China Property Investment Update:Expecting solid FY12 earnings growth

We anticipate solid c.20% FY12 earnings growth from the major Chinese property developers on higher sales and GFA completions. We also expect net gearing levels to improve by 5-10 ppt due to better cash collection and lower gross profit margins (1-2 ppt) after many developers modified their pricing strategies.

Robust year-on-year growth in contracted sales for January-February 2013, because of the low comparison base from the same period last year in addition to favorable mortgage lending practices introduced at the start of 2013. We expect current momentum to continue into March, though year-to-date growth momentum is likely to slow as we approach 2Q13F, which has the disadvantage of being compared with 2Q12, a quarter when contracted sales were particularly strong (this comparison base will move even higher in the third and fourth quarters). Over results season (12-29 March), we expect Chinese property names to announce FY13F sales targets that are on average 15% higher than they were in 2012.

Valuations. China’s property developers face sector-wide downward pressure as concerns mount that the government will institute further property price controls. The government will have to be more forthcoming about the direction of its policies pertaining to the sector if this situation is to have any chance of improving. In the meantime, we widen target NAV discounts for all of our covered China property names by 10%, mainly to account for higher risk premiums related to potential policy changes in the wake of the National People’s Congress (NPC) now taking place. We intend to maintain our key ASP assumptions until the end of the year.

Action. In view of the property controls (“新国五条细则”) recently announced by the State Council, China’s developers are likely to see short-term volatility until late March when the NPC comes to an end. In our view, now is the time to accumulate mass-market property developers with solid FY12F earnings, attractive valuations (wider than a 30% discount to NAV), modest net gearing ratios (below 60.0%) and ample land bank sizes (larger than 30m sqm). Developers matching this profile include: Country Garden (2007 HK, Outperform), CR Land (1109 HK, Outperform) and Shimao Property (813 HK, Outperform).

Risks. The possibility of additional property controls, including trials of the proposed property tax, remains an overhang in the short term.