China Developer Blames ‘Strict’ Auditor for Profit Plunge

(Bloomberg) -- A Chinese real estate firm said Ernst & Young’s “strict” accounting standards were partly behind a collapse in the company’s profit last year.

Profitability was hurt because Yuzhou Group Holdings Co. was unable to include some projects on its balance sheet, Chief Financial Officer Steve Chiu said in an earnings call Tuesday, according to people with direct knowledge of the matter. E&Y required additional information, which the company couldn’t provide on time, Chiu said, according the people.

The company’s shares plunged 7.9%, taking their decline from this year’s high to 26%. JPMorgan Chase & Co. cut the stock to the equivalent of sell from buy, saying the drop in profit shows the management’s “subpar ability” to manage earnings growth and a “potential corporate governance red flag” because some revenue booked in the first half was unwound by the auditor. DBS Group Holdings Ltd. made a similar downgrade.

During a Wednesday call, executives including Chiu said revenue is likely to be restated to as little as 7 billion yuan ($1.1 billion) for the first six months of 2020, versus the 14 billion yuan reported in August, according to people who listened to the call. Yuzhou on Tuesday said revenue for all of last year tumbled 55% to 10.4 billion yuan, attributing it in a stock exchange filing mainly to delays with projects in Shanghai, Wuhan and Tangshan as a result of the coronavirus outbreak.

The executives said during the Wednesday call that Yuzhou was informed by its auditor in late February of stricter accounting policies, leading to the anticipated revenue restatement, according to the people. The new policies include stricter standards on when revenue can be recognized and documentation that Yuzhou controls joint ventures before they’re able to be added to its balance sheet.

A Yuzhou media representative declined to comment and E&Y didn’t immediately respond to requests for comment.

Concern has grown about Yuzhou’s ability to repay its debts amid a government clampdown on leverage in China’s property market. Beijing’s “three red lines” campaign limits the capacity of highly indebted firms to raise fresh capital in the credit market. The risks to global investors were illustrated earlier this year when China Fortune Land Development Co. defaulted on a $530 million dollar bond.

Yuzhou’s dollar bonds maturing in 2025 and 2026 have fallen more than 20 cents on the dollar within the past two weeks to less than 85 cents. The bonds rose as much as 5.5 cents as of 4:25 p.m.

Moody’s Investors Service downgraded Yuzhou’s corporate family rating deeper into junk territory last week, cutting the grade to B1 from Ba3 and lowering the outlook to negative. The ratings agency cited uncertainty over the company’s ability to deliver pre-sold projects on time as credit conditions tighten. Yuzhou’s reliance on sales from joint ventures and associates limits its corporate transparency, Moody’s said.

While the firm had sufficient internal resources to cover its maturing debt and committed land payments over the coming year, its key credit metrics are expected to stay weak over the next 12 to 18 months, according to Moody’s.

Yuzhou is prepared to repay its debt coming due in a year and has set aside funding to pay off a 7.9% dollar bond maturing in May, the CFO said, according to the people.

Founded in the southern city of Xiamen in 1994, Yuzhou ranked 37th in China out of the top 200 developers by contracted sales, according to China Real Estate Information Corp. Yuzhou tapped international capital markets to help fund its expansion, with an initial public offering in Hong Kong in 2009. The developer is also a frequent borrower in the offshore debt market, with some $5.8 billion in dollar bonds outstanding, Bloomberg-compiled data show.

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