'Stock Price Halved' Hyundai Construction, Strong Financial Structure

Q3 2019 Consolidated Borrowing Dependence at 13.3%
Cash Equivalents 1.8 Trillion Won

The government is rolling out stringent regulatory measures to stabilize real estate prices. As it implements a price ceiling system on pre-sale prices and tightens loan regulations to curb speculative demand in real estate, concerns over the profitability deterioration of domestic construction companies have increased. Moreover, with the added impact of the novel coronavirus disease (COVID-19) pandemic, the construction industry is facing a downturn due to real economy contraction and a decline in international oil prices. We examine the financial status of Hyundai Construction and GS Construction, leading domestic construction companies, to assess whether they can overcome this crisis.

[Asia Economy Reporter Park Hyung-su] Since the beginning of this year, the construction sector index in the domestic stock market has fallen by 40.4%. Considering that the KOSPI dropped by 26.7% during the same period, the sector's return is 13.7 percentage points lower than the market. Although global stock markets have plunged due to the spread of COVID-19, the outlook for the domestic construction sector is particularly pessimistic. This is due to expectations of reduced overseas orders following the sharp drop in international oil prices, compounded by concerns over a domestic housing market slump caused by the government's strengthened regulations.

The decline rate of Hyundai Construction's stock price is below the sector average. It fell from 42,300 KRW at the end of last year to 21,950 KRW on the 24th, a sharp 48.1% drop in just three months.

◆ Impact of Strengthened Real Estate Regulations and Housing Market = Hyundai Construction is one of the leading domestic construction companies ranked second in construction capability. In September 2006, it launched the housing brand HILLSTATE, and in 2016, it added the premium apartment brand 'THE H'. In September 2017, it was selected as the redevelopment contractor for Banpo Jugong 1 Complex, which has over 5,000 units, expanding its influence in the luxury apartment market. Last year, on a consolidated basis, it recorded sales of 17.2788 trillion KRW and operating profit of 859.7 billion KRW. Sales increased by 3.3% and operating profit by 2.3% compared to the previous year.

On January 22, Hyundai Construction announced its performance forecast for this year. It expects to achieve consolidated sales of 17.4 trillion KRW and operating profit of 1 trillion KRW this year. The expectation of a larger increase in profit than sales is based on increased domestic housing sales and improved cost ratios in overseas operations. Last year, housing supply was limited to 20,000 units, but this year, the plan is to supply more than 32,000 units.

However, the situation has rapidly changed in the two months since the forecast was announced. The government's continuous use of regulatory measures to stabilize real estate prices is also significantly affecting the business environment of construction companies. While it is difficult to directly assess the impact of government regulations on construction companies' performance, in an atmosphere of growing recession concerns, strengthened regulations inevitably affect housing prices. Korea Ratings recently analyzed that the government's comprehensive regulatory policies, amid a phase of declining housing market following several years of abundant pre-sale supply and a housing boom, could increase housing market volatility and deepen the downward phase.

Researcher Rajinseong from Kiwoom Securities expressed concern, saying, "According to the December 16 real estate measures announced last year, it has become difficult for multi-homeowners to obtain housing mortgage loans for living stabilization funds," adding, "When they try to sell houses to use as living funds, the increase in existing housing supply could exert downward pressure on housing prices."

◆ COVID-19 More Daunting Than Government Regulations = Last month, the Construction Business Survey Index (CBSI) stood at 68.9, down 3.2 points from January. CBSI recorded its highest level in 4 years and 5 months at 92.6 in December last year but dropped to 72.1 in January, a 20.5-point decrease from the previous month. Overall construction orders have decreased, and due to the impact of COVID-19, local and small-to-medium construction companies are facing difficulties in starting construction projects.

Hyundai Construction also experienced delays in its pre-sale schedule due to COVID-19. The Daegu site was scheduled for pre-sale but the schedule has been postponed. Researcher Park Sera from Shin Young Securities explained, "Whether to pre-sell in the 2nd or 3rd quarter will be decided depending on the COVID-19 trend," adding, "Currently, the situation is on hold."

Concerns also include the reduction in overseas plant orders due to the decline in international oil prices.

With continued low oil prices, cancellations and delays in orders in the Middle East are ongoing due to clients' financial shortages. Moreover, with the recent impact of COVID-19, West Texas Intermediate (WTI) crude oil for May delivery has been fluctuating sharply between 20 and 30 dollars per barrel. Researcher Kim Seryeon from Ebest Investment & Securities analyzed, "The breakeven price for Middle East onshore crude oil is 25 dollars per barrel," adding, "If the current oil price level continues, risks related to order cancellations and deferrals will increase."

In the past, during the international oil price decline phase in 2015, Qatar canceled two large chemical projects consecutively. Recently, international oil prices have fallen so much that support levels are unknown. The financial deterioration of Middle Eastern countries has reached an unavoidable level. Even Saudi Aramco, the world's largest oil company, is reducing capital expenditures, making it unlikely for the overseas plant order market to improve.

◆ Responding to Crisis Based on Solid Financial Structure = Despite overlapping adverse factors, domestic large construction companies are evaluated to have accumulated the strength to overcome the crisis. Hyundai Construction has made efforts to improve its financial structure over several years. Its debt ratio has steadily decreased every year since recording 161.8% in 2015. As of the third quarter of last year, it stood at 106.4% on a consolidated basis, and its debt dependency ratio is only about 13.3%. As of the end of the third quarter, total borrowings on a consolidated cumulative basis were 2.4411 trillion KRW, with short-term borrowings and current portion of long-term debt totaling 829.2 billion KRW. As of the end of the third quarter of 2019, short-term borrowings were 419.6 billion KRW, an increase of 147.4 billion KRW compared to the end of 2018. Since it consistently generates operating profits exceeding short-term borrowings, there is no problem with financial repayment capacity yet.

The scale of accounts receivable is also one of the important factors in assessing Hyundai Construction's financial soundness. Changes in domestic and international economies and financial markets may cause fluctuations in the housing market or increases in accounts receivable and bad debt expenses. As of the end of the third quarter last year, consolidated accounts receivable were about 2.4222 trillion KRW, slightly up from 2.3435 trillion KRW at the end of 2018. During the same period, the bad debt provision ratio decreased from 7.1% to 6.1%. Individual impairment tests and bad debt provisions are made for secured receivables, receivables with no collection uncertainty, and defaulted receivables.

Senior researcher Sung Taekyung from Korea Ratings said, "Of the total borrowings of 1.4788 trillion KRW on a separate basis at the end of last year, 22%, or 318 billion KRW, will mature within one year," adding, "The financing structure is mainly based on corporate bonds, so the short-term repayment burden is low, and cash equivalents of 1.8 trillion KRW exceeding total borrowings have been secured." He also evaluated, "Considering stable operating cash flow generation, asset value, and financing capability based on creditworthiness as an affiliate of Hyundai Motor Group, liquidity response capability is at an excellent level."