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

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