AMTD Research - 15 September 2017

China property sector 1H17 Results Review

Solid margin, robust sales & better balance sheets

Laggers! Top pick China Aoyuan (3883.HK); KWG (1813.HK)

The sector is trading at 8.1x 2017e PE, which is at the peak for the last three years. Therefore, we recommend investors to look at the names with high growth potential, valuation lag and high ROEs. We believe most of giants are enjoying high premium in valuation, with limited upside. We see that downside risk is higher than before.

For the national top 20-100 developers, Aoyuan is one of the most active developers with biggest landbank in Greater Bay Area (58% of land bank located in Guangdong). High expectation of more immigrants from West Guangdong to Zhuhai, Zhongshan and Foshan is likely to boost home prices in these cities. We expect Aoyuan to benefit from this factor. Aoyuan’s high sales growth will be delivered into revenues in next 2 years. Therefore, we reiterate ‘Buy’ and revise up target price to HK$ 5.78, 20% of NAV discount to Dec-17 NAV, which implies 10.8x 17PE and 7.9x 18PE.

We also like KWG given its RMB 450bn saleable resource, which is sufficient for its growth target. Its delivery pipeline in 2018-2020 shows the GPM will maintain on high level. The growth target will be delivered by high GPM and absolute amount increase. We see ambitious growth target released by management recently which may mark a turning point for the company. We see it enter a fast track of growth in next 3 years. KWG has come to the timing for releasing its value of quality saleable resource. We initiate KWG with ‘BUY’ and TP of HK$ 10.71, which implies 7.9x 17PE & 6.9x 18 PE, 1.1x 17PB & 0.9x 18PB.

Solid margin & stronger balance sheet

Home price rebounded in 1H2015 and destocking in 2H2016 were the main drivers for GPM improvement. Home price index (mom) is a leading indicator for GPM improvement. After a contraction in GPM in 1H2016, many developers witnessed a rebounded GPM in 1H2017. Only 7 out of 29 developers recorded yoy decline on GPM. 13 out of 29 recorded yoy decline on NPM. Strong sales performance in YTD2017 largely improved cash inflow and lower net gearing for developers. 11 out of 29 developers have lowered their net gearing ratio. Evergrande’s net gearing ratio dropped by 55.3 ppt yoy, Country Garden dropped by 26.1 ppt yoy. Agile and BJ Capital Land dropped by 22.2 ppt and 40.2 ppt, respectively. We believe net gearing ratio will decrease further, as more saleable resource are launched in 2H2017 and we expect sales to improve HoH in Tier 1/Tier 2 cities. Developers’ average borrowing costs also declined. Only 4 companies’ average borrowing costs were still higher than 6.5% in 1H2017 (Figure 5).

Strong sale & low inventory level

Strong sales exceeded most developers’ expectation despite a tightened Home Purchase Restriction (HPR) and mortgage policies in Tier 1/Tier 2 cities. This was driven by strong sales in Tier 2 and Tier 3 cities given the relatively loose credit condition. The developers will launch more saleable projects to boost sales in 2H2017. All developers are strongly confident on their sales performance except Greentown. They are expecting: 1) home price cap policy will be loosened in Mid-Oct in Tier 1/Tier 2 cities; 2) rigid demand will be released in 2H2017 in Tier 1/Tier 2 cities, thanks to less new supplies in 1H2017. However, we believe it could be challenging as most developers are waiting for the Mid-Oct time window to launch new projects. Besides, national inventory level lower to 20.7 months, which is close to that of 6 year ago.

Policy outlook

A healthy inventory level at 20.7 months in July 2017, from a high of 32.8 months in February 2015 gives some room for potentially even tighter policies. We view current mortgage loan growth at over 30% unsustainable. However, the mortgage loan growth is likely to stay at above 20% in 2018 given banks have limited option to grow. This highlight the downside risks for sales growth in lower tier cities without population inflows where sales growth was mainly stimulated by relatively loose credit conditions.

IFRS 15/HKFRS 15 is earning booster for developers in 2018

Regarding property developers, if developers receive full prepayment for products in advance, developers can recognize revenue following completed percentage of construction. It will benefit developers who receive more full-prepayment for property sales to recognize contracted sales in advance under IFRS/HKFRS 15.

Rental housing, new way to relief rigid demand in core cities

We believe if more supplies of rental housing are launched and tenants can enjoy same rights as what home owners are entitled to, part of rigid demand will be partly diluted and absorbed by rental market. Rental housing should be negative for developers of mass market product, while rigid demand will be diluted and absorbed by rental market. In short term, this policy will not imply any influence on developers until mass supplies are launched in 2019. For long term, developers of high-end products have to suffer from more developers switch from mass market to high-end market while home price cap keeps going. Competition will be fiercer than before. We estimate the first wave of abundant rental supplies will be launched in 2019 (after 2-year construction from now). Regarding HPR and home price cap, we estimate it will keep going till 2019. There are no signals showing that home demand weakens. Currently, even HPR and home price cap are strictly executed, 70 cities home price index (mom) is still at positive level.