China Property 2 January 20192
Contents
OUR THESIS IN PICTURES ........ 4
OUR FUNDAMENTAL SCORECARD ...... 7
PIVOTAL QUESTIONS ... 9
Q: Where are we in the China property cycle ......... 9
Q: Will developers' leverage cause them financial distress in the current
slowdown26
WHAT'S PRICED IN .. 30
STOCK PICKS36
Company Pages ...... 42
China Evergrande Group ... 43
China Vanke - H .... 55
China Overseas Land & Investment65
China Resources Land ........ 76
Country Garden ..... 86
Longfor Group ....... 97
Shimao Property .. 106
Guangzhou R&F Properties .......... 118
KWG Group......... 128
Appendix .. 140
John Lam, CFA
Analyst
john-za.lam@ubs
+852-2971 6358
Mark Leung
Analyst
mark.leung@ubs
+852-2971 8636
Michael Xu
Associate Analyst
michael-a.xu@ubs
+852-2971 5573
Edwin Chen, CFA
Analyst
S1460516010001
edwin.chen@ubssecurities
+86-105-832 8186
Titus Han
Associate
titus.han@ubssecurities
+86-105-832 8777
China Property 2 January 20193
China Property
UBS Research THESIS MAP MOST FAVOURED LEAST FAVOURED
COLI, Vanke, Logan Evergrande, KWG
PIVOTAL QUESTIONS Q: Where are we in the China property cycle
After an upcycle in 2017-18 we expect a moderate slowdown in 2019, driven by the fading
contribution from shanty redevelopment and weaker purchase sentiment. We think this downcycle is
demand driven, unlike the supply-driven downcycles in H211-H112 and 2014. We view this as more
positive, as demand can be stimulated by government policy or mortgage rates/accessibility, while it
takes much more time for the market to digest oversupply.more
Q: Will developers' leverage cause them financial distress in the current slowdown
No. 1) Inventory in the system is lower than in the last two downcycles (see PQ1 discussion),
suggesting there is less inventory pressure sitting on their balance sheets 2) We think there is more
room for developers to preserve their cash flow by cutting back on land acquisition, as land costs are
the largest cash outflow item. 3) Listed developers have now gone through multiple downcycles, and
have experience in balance sheet management, as suggested by their lower short-term debt to cash
ratios. 4) Listed developers have become more geographically diversified, and are therefore less
exposed to a sharp slowdown in a single city or region.more
UBS VIEW We view this downcycle as less severe: we view this downcycle as different from the past two
because it is demand driven. We think it will be easier for developers to weather than downcycles
driven by oversupply, in which it can take a long time to digest inventory. We think the sector’s
current close-to-trough valuations factor in a distressed situation for developers.
EVIDENCE The September 2018 UBS Evidence Lab China Housing Survey suggests purchase intentions
and property price expectations have slowed, due to rising mortgage rates and macro concerns,
instead of too much supply. Our supply analysis suggests inventory remains lower than in the H211
and 2014 downcycles as new starts have been lower than in 2010 and 2013.
WHAT'S PRICED IN Valuation close to trough cycle in H211 and 2014: Using price-to-earnings valuation, the MSCI
China Real Estate Index is trading at 5.1x, -1.4 SD since 2010, similar to the H211 and May 2014
trough cycles of 4.7x and 5.3x. We think the market is concerned on developers' balance sheets and
margins. After our stress test on developer margins, we estimate downside risk of about 17% to
2019 consensus earnings. This implies the MSCI China Real Estate Index PE would return to 6.2x,
between -1SD of 5.8x and the average (since 2010) of 7.5x. We think margin risk may have been
priced in at this level.
more
National new starts, sales area, and cumulative inventory—base case
Source:CEIC, UBS estimates500
1,000
1,500
2,000
2,500
3,000
3,500200
400
600
800
1,000
1,200
1,400
1,600
Jan
-05
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Inventory in the pipeline (RHS)New starts (T12M, LHS)Sales area (T12M, LHS)
m sqm m sqm Sector was
adding stock
Sector was
destocking
2019E: Sales -4%; New starts -3%
Inventory down
15% from peak
China Property 2 January 20194
China Property UBS Research
OUR THESIS IN PICTURES return
There is less inventory in the system than during the
cycles in 2013 and 2015 because there is less land supply
compared to previous cycles. We expect ‘inventory
months’ to be 21 months by end-2019E, below the 28
months in 2013 and 33 in 2015.
* Inventory is defined as the cumulative floor space started minus floor space sold.
Though land supply has been increasing over the past 12
months, the absolute level of supply remains about 30%
below the levels in 2011 and 2013, which explains why
there is less inventory than during the previous cycles.
We think it will be easy for developers to preserve their
cash flow and therefore deleverage by cutting land
acquisition—which accounts for about 60% of the cash
proceeds from contract sales.
* Based on simple average of 8 developers' actual H118 cash flow (COLI, CG, CIFI,
Aoyuan, KWG, Longfor, Sunac); assuming total operating cash inflow = 100.
Policies vs property price & real estate investments
Historically, China’s property policy aims to strike a
balance between prices (preventing a sharp increase)
and real estate investment (preventing a sharp
slowdown). In 2019, we expect some fine-tuning of
existing austerity measures due to slowing growth in
prices and real estate investment.500
1,000
1,500
2,000
2,500
3,000
3,500
12.0
15.0
18.0
21.0
24.0
27.0
30.0
33.0
Jan
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National inventory months* - base case
Inventory in the pipeline (RHS)Inventory months (LHS)
m sqm
33 months
28 months
23 months
16 months
21 months20
40
60
80
100
120
140
Jan
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Jul
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Monthly residential land sale - 300 cities (in GFA)
m sqm (LHS)GFA (12mma)
m sqm
111 107
76
~30%
down from
the peak
(40)
(20)20
40
60
80
100
120
Sal
es
& o
the
r
pr
oce
eds
Lan
d c
ost
Co
nst
ruc
tion
co
st
SG
&A
ex
pen
se
Inte
res
t co
st
Tax
ex
pen
se
Div
ide
nd
&
oth
er o
utf
low
s
Ne
t o
per
atin
g
CF
Developers' operating cash flow (1H18)
100 (61)
(33)
(6)
(6) (12)(2)(20)
-10%
0%
10%
20%
30%
40%
50%
90.0
100.0
110.0
120.0
130.0
140.0
150.0
160.0
Jan
-09Jul-09
Jan
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Jan
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Jan
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Jan
-18Jul-18
Jan
-19Jul-19
70-city price index (Jan-09=100, LHS)REI YoY % (RHS)
2019EREI +4% YoY;
Property price index -4%*
EasingTighteningTighteningEasingEasingTightening。