China Property:A decade of excitement

Stock performance。

    Ten years ago, GR&F went public and marked the start of a whole slew of IPOsof Chinese developers in the subsequent five years. We take this opportunity toscore and differentiate the performance of these companies and highlightpotential winners in the coming five years. The best performers were CRLN(1838%) and COLI (1813%) since June 2005 and we continue to ‘top pick’ CRLNin the large cap space. Over a shorter period, the best performers were two Ashares, CMPA (222%) and POLA (202%), since June 2010. In terms of absoluteearnings growth between 2004 and 2014, the best performers were COLI(Rmb20.9bn) and VANK (Rmb14.9bn). CRLN (Rmb11.7bn), with 60% theearnings base versus COLI, should enjoy easier growth as CRLN strengthens itspresence in T1 cities.

    Fundamental strengths

    Revenue growth has slowed over the years, from 45% in 2010 to 19% in 2014,and will continue to trend down in 2015 (16%) and 2016 (15%) according toconsensus. Gross margin dropped sharply from the peak of 38% in 2011 to 29%in 2014 (no consensus forecasts). We expect margins for our coveredcompanies to flatten out in the next three years. Divergence among companiesshould widen in all areas: 2015 contracted sales target growth (-27% to 38%),2014 gross margin (17% to 38%), end-14 net gearing (7% to 292%), build up ofinventory in 2014 (-30% to 65%) and 2014 ROE (3% to 25%). This reflectsvariation in execution in land acquisitions, speed of development, cost control,positioning and marketing, sell-through rate, pricing, product quality andfinancing tactics. The culmination of these factors should lead to consistentquality earnings growth. Our stock picks are CRLN, KWGP, SUNC and FRAN.

    Market changes

    Transaction volume continues to improve with YTD YoY growth of 50%, versusjust 30% during 1Q15 for T1 cities. T2 cities also improved but at a slower rate(10% YTD vs 0% during 1Q15). We expect the trend of improvement to continueand peak in 4Q15 as most developers schedule new launches around then.However, the improvement will likely be limited to the top 40 cities as thenational market has grown only 3% so far. We expect 10% growth for the fullyear to bring us back to the 2013 sales level of Rmb6.8trn and low single-digitannual growth thereafter. T1/2 cities would outperform the rest of the market interms of price growth with T1 cities already in positive MoM territory since March,heading to 10% for the full year. T2 cities’ price growth should be around 5%.

    Macro implications

    From 2005 to 2010, developers expanded aggressively into T2 cities, followedby penetration into T3/4 cities from 2010 to 2013. T2 cities remain importantcontributors to sales, but T3/4 cities have failed to deliver on their promise as thenext frontier of growth. This is due to a slowdown in GDP growth and outflow ofthe population and wealth from these places. Oversupply is a dampening factor,but not a destructive force. Land supply is limited in T1 cities’ prime areas,contributing to price increases over the next five years. Land bought in T2/3cities should last for three years while that in lower-tier cities is sufficient for fiveyears. When measuring new starts against sales, the situation is more benignwith 0.45 years of supply in T1 cities; 1.06 years of supply in T2/3 cities and 1.36years for lower-tier cities. We remain Overweight on the China Property sector.