Uncertainty looms over the troubled China real estate sector as the saga continues to unfold
China’s real estate’s prevailing trends lays emphasis on two thorny issues such as further moderation in sales momentum and sluggish land sales. Both of which paint pale outlook for developers facing the task of balancing the need to grow and balance sheet risk management
In the first round of centralized land sales, the bidding intense and competitive whereas it was the opposite in the second round even with land premium shrinking. The average failure rate rose to 27% vs. 10% in the first batch. The reasons for this would be the reservation of high prices despite lower premiums, and regulators reinforcement of market discipline. The policies that served as a boon to the green-tier developers now may turn a bust and destroy any business opportunity. To preserve the margins, developers opt to delay the pre-sale permits. However, this in turn impacts the cash flow and slower contracted sales.
Amidst the sluggish second round of auction, COLI acquired 23 plots worth RMB54bn, CRL and Longfor invested over RMB12bn respectively in August-September, according to CREIS.
The weakened market confidence and strict mortgage approval policies seemed to be the root cause of the fall of Evergrande and other developers. Evergrande, alone, suffered a 90% y-o-y drop due to this. However, in select cities, the mortgage policies have been easier which may help in picking up the sales rather slowly in the coming months and with a possibility of catching up in the peak season of Q4. Though the dynamics seems weaker with the deteriorated fundamentals over the years.
In addition to high land cost, the auctions also failed due to more stringent requirement and scrutiny of developers’ source of funding used for land purchases, further margin compression caused by requirements on high construction quality or self-owned rental housing, and risk-off sentiment as the Evergrande saga continues to unfold.
The thought of recovery of margins for the developers seems far-fetched because of persistent home price cap and higher absolute land cost. Along with this, weaker home purchase dynamics also come into play as the buyers’ expectation on home prices has been gradually moderated. This also puts pressure on the profitability and developer’s margins.
The weakening home sales could have negative implications in local government’s fiscal income. Hence to avoid this, select cities have lowered mortgage rates and sped up mortgage disbursement. However, the full policy relaxations, like during other downcycles, seem unlikely.
Top Stock picks with a “Buy” rating are all green-tier developers and they are China Resources Land, Longfor Group and Shimao Group.
Both CRL and Longfor have maintained double-digit core profit growth and DPS growth y-o-y basis, and respectable margins as compared to their peers and sector average.
CRL has proven a strong rental performance and has the ability to embark on a countercyclical land-banking strategy via diversified channels underpinning its growth momentum. The concerns with this stock would be inability to maintain sales momentum, lower margins and uncertainty of macroeconomics.
While Longfor Group has a fast growth pace in it non-DP segments which contribute to its strong earnings and cash flow. Among its peers, it also has the strongest balance sheet and lowest funding costs which helps in optimizing its acquisition and expansion opportunities. The risks associated with the group are slow sales, overspending on acquisitions, sell off of shares by key personnels and macroeconomics uncertainty.
Shimao Group, on the other hand, displays strong dividend yield and attractive valuations. Once the Group’s landbanking attitude YTD as a means to preserve the solid margin profile is recognized, the company would become more popular among investors. With the share buyback at company and executive level, it signifies their confidence in the company and its future outlook. The risk associated with the Group is similar to the others, lower margins, slower sales and macroeconomics uncertainty.
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