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China Property Sector Summary

Core Content and Overview

The China property sector continues to face challenges from UK and European investors, who remain largely Underweight and express negative sentiment. However, there are early signs of a shift, with around one-fifth of investors adding China property stocks to their portfolios, primarily focusing on COLI and Agile. The sector is currently trading at a significant discount to NAV, with a 54% discount, and at low P/E and P/B ratios, suggesting potential value.

Main Concerns from Investors

Investors are primarily concerned with the following:

• Potential CNY depreciation: While the risk is not considered high, increased currency volatility could affect sentiment.
• Tight credit environment: Developers are facing challenges in accessing credit, with a crackdown on trust financing.
• Margin squeeze: There is concern about potential discounts and high land costs impacting margins.

Top Picks and Valuation Highlights

• COLI (688 HK): Trading at a 25% discount to NAV, with a target price of HKD27.80. It has a strong potential for corporate restructuring and low funding costs.
• Franshion (817 HK): Trading at a 56% discount to NAV, with a target price of HKD3.32. It is considered attractive due to its potential for asset injection and low funding costs.
• Shimao (813 HK): Also attractive at current levels, though not as much as COLI and Franshion.
• SOHO China (410 HK): Maintained a SELL rating due to its bumpy road to improving leasing capability and forecasted earnings void.

Inventory Situation

• The average inventory months for 14 major cities grew from 9.5 in Jan-13 to 12.5 in Jan-14, and is expected to surpass 13 months in Feb-2014.
• Tier-3 cities have the worst inventory situation, with an average of 17-19 months.
• Tier-1 cities have lower inventory levels, generally between 7-11 months.
• Tier-2 cities have inventory levels between 14-15 months, with some cities like Ningbo, Fuzhou, Hangzhou, and Changsha showing over 20 months, indicating potential for price cuts.

Bear-Case Scenario

In a bear-case scenario, developers are expected to:

• Slow down construction to reduce supply.
• Reduce land purchases to conserve cash.

The Chinese government may intervene with measures such as:

• Interest rate cuts or RRR reductions.
• Lowering down-payment requirements for mortgages.
• Relaxing credit quotas and liquidity conditions.
• Reducing deed tax or loosening HPF lending.
• Delaying land payments or stretching out tax payment schedules.

Developers with High USD and HKD Debt

• COLI, Yuexiu Prop, and Agile have the highest ratios of USD and HKD debt on their balance sheets.
• Poly Property, Sino-Ocean, and GZ R&F have the least exposure to foreign currencies, making them less susceptible to CNY depreciation risks.

Sales Growth Forecast for 2014

• The sector is expected to see an average 20-25% YoY growth in contract sales.
• Franshion, GZ R&F, Sunac, and Yuexiu Prop are forecasted to have close to 40% contract sales growth.
• Country Garden is expected to have a 33% YoY growth in contract sales.

Sensitivity to Price Corrections

• Developers with high leverage and significant investment in development properties are more sensitive to price corrections.
• Sunac, Poly, and GZ R&F are the most sensitive to price drops in development properties, with NAV declines of up to -67% under a 20% price drop scenario.
• Country Garden has relatively low sensitivity due to its lower land costs and fewer investment properties.

Earnings Growth Forecast

• Franshion, Yuexiu Prop, and Sunac are forecasted to have the highest earnings growth over the next few years.
• The underlying earnings growth for these companies is expected to exceed the sector average of 21% in 2014F and 24.5% in 2015F.

Valuation Metrics

• The sector is trading at:
  • 5.6x 2014 PER
  • 5.1x 2015 PER
  • 0.7x 2014 P/B
  • 0.6x 2015 P/B
• These valuations suggest the sector is significantly undervalued, especially when compared to NAV.

Summary of Key Points

• Investor Sentiment: Majority remain Underweight, but some are showing interest in COLI and Agile.
• Valuation: Sector is trading at a 54% discount to NAV and at attractive P/E and P/B levels.
• Inventory: Tier-3 cities have high inventory levels, while tier-1 and tier-2 cities have lower levels.
• Debt Exposure: COLI, Yuexiu Prop, and Agile have high USD and HKD debt, while Poly Property, Sino-Ocean, and GZ R&F have less.
• Sales Growth: Franshion, GZ R&F, Sunac, and Yuexiu Prop are expected to have strong sales growth in 2014.
• Earnings Growth: Franshion, Yuexiu Prop, and Sunac are expected to lead in earnings growth.
• Sensitivity: Sunac, Poly, and GZ R&F are most sensitive to price corrections due to high leverage.
• Market Outlook: The sector is expected to recover with improved sales and earnings, and a potential reduction in short positions.