China Property Outlook : Solid FY12 results followed by predicted policy announcements

Major developers reported solid average FY12 earningsgrowth of 20.8% from the strong recovery in 2012 propertysales. Gross profit margins throughout the year continued totrend downward as developers became more conservativein their pricing. Cash collections from presales improved,and construction and land banking plans are now beingconducted with greater scrutiny. The result for the period isthat net debt over equity improved, declining on average53.5% in FY12, down from 67.0% in 1H FY12. In 2013F, weexpect (1) busier completion schedules from majordevelopers as projects delayed in 2012 are reactivated;(2) profit margins to bottom for outperformers; and (3) areturn to higher debt ratios as the credit markets tightentowards both developers and buyers.

Policy changes create uncertainty within China’sproperty market. From 29 March to 1 April, 22 localgovernments imposed various controlling measures on theirrespective property markets as prescribed by the StateCouncil in the New National Five Measures (“新国五条”).

Beijing and Shanghai took the lead in setting thebenchmarks for other cities. The general target has been tokeep ASP growth lower than growth in local personaldisposal income in 2013F. Existing laws mandate a 20%personal income tax. This will be strictly implemented andthere has been talk of further tightening on housing loansdepending on market developments. Based on our channelchecks, certain local governments are showing flexibility onregulations for fear of the negative implications of excessivetightening in the property market. Further policydevelopments will be largely subject to property pricemovements in key cities.

Valuations. Property stock valuations will continue to beconstrained by policy risk and dour market sentiment.

Further tightening will also affect 2013F ASPs and salestargets. Stocks under coverage are trading at 7.3x FY13FP/E, 1.1x P/B (versus historical means of 9.3x and 1.5x,respectively) and a 34.4% sector average current discountto NAV. Action. Considering the overhangs on the sector,we advise investors to adopt a pair-trading strategy for thespace that hedges against sector-wide policy risks while stillmaking modest gains. Good examples of long-short pairsare: Greentown (3900 HK, Outperform) versus Agile(3383 HK, Neutral); and Shimao (813 HK, Outperform)versus Country Garden (2007 HK, Neutral). We also advisebuying CR Land (1109 HK, Outperform) on weakness dueto stable income streams from its commercial properties.