Auditor Gives Clean Bill of Health despite Debt

The auditor for China Evergrande Group gave the company a clean bill of health despite its huge debt. This is because the auditor found that most of the company’s income came from land deals, and not from risky high-yield investments. The future looks bright for this property developer, who has grown quickly in recent years to become one of China’s largest developers.

China Evergrande Group is a leading real estate company in China. It developed several major residential projects, including the largest housing project in Asia -Changsha Meixihu International New City. The company’s revenue has increased at an average rate of 90% every year since 2010 with most of its income coming from property sales and rental income.

The company is heavily indebted – it has over HK$500 billion in debt, with only HK$62 billion in equity. A high debt level often makes companies vulnerable to adverse events that may affect their cash flows. Such events include economic downturns that lead to a reduction in demand for properties, or increases in interest rates that boost the cost of debt repayments.

China Evergrande Group has a high debt level because it expanded rapidly in recent years. The company’s revenue was “driven by land sales and rental income from completed developments, reflecting its volume growth in property development projects” said the auditor. The rapid expansion meant that the company paid for much of its expansion using debt.

“The group has a strong track record of earnings and cash flow growth since 2010, partly due to its acquisition and development of land sites and properties at favourable prices” said the auditor. As we mentioned above, most of the company’s income comes from property sales and rental income. This kind of income is very stable – it is not affected by interest rates or economic conditions.

China Evergrande Group’s land bank makes up 63% of the company’s total assets. Land usually has low turnover, so this means that much of China Evergrande Group’s revenue is expected to come from long-term projects which are very stable. “The group’s land bank has a remaining lease term of about 50 years and approximately 63% of its total assets are accounted for by land” said the auditor.

China Evergrande Group’s strategy is to increase scale in order to reduce construction costs. This will let it turn a bigger profit from its long-term projects, making them more sustainable.

China Evergrande Group did not reveal specific targets for future projects but it did say where they may occur. We can expect to see China Evergrande Group’s revenue increase in the coming years. It is planning to expand into emerging markets in the south-east Asian region, including Malaysia and Indonesia.

China Evergrande Group’s management team has strong experience in property development, which will allow it to further increase its scale of operations. “The group’s main business units are headed by Mr Wu Xiaohui, who has been the chairman of the board since 1999, and Mr Hui Ka Yan, who is the vice-chairman of Evergrande Health Industry Group” said the auditor.

China Evergrande Group’s auditor gave it a clean bill of health due to its stable revenue from long-term projects. The company’s high debt level may mean that it is vulnerable to adverse events, but its long-term focus and strong management team will allow it to increase revenue in the future. China Evergrande Group has a Zacks Rank #2 (Buy).