Heavily indebted China Evergrande too big to fail

Wednesday, September 04, 2019

There's a lot working against China's most indebted property firm. China Evergrande Group is sitting on US$113.7 billion in debt and its core profit fell by 45 percent in the first half of the year.

The company, whose portfolio already includes theme parks and a football club, now wants to become the world’s biggest electric-vehicle maker in the next three to five years, writes Nisha Gopalan of Bloomberg. It is burning through precious cash –160 billion yuan – to build factories in Guangzhou. 

Investors are voting on this folly with their feet. Shares have fallen by 30 percent this year, making Evergrande the worst performer among Hong Kong-listed Chinese developers. The property firm’s borrowing costs are among the highest in the offshore dollar market and its bonds are tumbling.  

For anyone gawking at Evergrande’s improbably ballooning debt load, just waiting for the doomsday clock to strike midnight, there’s a valuable lesson: this company is too big to fail. Evergrande is one of China’s biggest developers – with projects in 226 cities – and its billionaire founder, Hui Ka Yan, is the country’s third-richest man. With property accounting for about a quarter of China’s gross domestic product, any instability in the sector has proven too much for Beijing to stomach. Time and again, the government has reluctantly reopened the credit spigots to boost a flagging real-estate market. Just look at 2008, 2011 and 2014. 

Crucially, Evergrande has China's largest land reserve, with 905 million square feet of gross floor area, according to Citigroup Inc. While the developer has a lot of exposure to China’s smaller cities, where growth is slowing rapidly, it also dominates redevelopment in big, rich cities such as Shenzhen, where profit margins are robust. 

Land is scarce in Shenzhen, and urban renewal – demolishing old, low-density buildings to make way for high-rise apartments – is widely seen as the answer to the city’s growing population. These projects also give Evergrande access to cheap lots, which helps keep its land costs among the lowest of its peers, according to Toni Ho, an analyst at RHB Securities.

If the protests in Hong Kong accelerate China’s plans to make Shenzhen the the next “global cosmopolis,” according to Xinhua, Evergrande could be in a plum position.

The company’s diversification into electric cars is sure to bleed money for years.

Maybe there’s a method to the madness of wild spending by China Evergrande.