Country Garden is Likely to Default

We trimmed our Fair Value estimate because of the increased likelihood of default and subdued profitability.

Jeff Zhang, CFA 10.08.2023
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Key Morningstar Metrics for Country Garden Holdings Stock

  • Fair Value Estimate: HKD 1.2
  • Morningstar Rating: 3 stars
  • Morningstar Economic Moat Rating: None
  • Morningstar Uncertainty Rating: Very High

What We Thought of Country Garden Holdings Potential Default

We have cut our fair value estimate for Country Garden Holdings to HKD 1.20 from HKD 2.80 given the higher weighted average cost of capital on potential defaults and more compressed margins. CGH missed a USD 22.5 million interest payment on two offshore bonds on Aug. 7, fueling the market's concerns that it may eventually default after the 30-day grace period as evidenced by the plunge in its bond and share prices.

While management cited liquidity pressure due to a deterioration in sales and the refinancing environment, they underscored an ongoing effort to arrange coupon payments. That said, we remain cautious about the likelihood of CGH’s default, given its weak sales and elevated overseas funding costs. As such, we raised our assumptions for CGH’s cost of debt and cost of equity by 550 basis points and 200 basis points, respectively, leading to WACC rising to 12.8% from 9.5%, according to our prior estimate. In addition, following CGH’s profit warnings, we think pressured housing prices in lower-tier cities have further eaten into CGH’s profitability and lowered our 2023 gross margin forecast to 6.1% from 9.9%.

Country Garden Holding’s Missing Payment Not an Isolated Incident

We think CGH’s missing offshore interest payment may not be an isolated event given its worsened liquidity status currently compared with the end of 2022. For the first half of 2023, the firm’s attributable sales value has tumbled by over 30% year on year, adding to the pressure on operating cashflow. Also, CGH’s overseas financing on the debt and equity front has been muted since 2023, implying that the firm has likely used its cash denominated in foreign currencies. Aside from coupon payments due in August, we estimate that CGH needs to fulfill at least USD 137 million of bond interest payments through the rest of 2023.

Without additional credit support from Chinese regulators and sizable financial institutions, CGH should continue to see an elevated risk of defaulting on its overseas debt, in our view.
Another negative for CGH is that management expected net losses for the first half of 2023, mainly due to a gross margin decline, inventory impairment increase, and foreign-exchange losses. CGH remains heavily exposed to projects in lower-tier cities, which we do not believe will see a material sales improvement due to depressed homebuying sentiment.

While the firm has not massively acquired land parcels in the first half, we forecast that most of its existing projects should post lower margins given faltering selling prices and the tempered pace of turnover. The recent credit event may further dent homebuyers’ confidence in CGH’s ability to promptly deliver presold projects, in our view. Hence, we revise our long-term margin assumptions and foresee CGH delivering an 8.0% gross margin in 2027 versus 15.0% previously.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Country Garden Holdings Co Ltd0.49 HKD1.04Rating
Country Garden Services Holdings Co Ltd ADR0.64 USD-1.27

About Author

Jeff Zhang, CFA  Jeff Zhang, CFA is an Equity Analyst at Morningstar

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