Company Reports

We are placing Country Garden Holdings, or CGH, under review, given the company’s announcement regarding a delay in the publication of its 2023 annual results. The company clarified that it is still in the process of collecting the necessary information to make appropriate accounting estimates and is assessing the current financial resources and obligations. As no financial information was published by March 31, 2024, the Hong Kong Stock Exchange will suspend trading in CGH’s shares on April 2, 2024. In addition, CGH said that domestic housing delivery and offshore debt restructuring are underway, and it is working with creditors to formulate practicable solutions. Given an over 80% year-on-year sales decline for CGH for the year to February 2024, we think the company’s future remains highly uncertain, and its restructuring may not yield any positive outcome. Consequently, our fair value estimate of HKD 0.50 per share is under review, and we will revisit our valuation, key assumptions, and Morningstar Uncertainty Rating once the company updates its financial performance for 2023.

We published our inaugural China real estate industry pulse for the first quarter of 2024 with the view that housing demand should gradually recover through 2026, supported by ongoing policy tailwinds. While new home sales in China remained sluggish in 2023, the nationwide average price was steadier due to a continuing mix shift to wealthier regions with more resilient prices. Moreover, we like the ramping-up of supportive measures since the second half of 2023 and expect further easing in buying restrictions and mortgage rate cuts in large cities. While share price performances could remain volatile in the near term, we see an improving risk/reward profile at the current valuation as the market may be missing key developers' improving sales outlooks. As such, we prefer top state-owned builders, China Overseas Land & Investment and China Resources Land, as both have seen better sales growth, higher asset quality, and healthier gearing ratios versus their peers.

We cut our fair value estimate on Country Garden Holdings, or CGH, to HKD 0.50 from HKD 1.20 following the company’s essential default on offshore bond interest payment in October 2023. Although this is no surprise given CGH’s expectation of not meeting offshore payment obligations within grace periods, we expect the formal default to further weigh on homebuyers’ confidence in Country Garden’s brand. Hence, our updated forecast reflects lingering sales and revenue decline through 2027, with 2024-25 seeing the most pronounced drop. We also factor in more protracted operating losses for CGH through 2025, compared with 2024 previously, due to weaker assumptions on sell-through rates and home prices in lower-tier cities. Moreover, we lift CGH’s Morningstar Uncertainty Rating to Extreme from Very High amid its depressed earnings and muddled outlook of overseas debt restructuring. With CGH’s liquidity subdued by the sales slump, the company’s survival hinges on bondholders’ acceptance of a proposed repayment schedule, in our view.

In our view, the property market in China will see a mild rebound in sales growth in the next few years following the revival of site visits and improvement in homebuyers’ sentiment. That said, we expect housing demand to be contained by slowing economic growth and the government's restrictions on developers’ leverage and housing price inflation. As the market downturn persists, Country Garden Holdings, or CGH, should continue to post a sales decrease, which we think will negatively affect its operating cash flow. Also, CGH has seen deterioriation in balance sheet quality with a net gearing ratio of around 50%. As CGH has missed bond interest and principal payments, we think the firm needs to restructure all existing debt through negotiation with creditors to remain a going concern.

In our view, the property market in China will see a mild rebound in sales growth in the next few years following the revival of site visits and improvement in homebuyers’ sentiment. That said, we expect housing demand to be contained by slowing economic growth and the government's restrictions on developers’ leverage and housing price inflation. As market downturn persists, Country Garden Holdings, or CGH, should continue to post weak sales, which we think will negatively affect its operating cash flow. Also, CGH has seen deterioriation in balance sheet quality with a net gearing ratio of around 50%. As CGH has delayed bond interest and principal payments, we think the firm needs to further seek credit extension and financial support to ease liquidity pressure.

Country Garden Holdings, or CGH, first-half 2023 results reflected significant loss on write-offs and lower average selling prices. While the company is focused on averting default, we think the lack of cash flow details has added to the murkiness of CGH’s debt servicing capability. We now project a net loss of CNY 44.7 billion and CNY 4.5 billion in 2023 and 2024, respectively, after factoring in inventory write-offs of CNY 10.7 billion and CNY 3.0 billion. Despite the negatives, we maintain our fair value estimate of HKD 1.20, as we have addressed CGH’s high likelihood of default by previously raising the weighted average cost of capital and cutting gross margin estimates. Given the continuing absence of USD-denominated bond interest payment, we believe CGH’s default risk remains elevated, barring substantial credit extension or financial support.

In our view, the property market in China will see a mild rebound in sales growth in the next few years following the revival of site visits and improvement in homebuyers’ sentiment. That said, we expect housing demand to be contained by slowing economic growth and the government's restrictions on developers’ leverage and housing price inflation. As market downturn has largely subsided Country Garden Holdings, as one of the largest developers, will be better positioned than smaller peers due to its wider access to funding. CGH, supported by a healthy balance sheet with a net gearing ratio of around 40%, has reached the green category under China's "three red lines" policy in 2022, and we think the firm will further reduce its overseas debt exposure to alleviate liquidity pressure.

We have cut our fair value estimate for Country Garden Holdings to HKD 1.20 from HKD 2.80 given the higher weighted average cost of capital on potential defaults and more compressed margins. CGH missed a USD 22.5 million interest payment on two offshore bonds on Aug. 7, fueling the market's concerns that it may eventually default after the 30-day grace period as evidenced by the plunge in its bond and share prices. While management cited liquidity pressure due to a deterioration in sales and the refinancing environment, they underscored an ongoing effort to arrange coupon payments. That said, we remain cautious about the likelihood of CGH’s default, given its weak sales and elevated overseas funding costs. As such, we raised our assumptions for CGH’s cost of debt and cost of equity by 550 basis points and 200 basis points, respectively, leading to WACC rising to 12.8% from 9.5%, according to our prior estimate. In addition, following CGH’s profit warnings, we think pressured housing prices in lower-tier cities have further eaten into CGH’s profitability and lowered our 2023 gross margin forecast to 6.1% from 9.9%.

The Hong Kong market experienced a solid rally following the July 24 Politburo meeting, with the real estate stocks rebounding from recent losses. We believe signs of government support are positive but we would have liked to see more in addressing excess property inventory. We believe more details will emerge along with ongoing policy adjustments, but for the time being, our view remains that China’s real estate activity will recover gradually through 2025. As a result, we think risks remain in the sector with negative news likely to continue regarding possible defaults. There was no explicit language in the messages regarding financial support for the real estate developers. As such, we continue to prefer buying China Overseas Land & Investment over others given financial strength and an attractive project pipeline in Tier 1 and Tier 2 cities.

We transfer coverage of Country Garden Holdings and Country Garden Services with no moat and stable moat trend ratings for both. CGH has been one of the largest real estate developers in China over the past few years, while CGS became the leading property management service firm following the spinoff from CGH in 2018. Despite CGH’s leadership in housing sales, we think it will see tempered sales growth recovery amid a slow rebound in housing demand in lower-tier cities of China. Nonetheless, we are more positive on the top-line growth of CGS given increasing gross floor area under management acquired outside CGH, coupled with a rising contribution from quickly emerging value-added services. Our fair value estimates of HKD 2.80 for CGH and HKD 42.50 for CGS remain unchanged, and we view both firms as undervalued. That said, shares of CGS are more attractive with more than 100% upside versus around 20% for CGH, and we believe CGS warrants a more stable dividend payout given the higher resiliency of its fee-based revenue structure.

In our view, the property market in China will see a mild rebound in sales growth in the next few years following the revival of site visits and improvement in homebuyers’ sentiment. That said, we expect housing demand to be contained by slowing economic growth and the government's restrictions on developers’ leverage and housing price inflation. As market downturn has largely subsided Country Garden Holdings, as one of the largest developers, will be better positioned than smaller peers due to its wider access to funding. CGH, supported by a healthy balance sheet with a net gearing ratio of around 40%, has reached the green category under China's "three red lines" policy in 2022, and we think the firm will further reduce its overseas debt exposure to alleviate liquidity pressure.

No-moat-rated Country Garden Holdings, or CGH, posted a net loss in 2022 for the first time since its listing in 2007, albeit in line with its profit warning. Revenue also saw a 17.7% year-on-year slump due to delivery disruption and tempered inventory clearance in 2022. While management is optimistic that top line growth will recover with a pickup in housing demand, we think the sales drop in 2021-22 will weigh on revenue booking over the next few years. Excluding one-off impairment and foreign exchange loss, CGH’s core net profit remained positive at CNY 2.6 billion, despite a pronounced dip from 2021 levels. Although CGH has ramped up projects in Tier 1 and Tier 2 cities to lift margins, we expect the improvement to be gradual given stiff competition for limited landbank. We also foresee that inventory turnover of CGH will be slower than state-owned peers given heavier exposure to lower-tier cities. As such, we trim our fair value estimate to HKD 2.80 from HKD 5.10 on lower margins and higher inventory days assumptions through 2027. Our revised valuation still implies a 23% upside to HKD 2.28 close price as of March 30, 2023, and we believe stable dividend yield will resume with the turnaround in CGH’s profitability.

In our view, the property market's strong growth seen over the past decade is largely behind us. That said, with sentiment turnaround on housing prices, the sector will likely see meaningful demand recovery in the next few years. The physical property market will be constrained due to the tapering-off of overall growth and the government's continued policy to limit the risk of leverage and asset price inflation. Large developers are expected to be the main beneficiaries as smaller players are pushed out by less funding availability. Country Garden, as one of the largest China developers, would possess better positioning than smaller peers. Supported by a healthy balance sheet with net gearing of about 40% and targeting to reach the green category under three red lines policy by the end of 2023, the company can continue to seek value creation opportunities through spinoffs of diverse businesses.

The Chinese government has over the past few days laid out plans to support the real estate sector, leading to sharp share price gains for the real estate developers. While we think the recent policy moves are in the right direction to assuage debt risks, we believe more is needed, which we hope will materialize over the next six months. We think the initiatives are supportive of the share prices in the near term, but we maintain our view that we need to see a return of homebuyers’ confidence to support contracted sales, as this is essential for a durable improvement in the developers’ credit environment. We think indebted developers may see a lag in the return of buyers’ confidence compared with that for financially stronger companies. At this stage, we maintain our view for revenue and profit to trough in 2023 for the sector, but we see financial positions improving during the year. The policy support doesn’t change our view that state-owned developers, such as China Overseas Land and Investment, or COLI, and China Resources Land, or CRL, should still be best positioned to pick up reasonably priced landbank given their stronger balance sheets, which gives them a competitive edge in future projects.

Four China developers under coverage—Country Garden, China Jinmao, China Resources Land, and Agile—released first-half results at the end of the reporting period. The results takeaways support our continued preference for state-owned enterprise, or SOE developers. Bellwether Country Garden headlines the challenge to private developers, weighed by the weak property market, in which Country Garden’s first-half earnings are severely affected by the slowdown in project deliveries and continued margin disappointment. The weakness in its results were similarly observed in private developer Agile’s first-half result. On the flip side, the results of SOE developers, China Jinmao and China Resources Land, or CRL, are still showing steady results. This is consistent with China Overseas Land & Investment, or COLI, which reported first-half results earlier.

In our view, the property market's strong growth seen over the past decade is largely behind us. As the Chinese property market is in a consolidation phase, with Country Garden in line with peers across property developers focused on cost efficiency. The physical property market will be constrained due to the tapering-off of overall growth and the government's continued policy to limit the risk of leverage and asset price inflation. Large developers are expected to be the main beneficiaries as smaller players are pushed out by less funding availability. Country Garden, as one of the largest China developers, would possess better positioning than smaller peers. Supported by a healthy balance sheet with net gearing of about 50% and targeting to reach the green category under three red lines policy by the middle of 2023, the company can continue to seek value creation opportunities through spinoffs of diverse businesses.

China real estate activity has been weak through the first half of 2022, in line with our earlier expectations for the physical market weakness to persist. Despite green shoots of recovery in June, the pace of recovery, however, may be hampered by the start-stop zero-COVID-19 policy that likely limits the positive impact of policy easing. We differ from the market view that easing policies in the form of lower mortgage rates are adequate to support rapid recovery once lockdowns recede. Instead, we believe that healing the developers' access to credit is key to longer-term recovery. We expect any recovery to be slow as we do not expect a quick rebound in homebuyer confidence, and we think homebuyers will be selective. Support from financial institutions for onshore debt backed by derivatives for some developers strikes the liquidity issue at its heart—however, it has not lifted markets. Action in the bond market implies that investors remain concerned with the long-term debt repayment ability of some developers, especially if presales activities remain at a slower pace. Lenders may also be choosy, capping the abilities of some developers to expand.

We see Country Garden’s full-year results below expectations on a margin miss, albeit investor concerns on liquidity stress is likely overdone. On results, revenue of CNY 523 billion was in line, albeit gross margin was below expectations at 17.7% as margins did not reach the bottom the year before and earnings fell 23% year on year. There was not much clarity from management on margin compression, although our sense from management takeaways was that the pressure of selling from competing projects did affect original project underwriting and continued to compress margins. A final dividend of CNY 0.1012 per share, adding to the total annual dividend of CNY 0.311 per share translates into a payout ratio of 26.2%, a drop from 31% a year before. We lower near-term gross margins for the next two years before a gradual recovery, and lower our fair value estimate to HKD 9.60 from HKD 10.50 per share. Nonetheless, we expect Country Garden to be one of the better-positioned private-sector real estate developers to come out ahead in a consolidating industry. The relaxation of lending policies to the sector signals that the worst of the conditions of the past nine months may be ending and a positive policy narrative may support the share price in the near term.

In our view, the property market's strong growth seen over the past decade is largely behind us. As the Chinese property market is in a consolidation phase, with Country Garden in line with peers across property developers focused on cost efficiency. The physical property market will be constrained due to the tapering-off of overall growth and the government's continued policy to limit the risk of leverage and asset price inflation. Large developers are expected to be the main beneficiaries as smaller players are pushed out by less funding availability. Country Garden, as one of the largest China developers, would possess better positioning than smaller peers. Supported by a healthy balance sheet with net gearing of about 50% and targeting to reach the green category under three red lines policy by the middle of 2023, the company can continue to seek value creation opportunities through spinoffs of diverse businesses.

In parallel to another real estate credit risk driven sector correction beyond asset fundamentals, the Singapore REIT market suffered during the global financial crisis. During that period, the market's immediate concern was with the debt risks leading to a significant gap in share prices to fundamental values. This is as investors were focused on respective REIT debt expiry profiles instead, and unit prices trading at wide deviations from reasonable yield, capital values or rents that long-term fair value estimates should imply. Hence, even quality Singapore REITs with low risk of default were indiscriminately sold down with the sector-wide contagion and higher market risk premium.