Lotte E&C Faces Alarming Cash Crunch: "PF Debt Down, But Money Isn't Circulating" [Why&Next]

Units Remain Unsold, Payments Fail to Arrive
Debt Reduced, but Cash Crunch Worsens
Rated the 'Weakest' in Financial Health... Scrambling to Secure Cash

Lotte Engineering & Construction's (Lotte E&C) cash flow has been deteriorating, according to recent findings. Securities firms and credit rating agencies have successively issued reports warning of potential financial risks as a result. Although the company managed to reduce its real estate project financing (PF) contingent liabilities?worth approximately 6 trillion won?by about half in just two years, a sharp increase in unsold units and a rise in unpaid construction costs have put significant strain on Lotte E&C's cash flow. While the company's financial statements may appear to have improved due to a substantial reduction in debt, in reality, the company has failed to secure incoming payments, undermining its financial health. Experts warn that this situation could trigger a vicious cycle, leading to liquidity exhaustion and potential credit rating downgrades.

Units Remain Unsold, Payments Fail to Arrive

According to the construction industry as of April 30, the construction site for 'Gimhae Gusan Lotte Castle Signature' in South Gyeongsang Province faced the risk of a work stoppage last month. The crisis was triggered when the project developer delayed payment for construction costs. Lotte E&C, the general contractor, sent an official letter to the developer outlining its intention to halt construction. A Lotte E&C representative stated, "Discussions about halting construction arose during negotiations with the developer over the collection of construction payments, as we exchanged official correspondence. However, construction has not actually stopped, and work is continuing as usual." The details of the agreement between the two parties remain undisclosed.

As unsold units piled up, the developer became unable to pay construction costs. In both the first and second rounds of subscriptions last year for 'Gimhae Gusan Lotte Castle Signature,' all five types of 84-square-meter units failed to attract enough buyers. Only 487 applications were received for 683 available units, resulting in a subscription rate of just 71%. The sale price was in the 600 million won range, which is 200 to 300 million won higher than comparable properties in the area. When factoring in balcony extension fees, interim loan interest, and acquisition tax, the actual financial burden rises to around 700 million won.

The situation is not unique to Gimhae Gusan Lotte Castle Signature. Lotte E&C experienced a wave of unsold units at several regional projects launched last year. At 'Icheon Lotte Castle Central Feraz Sky' in Gyeonggi Province, three out of four unit types (all 84 square meters) failed to sell out, resulting in a subscription rate of just 21%. The recovery of construction costs is highly uncertain. Other projects, such as 'Jungang Park Lotte Castle Signature' in Gwangju, 'Uijeongbu Lotte Castle Narivek City' in Gyeonggi Province, and 'Beonyeong-ro Lotte Castle Central Sky' in Ulsan, also posted initial subscription rates below 50%.

Despite instability in the presale market last year, Lotte E&C significantly increased its supply. In 2024, the company released 17,439 units to the market, a 33% increase (4,357 units) from the previous year’s 13,082 units. This was the fourth largest supply, following GS E&C (about 19,700 units), Hyundai E&C (about 19,300 units), and Daewoo E&C (about 18,600 units). Construction companies secure operating funds through down payments and interim payments received during presales, and Lotte E&C appears to have aggressively expanded its supply to secure liquidity. NICE Investors Service recently noted in a report, "Lotte E&C faces 2.4 trillion won in PF contingent liabilities at sites where presales are weak or construction has not yet started. The risk of these liabilities materializing remains high due to the deteriorating presale market."

Debt Reduced, but Cash Crunch Worsens

Lotte E&C reduced several trillion won in PF contingent liabilities last year, but industry experts still consider the level high. The company’s PF contingent liabilities fell from 6.8 trillion won at the end of 2022 to 3.6 trillion won at the end of 2023, thanks to group support and the creation of bank funds. According to Korea Ratings' analysis of 16 construction companies with long-term ratings of BBB- or higher, Lotte E&C’s PF contingent liabilities are the second largest after Hyundai E&C (5.6 trillion won). The ratio of contingent liabilities to equity is even more severe for Lotte E&C (111%) than for Hyundai E&C (80.6%).

NICE Investors Service commented, "Although PF contingent liabilities have decreased, they remain excessive compared to equity (2.8 trillion won)." Korea Ratings also stated, "While the scale of PF guarantees has shrunk, financial burden persists due to uncertainty in collecting construction payments from sites with unsold units and unstarted PF projects." Eugene Investment & Securities further analyzed, "Among the top 10 construction companies, Lotte E&C has the highest risk sensitivity to contingent liabilities (PF guarantee execution risk). The company’s net debt ratio, which was previously 56.5%, surged to 154.5% when factoring in profitability, working capital, and contingent liability stress. This spike is primarily attributable to contingent liabilities."

Of Lotte E&C’s PF contingent liabilities, the scale of contract projects stood at 3.166 trillion won at the end of last year. Of this, 2.195 trillion won (69%) is high-risk PF guarantees for projects that have not yet started construction. More of these high-risk PF guarantee projects are located in the provinces (1.2756 trillion won) than in the Seoul metropolitan area (919.4 billion won). In addition, among projects that have started or been completed (971 billion won), those with a presale rate below 70% account for 231.8 billion won.

Accounts receivable?money not yet collected, including unpaid construction costs and unsold unit payments?have increased for three consecutive years. Unbilled construction costs (contract assets) for work completed but not yet invoiced have also risen. The combined amount of accounts receivable and unbilled construction costs was about 2.21 trillion won just before the Legoland crisis in 2021. However, this figure has grown every year since, reaching approximately 3.36 trillion won last year. Even if the money has not actually been collected, accounts receivable are still recorded as revenue in the books.

Due to the increase in unsold units and accounts receivable, cash is not circulating, and Lotte E&C's cash generation has turned negative. Cash flow from operating activities?the actual cash generated from core business?plummeted from 178.3 billion won in 2022 to 49.9 billion won in 2023. Last year, the company ultimately recorded a deficit (-97.9 billion won). Negative cash flow for a construction company means that the money spent on projects exceeds the payments received. The current ratio dropped to 112% last year, down from 121% the previous year.

Rated the 'Weakest' in Financial Health... Scrambling to Secure Cash

NICE Investors Service analyzed Lotte E&C’s negative operating cash flow, stating, "The burden on working capital has increased due to progress billings at sites where advance payments were received, a rise in unpaid construction costs at completed projects such as Magok MICE, and delays in collecting receivables at sites with low presale and occupancy rates." They added, "Considering rising construction material prices and delays in payment collection, it will take time before profitability and cash flow improve." Eugene Investment & Securities also concluded, "A comprehensive analysis of profitability, working capital, and contingent liabilities shows that Lotte E&C has the highest financial risk sensitivity among the top 10 construction companies."

Korea Ratings issued a warning about risks related to Homeplus. "Depending on the developments surrounding Homeplus, there is a possibility that PF contingent liabilities could materialize." Lotte E&C has provided guarantees for subordinated loans at Homeplus-related sites. Korea Ratings explained, "If Homeplus stores suspend operations or fail to pay rent, lease contracts may be terminated, and the maturity benefit of PF loans could be lost, resulting in asset foreclosure. In such cases, Lotte E&C would inevitably bear the losses."

In response to worsening cash flow, Lotte E&C is moving to sell assets. The company is pursuing a plan to liquidate assets worth 1 trillion won, including the sale of its headquarters site in Jamwon-dong, Seocho-gu, Seoul. The Lotte E&C headquarters building, located between apartment complexes in Jamwon-dong, is valued at around 500 billion won. In addition to the headquarters, the company is also considering selling warehouse assets in the metropolitan area and stakes in rental housing REITs.