Part C (28 marks) Question 1 Based on the article below, suggest the possible Implications of Hue Yang Bhcts gearing situation on the companys: (a) Current borrowings (b) additional borrowings in the near future (9 marks) (9 marks) HUA YANG ACQUIRES FOUR PARCELS OF LAND IN KAJANG FOR RM70 MILLION Hua Yang Bbd (Dec 28, 60.5 sen) Upgrade to market perform with a lower target prioe (TP) of 63 sen: Yesterday, Hua Yang Bhd announced that it is acquiring four parcels of freehold land measuring 19.8 acres (Sha) for a total consideration of RM70 million or at RMB1.3 per sq ft (ps). The land is adjacent to the Kaiana 2 development and is accessible via Jalan Reko via the Kaiang SILK Highway We were surprised with Hua Yang\'s land banking move as we were not expecting any land banking activities for the year, given its high net gearing of 0.70 times (as of second quarter ended Sept 30, 2017 12QFY18]) Hua Yang\'s management estimates a gross development value (GDV) of RM800 million for these four parcels of land, which we believe is fair as it would translate to an average selling price of RM300 ps derived from four times plot ratio, enabling them to position its product below RM500,000 per unit in the Klang Valley for the affordable segment. In terms of land cost, we deem that it is reasonable as the land cost to GDV ratio of 8 % is still within our comfortable range of 15% to 20%. While we are positive with its land bank replenishment, we remain worried about its high net gearing of 0.70 times (as of 2QFY18) which is set to reach 0.82 times upon completion of the deal Going forward, we are not expecting any more major land banking activities as we believe that Hua Yang needs to focus on realising their pipelines and also future plans with Magna Prima Bhd Considering its unbilled sales, which have fallen to a historical low of RM209 million, which is only sufficient for another one to two quarters, we opine that Hua Yang should be more aggressive driving its sales from launched projects that received a slow response from the market inspite of its positioning 14
(a) Current borrowings – The current borrowings will not see much of an impact due to the higher level of gearing being used by Hua Yang Bhd. The cost of current borrowings has been locked in and will not change for the company. However the increased gearing (from 0.70 times to 0.82 times) will lead to some worsening of debt-equity ratio and debt-asset ratio. The company’s credit ratings with regards to its debt issue are also likely to get a downward revision by credit rating agencies.
(b) The impact of higher gearing will be more profound on the company’s additional borrowings in the near future. Going forward the cost of debt will rise and with rise in interest expenses its interest coverage ratio will decline for sure. The company will also witness a tangible decline in its debt service coverage ratio. The resulting increased cost of debt will lead to higher weighted average cost of capital (WACC) for the company and this will put a strain on the company’s financial health going forward. Thus additional borrowings in the near future will become more expensive on an incremental basis.
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