Country Garden: Fair Value Trimmed on Increasing Likelihood of Default and Subdued Profitability

We have cut our fair value estimate for Country Garden Holdings 02007 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%.

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.