Guangzhou R&F:Short term gain,long term pain

A rate and policy cycle beneficiary. But doubtful moves.

R&F reported 21% growth in underlying net profit, in line with ourforecast. Given its high debt burden and reasonable exposure to tier onecity projects, the company is a clear rate and policy cycle beneficiary.

However, the decision to double dividend and double new starts isworrying with net gearing at 170%, cash to ST debt ratio at just 0.4x, andcompleted unsold inventory up 30% YoY. The stock has outrun our TP;upgrade from HK$7.6 to HK$9.5 (post 25% FY16 net profit upgrade onunchanged target PE of 5x) and downgrade to SELL (from U-PF).

Encouraging at first sight

R&F’s result looks encouraging at first sight: profit growth, high marginmaintained, and dividend doubled. The company reported underlying netprofit of Rmb4,776m (roughly in line with our forecast: Rmb4,405m), up 21%YoY. Revenue of Rmb44,291m was up 28% YoY driven by a 29% YoY growthin property development revenue. This is thanks to 11% growth in GFAdelivered to 3.51m sqm and 16% growth in booked ASP to Rmb11,590psm.

The company’s gross development margin was 33.8% down from 37% ofFY14 but stripping out the impact of a very high margin commercial project,and very low margin social housing projects, the resulting 34% gross marginis actually quite respectable among peers. R&F doubles DPS from FY13’sRmb0.62 to Rmb1.2. This seems a catch up act on the skipped DPS of FY14.

But doubtful moves

What worries us, however, is that, instead of taking the opportunity to unwindits debt, the company is re-leveraging. The 10pp net gearing fall by end-FY15to 170% was due to an increase in shareholder’s equity. Net debt actuallyrose by 9pp. The company announced plans to accelerate new starts, from3m sqm to 6.5m sqm at a time when completed unsold inventory wasclimbing quickly by 30% YoY. And the decision to pay a big dividend ofRmb3,848m, equivalent to 10pp net gearing, on an 80% underlying payoutratio, just looks imprudent rather than generous.

SELL on strength

We see the shares’ strength as an opportunity to sell. We raised our FY16earnings by 25% for two reasons: deferral of two tier one city projectsbooking from FY15 to FY16, and funding cost decrease. Re-pegging our targetprice to 5x (unchanged from previous: 5x) FY16 PE, which is about half a SDbelow 5-year historic average, we revise our TP to HK$9.5 (from HK$7.6). Onour revised TP the stock is a SELL, thus we downgrade our rec from U-PF.