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China Property Sector 2017 Summary

Core Content

In April 2017, the China property sector experienced a slowdown in transaction volume and a cautious outlook on developers' profitability despite relatively stable home prices. The report highlights the impact of tightening policies and the importance of evaluating developers based on their recurring income, cost control, and capital management capabilities.

Main Points

• Market Complacency: There was a sense of complacency in the market regarding the growth in contracted sales and profit margin recovery for China's property developers.
• Transaction Volume Slowdown: Transaction volume saw a sharp decline after austerity measures, with MTD (Month-to-Date) figures showing a -35% drop in April and -30% in March.
• Home Price Stability: While home prices remained relatively stable, this did not translate into higher profits due to the sharp increase in land prices.
• Tightening Policies: Multiple cities implemented home purchase restrictions (HPR), increased down payment requirements, and introduced minimum holding periods for property purchases.
• Investment Recommendations: The report recommends focusing on developers with stronger and less cyclical recurring income, better cost controls, and superior capital management.

Key Information

Tightening Measures

The tightening measures were applied across different tiers of cities, with specific examples including:

• Zhuozhou (Tier 3): Launched HPR, 1 unit for non-local hukou residents.
• Zhangjiakou (Tier 3): Launched HPR, max 2 units for local hukou residents and 1 unit for non-local hukou residents.
• Sanya (Tier 3): Launched HPR, max 2 units for local hukou residents and 1 unit for non-local hukou residents.
• Beijing (Tier 1): Raised mortgage down payment for second homes from 50% to 60%.
• Changsha (Tier 2): Launched HPR, max 1 unit for non-local residents; raised down payment for first homes from 25% to 30%, and for second homes from 30% to 35-45%.
• Huizhou (Tier 3): Introduced a minimum holding period of 3 years for newly purchased homes.
• Beijing (Tier 1): Restricted individuals from buying new commercial properties, only allowing second-hand commercial properties with proof of income tax payments for five consecutive years and no existing property.

Transaction Volume Forecast

• 2017E Forecast: Residential sales volume is expected to decrease slightly, with a -3.7% YoY growth nationwide.
• Tier 1: -6.0% YoY growth.
• Tier 2: -5.2% YoY growth.
• Tier 3: -2.9% YoY growth.

Home Price Forecast

• 2017E Forecast: Residential prices are expected to grow at a moderate rate, with 5.0% for Tier 1, 2.0% for Tier 2, and 1.0% for Tier 3.
• Inventory Support: Low inventory levels in Tier 1 cities supported home prices, but this did not guarantee higher developer profits.

Developer Profitability

• Booked Gross Profit Margins (GPM): Declined for most developers, with an average of 29.0% in FY16.
• Recent Land Acquisitions: Estimated GPM on recently acquired land sites showed a wide range, from 8.5% to 37.5%, indicating varying levels of profitability.

Stock Picks

• Longfor (960 HK): Recommended as a "BUY" with a target price of HK$15.15, reflecting 10% upside.
• COLI (688 HK): Also recommended as a "BUY" with a target price of HK$25.43, reflecting 9% upside.
• Country Garden (2007 HK): Rated "NEUTRAL" with a target price of HK$6.63, indicating a -14% upside.

Investment Criteria

The report emphasizes the following criteria for selecting property developers:

1. Recurring Income: Preference for companies with strong and less cyclical recurring income.
2. Cost Control: Ability to manage operating costs effectively.
3. Capital Management: Superior capital management practices.

Financial Highlights

Longfor (960 HK)

• Revenue Growth: 38.9% in 2017E, 25.7% in 2018E, and 20.0% in 2019E.
• Adjusted Net Profit Growth: 17.5% in 2017E, 11.5% in 2018E, and 14.8% in 2019E.
• Adj. EPS: 1.56 in 2017E, 1.74 in 2018E, and 2.00 in 2019E.
• Adj. P/E: 7.8 in 2017E, 7.0 in 2018E, and 6.1 in 2019E.
• Dividend Yield: 4.6% in 2017E, increasing to 6.2% in 2019E.
• Net Gearing: 70.1% in 2017E, decreasing to 52.7% in 2018E, and increasing to 67.0% in 2019E.

COLI (688 HK)

• Revenue Growth: 27.8% in 2017E, 14.3% in 2018E, and 12.5% in 2019E.
• Adjusted Net Profit Growth: 8.3% in 2017E, 12.3% in 2018E, and 8.8% in 2019E.
• Adj. EPS: 3.10 in 2017E, 3.48 in 2018E, and 3.79 in 2019E.
• Adj. P/E: 7.5 in 2017E, 6.7 in 2018E, and 6.2 in 2019E.
• Dividend Yield: 4.0% in 2017E, increasing to 4.9% in 2019E.
• Net Gearing: 32.1% in 2017E, increasing to 38.9% in 2018E, and decreasing to 24.4% in 2019E.

Country Garden (2007 HK)

• Revenue Growth: 26.0% in 2017E, 50.2% in 2018E, and 18.4% in 2019E.
• Adjusted Net Profit Growth: 23.7% in 2017E, 33.5% in 2018E, and 25.9% in 2019E.
• Adj. EPS: 0.66 in 2017E, 0.89 in 2018E, and 1.12 in 2019E.
• Adj. P/E: 10.4 in 2017E, 7.7 in 2018E, and 6.1 in 2019E.
• Dividend Yield: 3.4% in 2017E, increasing to 5.7% in 2019E.
• Net Gearing: 66.6% in 2017E, increasing to 74.9% in 2018E, and 72.3% in 2019E.

Sector Valuation

Investment Ratings

Analyst and Regulatory Disclosures

• The analysts responsible for the report certify that the views expressed are their personal views and not related to their compensation.
• The report is for informational purposes only and should not be construed as investment advice.
• The contents of the document may be subject to change without prior notice.
• The report is prepared by China Merchants Securities (HK) Co., Limited and is not available to U.S. persons without specific permission.
• The document may not be reproduced, distributed, or published without prior consent.
• The report is not directed at individuals in jurisdictions where it is prohibited or restricted.