Global Economics

Still Bullish on Chinese Property Stocks


Analysts expect more price declines in certain cities and suggest investors look north to make the most of a demand-driven rebound

Chinese property stocks have been one of the worst hit sectors in the current market downturn, which entered its fourth month last week. But even as investors are at pains to avoid the sector, analysts project the trough is near and suggest it could be time to exchange the selling for some bargain hunting as fundamentals remain favourable.

Not every laggard property stock will be a winner though, and with fundamentals and earnings growth likely to be a key focus this year, the development of the underlying physical property market will be highly important for picking the right ones, they warn.

While most market participants still believe there will be stricter regulations and more credit tightening to come, Fitch ratings agency argues that robust economic growth, urbanisation and renminbi appreciation will continue to drive demand for Chinese property. Limited land supply, land hoarding, delay in property development and sales are also expected to create a shortage in the housing market, it says.

Analysts at UBS are cautious about the China property market in the near team, given the policy risks and unfavourable near-term macro factors, but longer-term they agree with Fitch and expect demand-driven growth in the physical market to resume in the second half of this year. Their counterparts at Credit Suisse are even more optimistic and predict that strong momentum in home sales will return already in the first and second quarters. According to a research report published last month, the Credit Suisse team believes strong investment and end-user demand will support prices in both the physical market and the stock market. The bank remains "overweight" on the Chinese property sector, although they contend that 2008 will be a much tougher year than 2007 for the Chinese developers.

In general, analysts favour property developers operating in northern China where prices haven't risen at the same rapid pace as in the large cities further south. And William Leung at RREEF, a global alternative investment management division of Deutsche Bank, argues that developers focusing on commercial real estate are preferable to those focusing on residential properties as they are less affected by the austerity measures. He favours developers with more exposure in second-tier cities for the same reason.

"The latest monthly figures (of property prices and sales) show that Beijing, Shenzhen, Hangzhou and Chongqing are still growing much faster than other cities. We believe they will face more severe cooling measures, which may lead to a drop in both prices and volumes in the coming months," UBS analysts say in a January research report.

The report projects a 10% decline in the Guangzhou property market in the first and second quarters of 2008 as a result of recent mortgage tightening measures. The price growth in Beijing and Shanghai will slow to 5% in 2008, from 17% (Beijing) and 9% (Shanghai) last year.

However, the analysts believe Shenzhen will be the worst hit among the four major cities, because of the high percentage of speculators among the property buyers in 2006 and 2007. Prices at several Shenzhen real estate projects corrected by more than 20% in 2007 and there could be another 20% of decline, they say.

According to Shenzhen Municipal Bureau of Land Resources and Housing Management, the residential property market started to adjust in September after a two-year boom and experienced a 13.15% decrease of home prices from October to November. New apartment sales fell to 179,900sqm in November, from 802,600sqm in January last year.

Other major cities have also seen substantial declines in prices over the past few months. For instance, several projects in Guangzhou have cut prices by around 10%, according to the UBS report.

"We expect more credit tightening measures to be announced and for southern Chinese cities to be hit harder than their counterparts in northern China because of the more prevalent use of mortgage financing," the UBS analysts remark in the report and add that the decline of prices and sales volumes in Guangzhou and Shenzhen since the third quarter last year may also lead to downgrades of consensus earnings for fiscal 2009.

Others argue that substantial earnings downgrades are unlikely and that more data on prices and sales are in any case needed to make such a call.

"The first quarter around the Chinese New Year is not the peak season for home sales. But if the property market continues to perform poorly in May and June, some property companies could experience earnings downgrades," comments Leung, who is the lead portfolio manager of Asia-Pacific real estate securities at RREEF.

However, Leung sees this as a good opportunity to invest in the sector for those who seek long-term gains, since shares prices have corrected a lot and are pricing in the bad news.

"Given the sharp correction of Chinese property stocks in recent months, the sector as a whole is currently trading at less than 15 times 2008 earnings with a 40% compound annual growth rate from 2006 to 2009. This looks markedly cheaper than their Asian peers and we believe the decline in sales volume is already in the price," agrees Andy So, property research analyst at BNP Paribas Securities (Asia).

Although he thinks the short-term share price movement is still highly dependent on the potential release of more bad news regarding a slowdown in sales, price cuts and changes in government policy, So believes that the worst time might have passed.

"Guangzhou R&F has just announced their January 2008 contracted sales figures, which were in line with their target at Rmb1.08 billion. These are very encouraging figures, especially in light of the sour investment sentiment and the snow storms that have affected mainland China," So says.

Indeed, a number of Chinese developers staged what appeared to be a pretty solid recovery after the Federal Reserve's latest rate cut on January 30. The emerging uptrend was broken yesterday, however, after finance leaders from the Group of Seven nations raised their forecasts for subprime-related losses and warned the economic slowdown would spare nobody.

But even with yesterday's losses, which range from 0.3% to 6.5%, Shimao Property Holdings has gained 19% over the past six sessions, Agile Property Holdings is up 15.5%, Guangzhou R&F Properties 8.9%, Country Garden Holdings 5.3% and Greentown China Holdings has added 7%.

While the gains are still fragile—as evidenced by yesterday's negative turnaround—they have broken the downward trend which saw Shimao, Agile, Guangzhou R&F and Country Garden lose more than half of their market value between the beginning of November and the end of January. Greentown fell 45% in the same period, while the Hang Seng China Enterprises Index dropped 36.5%.

The latest recovery may convince a number of the real estate listing candidates in the pipeline to brave the volatile markets and go ahead with their initial public offerings. Among the listing hopefuls are Evergrande Real Estate Group and Central China Real Estate Group, which are both hoping to list in the first quarter, as well as Changsheng Properties, which withdrew its first attempt to list in mid-January after the markets turned sour but is pondering a return as soon as feels confident the markets will hold up, according to sources.

"The success of any IPO definitely hinges on the current market situation. If we continue to see a rebound in the Chinese property sector across the board, it is highly likely that these IPO candidates will have a successful listing—if they seek to list at a discount to net asset value or at a forward PE of 12 to 14 times," remarks So.

But following a four-year bull run and a record 30%-60% surge in home prices across China in 2007, China's property market is by no means without risks.

The People's Bank of China (PBOC) raised the bank reserve ratio by 0.5% in January, less than a month after it had announced increases of the one-year base deposit rate and lending rate by 27bp and 18bp respectively. It also required mortgage holders to make a down-payment of at least 40% and pay a 10% premium on their interest rate.

The possibility of more such austerity and monetary policy measures together with a slowdown in the US and an increase in alternative investment opportunities could divert liquidity away from the domestic market and ultimately hurt the demand for properties. So while the long-term fundamentals are still positive, the road ahead seems destined to be much bumpier than in recent years.


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