Four years ago, property magnate Hui Ka Yan topped the Rich List as the wealthiest person in Asia. Hui is no pauper now, still a billionaire, but he is clawing to keep his sprawling empire afloat as investors fret about the financial position at the world's most-indebted developer.
Investors should watch the situation even if they don't have direct exposure. A default at Evergrande, which has frequently tapped overseas bond markets, could have a spillover effect. And if China's largest developer has run aground, it spells trouble for the rest of the Chinese property sector.
Hui's flagship China Evergrande Real Estate (EGRNF) saw sales restricted by the pandemic in Q1 2020. But for the full year, it still saw sales rise, even though that came at the cost of profits, which slid by one-quarter.
As a result, Evergrande remained China's largest developer last year, with C¥669.0 billion (US$103.4 billion) in property sales, up 13.5% over 2019. That gave it top spot ahead of rivals Country Garden Holdings (CTRYF) and China Vanke (CHVKF) for the third straight year.
Evergrande's system is built on bulk. As a mass-market homebuilder, it relies on a fast turnaround on projects. The vast majority of residential developers in China rely on upfront deposits on "off-plan" unbuilt apartment complexes to fund their construction. Buyers put their faith that a piece of paper will turn into a home.
The system works well as long as turnover stays high, projects get completed, and the cash keeps flowing. It gets a lot trickier when credit dries up.
Or when the authorities step in. On Monday, housing officials in the city of Shaoyang, in Hubei Province, said sales must be suspended on two projects since the company had not set aside enough funds in the presale accounts, and deliberately evaded supervision. The suspension was lifted on Tuesday after the company transferred more money into the accounts, but word of the financial troubles had spread.
Over the weekend, a court order surfaced from Jiangsu Province showing that the court there froze a C¥132 million (US$20.4 million) bank deposit, due to a disagreement with its lender Guangfa Bank.
This week compounded what were already steep losses for the company in financial markets.
The price of Evergrande's bond due in June 2025 near an all-time low, trading today at 56 cents on the dollar. That has brought its yield to an eye-watering 27.5%.
Evergrande's shares have lurched 26.2% lower since last Friday's close, exacerbating steep declines that have set it back to 2017 levels.
Evergrande shares have plummeted 72.1% since last July in Hong Kong. The infrequently traded ADR has plunged 69.8% in the United States over the same period.
Its separately listed property management arm, Evergrande Property Services Group, has seen its shares fall 30.5% this month, and 65.0% since February. It went public in December, raising C¥12.1 billion (US$1.9 billion) for the parent.
Evergrande had C¥570 billion (US$88.1 billion) in outstanding interest-bearing debt as of June, down from C¥874 billion (US$135.1 billion) in March 2020. However, it has other forms of non-interest borrowing such as commercial paper, bills with contractors and other partners, which were as high as C¥205.3 billion (US$31.7 billion) last year. Regulators are looking at whether developers are using those transactions to skirt fundraising rules.
In August 2020, Chinese regulators introduced a policy of the "three red lines," limiting how much developers are allowed to borrow. Developers have to maintain a liability to asset ratio of less than 70%, a net gearing ratio of less than 100%, and a cash to short-term debt ratio of more than 1x.
Only 6.3% of Chinese developers could satisfy all three red lines, Standard & Poor's said at the time of their introduction. Evergrande could satisfy none, forcing it to deleverage when its business plan demands heavy levels of borrowing. It says it will cut debt by C¥150 billion (US$23.2 billion) per year for three years to get below those caps by the end of 2022.
Evergrande has been selling noncore assets ever since. Hui and his team have done their best to restore confidence in the company. Last week saw a share rally after the company hinted that it may declare a special dividend for investors. The board is due to discuss that at a meeting on July 27.
The Evergrande Group is also considering spinning out its bottled-water company, Evergrande Spring, in an initial public offering in Hong Kong, Bloomberg reports. It is in "exploratory discussions" with investment banks about a separate listing for the drinks business, with a potential IPO next year raising several hundred million dollars.
Don't buy those shares if they do come to market. Market leader Nongfu Spring (NNFSF) has seen its shares double since their debut in Hong Kong last September, in a heavily overbought IPO. They're now up 105.8% although have struggled for direction since peaking in January and February. But consumer tastes are fickle in China, and it's easy to start a competing water brand.
Evergrande has a history of entering industries almost at random, apparently following Hui's whims and interests. Bottled water today, electric cars tomorrow.
China Evergrande New Energy Vehicle Group (HK:0708) hopes to launch an electric-vehicle brand Hengchi with pilot models later this year and a full launch in 2021. But work on constructing its factories has been slow. The Chinese government has been investigating whether property developers have used lofty electric-vehicle projections to secure state subsidies and cheap prices on land, intent on developing homes around the "factory." Whether that takes shape or not.
The special dividend from Evergrande's property developer parent will likely not consist of cash due to the company's financial woes, according to the analysts at CCB International. Investors may get shares of Evergrande New Energy Vehicle instead. Whether they want them or not.
It's not the first time investors in one sector have found themselves holding Evergrande shares in a totally different one.
Until August 2020, the electric-vehicle subsidiary was called Evergrande Health Industry Group, having listed in 2015 to build and run hospitals and health clinics. Despite its new-found focus, it already slipped an original deadline to deliver cars this year, having unveiled six models in 2019.
This is the latest debt scare for Evergrande. It scrambled to assuage investor concerns in June, too, when it arranged funding of US$1.75 billion to repay bonds coming due at that time. It said the money also gave it the cash to pay interest on all its other dollar bonds.
The company can't keep scrambling from crisis to crisis. Officials from China's top financial regulator told Hui at the end of June to sort out Evergrande's debt problems as fast as possible, without causing major economic disruption. Evergrande is so big, it could cause systemic shock that would ripple through the property sector. It would also shake the Chinese buying public's confidence that bricks and mortar are as safe an investment as houses.
