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China Property Sector Summary

Core Content

The China property sector is currently in a downcycle, but the report suggests a positive outlook for the second half of 2014 (2H14) as supply-demand dynamics are expected to improve. Despite property price declines, land costs in Tier 2 and Tier 3 cities are softening, which should help alleviate margin pressures. The report also highlights that policy loosening in Tier 2 and Tier 3 cities could act as catalysts for the sector.

Main Points

• Valuation: Property stocks are still undervalued, trading close to -1 standard deviation below the six-year average forward PER and P/BV.
• Supply Reduction: Residential new start GFA has declined for five consecutive months, with the supply expected to taper by end-2014 or early-2015 due to a nine-month lag between new start and project pre-sale.
• Demand Trends: Commodity residential GFA sold has declined for six months as of end-May, suggesting the sector is about halfway through a typical downcycle.
• Policy Loosening: Recent policy adjustments in Tier 2 and Tier 3 cities, such as relaxed mortgage conditions and removal of home purchase restrictions, indicate a more market-oriented approach and could support investor sentiment.
• Regional Differences: Tier 1 cities have seen less land cost reduction and more stringent mortgage policies, while Tier 2 and Tier 3 cities are experiencing softer land costs and more flexible policies.
• Market Outlook: The report expects property stocks to outperform the broader market in 2H14 due to the stock market leading the physical market by about six months.

Key Information

• Land Cost Trends:
  • 2Q14 land costs for 300 cities dropped 15% QoQ.
  • Tier 2 and Tier 3 cities show a softening trend, while Tier 1 cities remain relatively stable.
• Inventory Levels:
  • Average inventory months for 14 key cities reached 14 months in May.
  • The oversupply situation is expected to ease by end-2014 or early-2015.
• Mortgage Release Timing:
  • Most projects have relatively quick mortgage release times, typically within one to two weeks.
  • Beijing maintains strict mortgage policies, requiring buildings to be topped-up before release.
• Demand Dynamics:
  • Buyers are adopting a wait-and-see attitude due to lower price expectations.
  • Government officials' demand has contracted significantly, impacting the market.
• Policy Environment:
  • The government is shifting towards structural reforms rather than large-scale stimulus.
  • Local governments in Tier 2 and Tier 3 cities are showing more autonomy in policy adjustments.

Top Picks

• COLI (688 HK):
  • Current price: HKD20.30
  • Recommendation: Buy
  • Key factors: Limited Tier 3 exposure, decent margins, cheap landbank, good earnings growth, and favorable valuations.
• KWG (1813 HK):
  • Current price: HKD5.80
  • Recommendation: Buy
  • Key factors: Limited Tier 3 exposure, decent margins, cheap landbank, good earnings growth, and favorable valuations.
• GZ R&F (2777 HK):
  • Current price: HKD10.50
  • Recommendation: Buy
  • Key factors: Limited Tier 3 exposure, decent margins, cheap landbank, good earnings growth, and favorable valuations.
• Sunac (1918 HK):
  • Current price: HKD4.85
  • Recommendation: Buy
  • Key factors: Potential for earnings surprise, limited Tier 3 exposure, and favorable valuations.

Valuation Criteria

Policy Adjustments

Economic Indicators

• M2 Growth: Expected to rise to 13.5% for 2014, signaling a more supportive monetary environment.
• Loan Growth: Estimated to be CNY9.5-10t, representing YoY growth of 13-14%.
• Household Leverage: Estimated loan-to-value ratio of mortgages at 34% in 1Q14.

Market Outlook

• The property sector is expected to see a recovery in 2H14 as supply-demand dynamics improve.
• Policy loosening in Tier 2 and Tier 3 cities is likely to continue, acting as a catalyst for stock performance.
• The current downcycle is expected to be about halfway in duration, with signs of stabilization emerging.

Conclusion

The report maintains an OVERWEIGHT rating on the China property sector, highlighting the potential for recovery and improved valuations. The sector is expected to benefit from policy adjustments, softening land costs, and a more balanced supply-demand situation by the end of 2014 or early 2015. Key players such as COLI, KWG, and GZ R&F are highlighted as Top Picks due to their strong fundamentals and favorable valuations.