China Aoyuan (3883.HK; Buy) - Continuous growth supported by strong execution
Initiate with Buy rating: High earnings visibility; low valuation; industry consolidation provides growth opportunity
China Aoyuan is a medium-size Chinese developer that focuses in developing and managing properties in China’s Tier 1 and Tier 2 cities, with a strong presence in Guangdong province. Since 2012, the company entered a phase of fast growth with its contracted sales expanding to Rmb 25bn in 2016 from 5bn in 2012. We expect Aoyuan’s share price to outperform the sector due to 1) high earnings visibility from unbooked contracted sales; 2) high dividend yield; 3) low cost land bank in Tier 1/Tier 2 cities; 4) tightening policy may trigger industry consolidation and provide opportunity to replenish land bank at reasonable cost, given Aoyuan’s healthy balance sheet. With its strong unbooked contract sales reserve, quality land bank and strong execution, we forecast a contracted sales CAGR of 20%, revenue CAGR of 33%, net profit CAGR of 38% during 2016-2019e. With its accelerated asset-churn, we forecast ROE to expand to 18.3% in 2019e from 10.3% in 2016.
Price target HK$2.92, 22% upside; 7.1% dividend yield attractive
Our price target applies 60% discount to Dec-17 NAV. Aoyuan proposed Rmb 15 cents dividend per share for 2016, which represents a 7.1% dividend yield. The stock is trading at 67% discount to NAV, 4.1x 2017 PE and 0.56x 2017e PB, 0.22x 2016 contracted sales, at a deep discount compared to peers.
Industry consolidation benefits developers with healthy balance sheet
YTD the listed Chinese developers posted better-than-expected presales particularly in cities without sales restriction, which has driven the re-rating of the property stocks. We believe the re-rating is not over yet. With relative loose mortgage loans in lower tier cities, developers will continue de-stocking there. In core Tier 1/Tier 2 cities, tightening policies may trigger industry consolidation and create opportunities for Aoyuan to replenish land bank at reasonable cost. In the longer run, we still see more sustainable end demand for housing in core cities due to continued population inflow. Aoyuan has proven its track record in growing across policy cycles and accumulated extensive experience in acquiring land through equity/asset acquisition. This model could help accelerate asset-churn with projects launched at fast pace.
Strategic optimization of land bank in core cities at relatively low cost
Tier1/international cities and tier 2 cities accounted for 80% of Aoyuan’s land bank by land cost as of Dec-16. In 2016, Aoyuan further strengthened its land bank in core Tier 1/Tier 2 and international cities. Its average land cost was only Rmb 3,170 per sqm as of Dec-16, which gives it margin flexibility.
Improving credit profile reduces financing cost
With strong cash collection from property sales, Aoyuan’s net gearing has declined to 50.7% at Dec-16 from 64.0% at Dec-13. Its credit rating/ outlook were upgraded by all three international rating agencies in 2016/17. This effectively reduced its financing cost to 8.1% in 2016 from 11.4% in 2013.
Catalysts: New projects in core cities; inclusion in SZ-HK stock connect
New project announcement in core cities in China and overseas markets could further strengthen Aoyuan’s market position in these markets. Since Aoyuan’s market cap has passed HK$ 5bn, the company’s stock is likely to be eligible for trading through the SZ-HK stock connect program in June 2017.
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