Fitch Ratings-Hong Kong-30 July 2013: Fitch Ratings has affirmed property developer Sunac China Holdings Limited's (Sunac) Long-Term Issuer Default Rating (IDR) at 'BB-' with a Stable Outlook. The agency has also affirmed the company's senior unsecured rating at 'BB-'.

The affirmation reflects falling margins and rising structural subordination, balanced against rapid sales growth and a track record of strong execution.

Key Rating Drivers

Strong execution of niche strategy: The company has strong branding and execution in its core markets, i.e. mid- to high-end segments, primarily in China's higher tier cities. Its solid execution and marketing strategy result in fast asset turnover, as demonstrated by 1.4x of contracted sales/total debt in 2012, and over 80% year-on-year growth in contracted sales to CNY20.3bn in H113. Fitch expects the outperformance to continue for the rest of 2013.

JV facilitates growth: Fitch expects joint ventures (JVs) to continue playing an important role in Sunac's capital structure and land acquisitions in the next 18 months. Around 34% of total gross floor area (GFA) in Sunac's land bank is estimated to be attributable to minority interest. The use of JVs facilitates the company's business expansion, shares the burden of land premiums, and leverages off the strengths of different developers.

Higher structural subordination: The JVs, especially Shanghai Sunac Greentown Real Estate Development Ltd, also mean Sunac's access to their cash is subordinated to the obligations of these JVs. To reflect the structural subordination, Fitch includes unconsolidated subsidiaries and treats minority interests as debt in its calculation of Sunac's leverage. This results in a modified net debt/adjusted inventory of 43% at end-2012 compared with the reported 29%.

Subdued margins: Despite major improvements in its business scale over the past three years, EBITDA margin showed a downward trend to 22% in 2012 from 40% in 2010, due to rising competition and higher land costs in China. Fitch expects margins to remain similar over the next 12 months until the company sells off old inventory in newly acquired projects.

Regulatory risks remain high: Sunac's focus on mid- to high-end segments increases its exposure to regulatory risks compared with mass-market peers, given the government's aim to make housing more affordable. Sunac's CNY17,800 per square meter of average selling price for residential projects in 2012 is higher than peers'.

Diversifying funding sources: At end-2012, Sunac's total debt of CNY21.8bn comprised of offshore bonds and onshore bank loans. In addition to USD500m notes issued in 2013, the company raised USD400m in an offshore three-year term loan at a joint venture, Sunac Greentown Investment Holdings Limited, level. These developments allow Sunac to term out maturities and lower funding costs.

Rating Sensitivities

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Adverse changes to Sunac's markets and product mix leading to an EBITDA margin below 20% on a sustained basis (2012: over 25% excluding impact of revaluation of acquisitions)

- contracted sales/total debt below 1.2x on a sustained basis

- Modified net debt /adjusted inventory above 50% on a sustained basis

- Substantial growth in Shanghai Sunac Greentown, relative to the company's size

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

-EBITDA margin above 30% on a sustained basis

-Modified net debt /adjusted inventory below 35% on a sustained basis

-Contracted sales/gross debt above 1.5x on a sustained basis