst we spoke to, little attention is paid to these investments which, despite only accounting for 9 per cent of total assets, represents half of Evergrande's equity due to its levered nature.
According to its half-year report, Evergrande's investment properties “include commercial podiums in living communities, office buildings with gross floor area of about 8.43 million square meters and approximately 408,000 car parking spaces”.
Yet it does not look like these investment properties generate much cash. In the past six months, rental income from investment properties amounted to $68m, an annualised yield of only 0.6 per cent. A figure significantly below the Shanghai Interbank lending rate, which stood on Wednesday at 2.49 per cent, according to S&P Capital Markets IQ.
One reason for the low rental incomes is that some of the properties are still under construction, but at the end of 2017, this was the case for just 14 per cent of the portfolio. So unless all are let at peppercorn rents, some must be empty, provoking memories of China's ghost cities, vast unoccupied real estate developments built in the hope of future demand.
Recently it has been borrowing more from China’s trust companies: its loans from those quarters jumped 63% last year to $42 billion. That move showed that the company may be running out of "the usual options" for refinancing. It also shows that Beijing is aware of the importance of Evergrande, and cannot let it fail. Sounds familiar - too big to fail.
Strategy, Views, Opinions... & Catalysts
One can have a view that a certain market is overvalued or overpriced, or vice-versa. That does not become actionable unless we have a sense of timing involved because if you are bearish or bullish long enough, BOTH will eventually be right.
Key then is to note the catalysts, and to me Evergrande has just provided the biggest bullet... excessively high coupon rate with $44bn due over the next 12 months.
Battling Shorts
It is also the most shorted stock in HK, almost 18% being shorted. The owner has been very combative, engineering sudden share buyback to squeeze the shorts. You cannot squeeze the shorts forever if your balance sheet and cash flow have problems.
Trouble is, the funds you raised will somehow go to more share buybacks to battle the shorts, instead of actually paying down loans. You do the math, something's gotta give...
Hopeful Saving Grace
- If the trade war ended completely, then Evergrande may have a chance to survive the next 12 months. Otherwise, its implosion possible at the cinemas.
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