China Real Estate Developers:Five questions on valuations;depressed industry outlook has been priced in too much

Valuations have stayed persistently low

In the past five years, despite two cyclicalupturns/downturns, NAV valuations for our offshorecoverage has been most of the time tradingbelow its 10-year mean, with the trading rangenarrowing from the first half of last 10 years.

Similarly,12-m trailing price to book (accounted atcost) has been largely hovering around historical10-year trough level. In this report, we addressfive common questions from investors on NAVvaluation: 1) Why use it?; 2) What are the keydrivers?; 3) Why the valuation range can be widerthan cyclical property price changes?; 4) What hasit priced in?; 5) What will drive valuations to breakthrough the range?

Reflecting lingering housing price concerns

We think such low valuations reflect concern overan industry supply and demand imbalance,driving subsequent worries about a potentiallydeep property price correction amid the economicslowdown. As asset-based valuation such as NAVand P/B are most sensitive to price changes, withthe bearish expectations on long-term housingprices leading to low NAV/PB valuations.

Valuation already priced in a deep downturn

We examine what we believe has been priced into the valuation. We split our off-shore coverageuniverse into two camps: those trading above2016E book value (excl. accumulative revaluationgain) and those trading below. Large and/orquality developers are trading above 1X 16E P/Bor with narrower NAV discount. But even then, thevaluation implies extremely low total returns foryears from their existing property portfolio, eg. 3%for COLI; for those trading below book, valuationimplies average 21% write-down of their portfolioor average 37% price decline from current level,which will send China housing stock value toRmb97tn, or 1.3 times of 2016E GDP vs. 1.8X and2.8X for US and Japan. In our view, this is toobearish given China’s economic growth potential.

Two positive developments are neglected

1) Supply consolidation in higher-tier cities wherewe expect secular growth to last longer oncontinuing population growth; 2) A 37% reductionof land supply in 200+ cities during 14-16 from 11-13 levels. More details in companion report (Jan.

10) where we add COLI to CL-Buy, R&F up to Buy.