20 November 2018
Through the aggressive use of loans, Evergrande chairman Xu Jiayin has built the company to become the country's second largest developer within just a decade. Photo: Bloomberg
Through the aggressive use of loans, Evergrande chairman Xu Jiayin has built the company to become the country's second largest developer within just a decade. Photo: Bloomberg

Evergrande: Too big to fail?

Evergrande Real Estate Group (03333.HK) has wowed the market recently with its purchase of a stake in bigger rival Vanke Co. (02202.HK, 000002.CN).

So far Evergrande has spent 20.8 billion yuan (US$3.14 billion) and has built up its holdings to 6.682 percent.

While Evergrande now holds an estimated cash pile of 300 billion yuan, making the spending spree look like it is well within its means, a closure look will show its financial problems.

Often known for its aggressive style, Evergrande also has a lot of debt in its books.

Evergrande’s short term debt jumped 70 percent to 456.7 billion yuan last year. Excluding projects under development, its liquid assets amounted to 282.7 billion yuan.

Adding its year-to-date sales revenue of 184.8 billion yuan, the total is just enough to cover those borrowings.

The company’s gearing ratio stood at 93.5 percent by the end of last year.

The ratio would have exceeded 300 percent if its perpetual bond is excluded from the calculation of shareholders’ equity. That compared with Vanke’s much lower gearing ratio of 19.3 percent.

Also, Evergrande had nearly 400 billion yuan of inventory, double the size of its full-year sales target of 200 billion yuan this year.

That’s not to mention the fact that the company has kept adding new projects and buying land plots.

Many of its projects are in lower-tier cities, where the local housing market has been haunted by severe inventory glut.

To boost sales, the company even introduced an unconditional refund policy nationwide last year. Home buyers can get their money back without having to give any a reason any time before the homes are delivered.

The guarantee is all about assuring buyers that they have a way out if the property market takes a dive.

While this helps to attract buyers, if the property market slumps for some reason, Evergrande will be hit hard as it has to honor its commitment to return a large portion of its revenues to its customers.

The use of such extreme sales gimmick in a way indicates how hard it is for Evergrande to move its inventory. It also means investors need to take Evergrande’s sales numbers with a grain of salt.

Evergrande needs to maintain strong sales to generate enough cash for loan repayment.

The constant fear of a potential liquidity crisis in the company has been keeping numerous institutional investors away from the controversial property play.

That’s why for a long time, the shares trade a deep discount of just 0.3 times book value. Even after the recent uptick, the price to book ratio is only 0.5 times, against Vanke’s ratio of 3 times.

Nevertheless, Evergrande survived housing market downturns over the years, including the 2008 financial crisis and 2013 credit crunch in China.

From a medium-sized developer, the company has become the nation’s second-largest property developer in just a decade.

It has also aggressively expanded into other fields such as banking, insurance, consumer goods, entertainment, football, etc.

While we have to credit Evergrande chairman Xu Jiayin for his amazing balancing act, it also begs the question of whether Xu is deliberately pursuing a high risk strategy, that is, building an empire so huge that it becomes too big to fail. Its recent move on Vanke could be part of that strategy.

Owing lenders hundreds of billions of yuan, Evergrande will prompt banks to think twice before calling the loans for fear of pushing the company over the brink.

With a large number of projects across China, failure of Evergrande, which would also affect lots of upstream and downstream companies, may leave authorities with no choice but to bail it out in the event of a property market crash.

This article appeared in the Hong Kong Economic Journal on Aug. 17.

Translation by Julie Zhu with additional reporting

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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