China Property Update:Time to rotate out of high-risk names

Our recent channel checks on mortgage lending activities with banks in key regions in China (including Shanghai, Beijing, Guangzhou, Shandong, Dalian, Fujian and Hebei) indicate that the banks in 1H14 seem to be following stricter guidelines for approving mortgage applications. In Guangzhou, some mortgage applications are being turned away due to the tighter filtering criteria adopted by the banks. In Fujian, certain banks received lower mortgage applications in 2Q14 compared with 1Q14. Feedback from those banks seems to hint that mortgage loans, though low at current levels, may improve in the coming months, in line with the survey findings reported in the 17 June edition of our China Credit Monitor.

Risk associated with disappointing property sales in 1H14. In 5M14, major developers on average achieved only 33% of their full-year sales targets, a level lower than 5M13 (43%) and in line with 5M11 (34%). Tight mortgage lending will make it more difficult for developers to achieve their 2014 full-year targets. We believe possible failure to meet sales targets will give rise to additional downside risk for Agile (3383 HK) and Sino Ocean Land (3377 HK).

Where is the earnings risk? We have assessed the earnings risk for key developers by comparing the locked-in revenues (i.e. unrecognised revenues in 2013 carried over and 5M14 sales that may be booked in 2014) and the consensus estimate of 2014 revenues. We believe developers with low revenue lock-in, such as Agile (28%) and Guangzhou R&F (2777 HK, 44%), are exposed to high earnings risk and may be subject to earnings downgrades especially if there is no substantial improvement in mortgage lending activities in 2H14. Other developers, such as Kaisa (1638 HK, 100%) and Country Garden (2007 HK, 87%), have higher lock-in ratios and will be exposed to less risk. They are more likely to fulfill their earnings expectations.

Risk avoidance. The high gearing of some developers, such as R&F and Agile (at 112% and 79%, respectively, for 2014) will also raise their earnings sensitivity risk should there be further pressure on the ASP of the property market. We would avoid these stocks.