SINGAPORE (July 15): Singapore’s property developers are enticing investors with hefty discounts of 45% to book value, relatively reasonable valuations of 16 times earnings and yields of 3.2%. Yet, from the perspective of Raymond Cheng, head of research at CGS-CIMB Hong Kong and China, these metrics are nowhere near as attractive as those of property developers listed in China.

These Chinese stocks are trading at a price-to-earnings ratio of roughly six times and a 40% discount off book value, and offer an average yield of 6.2%. “There are some risks, but valuation is really cheap,” says Cheng, a veteran property sector analyst. The risks include relatively higher levels of gearing and possibility of the renminbi being devalued, which would in turn hurt companies that hold substantial amounts of US dollar-denominated debt.

But Cheng also lists several reasons to own China property stocks.

First, as a sector, property is critical to China’s overall economic health. For 9M2018, property sales totalled some RMB15 trillion ($2.97 trillion), accounting for 16% of the country’s total GDP. If related sectors such as cement and aluminium production are included, the sector accounts for as much as 40% of China’s total GDP. “This means, if there are any problems for the local economy, this will be an area where the policymakers will want to try and help support,” says Cheng, who was speaking at the Mid-Year Investment Forum organised by The Edge Singapore on July 6.

During the global financial crisis in 2008, for example, the Chinese government introduced a massive RMB4 trillion stimulus package. Property buyers paid lower deposits for their purchases. As such, Cheng believes the authorities will be ready to act when necessary. “Given the concerns over the trade war [and] already weak local economies, policymakers are likely to continue with their existing favourable local policy.”

Secondly, the trend of urbanisation in China can only be positive for property developers there. The government has set a target of achieving 70% urbanisation by 2030, up from 56% in 2018. This means that for each year, another 1% of China’s population, or about 15 million people, will be moving from rural areas to urban centres, driving demand for development in the cities. “As long as China continues to urbanise, housing demand will grow. Even though [it may not be] as fast-growing as before, the stable demand will still be there,” he says.

Thirdly, the market is likely to see some consolidation. Right now, the country has some 40,000 developers of different sizes, which works out to an average of 100 developers for each city — a level of fragmentation that is “definitely too much”. In 2007, the top 15 developers commanded just 7% of market share in terms of sale value. In 2018, they increased their market share to almost 30% and Cheng sees this increasing to 40% by 2020.

It also means that smaller players will find it tougher to compete. Whenever new land is up for bidding, the bigger and more established players will bid aggressively and crowd out the smaller players.

A fourth reason for Cheng’s optimism is that the listed developers have considerable visibility in terms of earnings, at least for the coming two years. As of now, he estimates that the companies have locked in between 70% and 90% of their FY2019 earnings in the form of presales. Unlike in the Singapore property market, where progressive payments are made over the three to four years it takes to launch, build and complete new apartments, Chinese developers can collect the entire sales proceeds just two to three months after the sale and purchase agreements are signed. The value is then recorded as presales in their income statements and as revenue only when the completed units are delivered to the buyers.

Based on this practice, CGS-CIMB estimates that according to sales made over the past two years, listed Chinese developers have already locked in up to 90% of their earnings for this year, and another 20% to 40% for FY2020. At current prices, the developers are trading at just around six times earnings. Their earnings this year are on average seen to be 20% higher than FY2018. Cheng is expecting earnings to grow another 15% for FY2020, driven by both organic growth and consolidation of the various developers.

More commercial than political

Cheng acknowledges that while valuations seem cheap, there is potential for the sector to be rerated, as more investors better appreciate what they are buying. One potential driver would be the Stock Connect scheme between the mainland and Hong Kong that allows investors from the mainland to invest in Hong Kong-listed stocks, and vice versa. He observes that over the past two years, more mainland Chinese have been buying stocks of Chinese property developers listed in Hong Kong, as they are trading at half the valuations of those on the stock exchanges of Shenzhen and Shanghai. “They can use the same money [and] get much higher returns, much higher dividend yields,” says Cheng.

Among the China-based developers, Cheng prefers those with a bigger exposure to the Greater Bay Area. The GBA is a strategic plan by the central government for the nine cities in the Guangdong Province, Macau and Hong Kong to form a tighter, bigger economic development zone. China regularly introduces such strategic economic master plans, ranging from Go West in the early 2000s to the Xiong’an New Area a couple of years ago, which was meant as a new administrative region to alleviate overcrowding in Beijing 100km away.

However, quite a few of these projects, introduced with great fanfare, have yet to materialise in a significant way. The GBA, however, could be different. The southern coastal region, which includes the GBA, is the traditional centre of commercial and trading activities. By contrast, the northern regions, given their proximity to Beijing, are more focused on carrying out the latest political ideology of the central government. “One of the reasons I am convinced by GBA is that they are close to Hong Kong. Many local governments are so commercial, unlike those in northern China, where they are more political,” says Cheng.

He believes GBA might enjoy some additional leeway compared with other parts of the country. For example, Facebook and other US social media platforms, which are not freely accessible elsewhere in China because of its internet censors, might not suffer the same fate within the GBA, as the local authorities might want to drive the growth of high-technology sectors within the GBA. Flow of capital, both in and out, will also see fewer restrictions.

Right now, the GBA has a population of some 60 million and this number is expected to hit 100 million by 2035. “If this population growth can be realised, that’s creating housing demand,” says Cheng.

Cheng believes that while demand for Hong Kong property by local Hong Kongers remains strong, so too is the demand from mainland buyers. He estimates that mainlanders account for 20% of total purchases of Hong Kong residential properties.

“When the Hong Kong government planned the supply of housing, they underestimated or ignored this demand from the mainland. Even after they imposed stamp duties of up to 30%, [mainlanders] still keep buying,” says Cheng. Based on what the Hong Kong government can release into the market, Cheng sees a tight supply situation continuing.

Some of Cheng’s picks among developers include Longfor Properties, Shimao Property Holdings, CIFI Holdings; R&F Properties, Times China Holdings, China Aoyuan Group and Logan Property Holdings. “We think property in these markets should outperform the overall industry,” he says.

Currency risks and opportunities

Cheng also warns of some key risks. For one, further depreciation of the renminbi will hurt developers. As at end-2018, some 30% of their borrowings were denominated in the US dollar. If the renminbi is devalued by 5%, it can translate into a 7%-to10% drop in earnings between FY2018 and FY2020. The authorities, well aware that out-of-reach housing prices can be a source of unrest, have been known to occasionally impose price caps on how much developers can sell, potentially hurting margins.

However, with the US poised to trim its interest rates, this will likely bring down Hong Kong rates too. For decades, Hong Kong has pegged its dollar to the greenback. What this means for homebuyers is that their financing costs will be lower and property purchases more affordable, though job security remains a key risk.

“As long as the unemployment rate is kept low, people will be keen to buy instead of rent,” says Cheng, referring to the 2.9% unemployment rate currently. Unless the trade war deteriorates substantially, he sees the rate hovering at this level. As for developers, they now have much stronger holding power compared with two decades ago. Back then, because of their high gearing, they had to slash prices in order to recover some cash to pare down debt. That caused property prices to crash 80% from their peak. Today’s developers are much more cautious. Cheng says most have a net debt of just 10%, with a handful even in a net cash position.

So, even if the property market weakens in the near term, the developers will be able to withstand the pressure to cut prices. Funding costs, at just 3%, are easily manageable. Even taking into account a two-year wait before a property is sold, it works out to only a six percentage point cut to margins.

Cheng’s pick of Hong Kong developers includes Sun Hung Kai Properties, Henderson Land Development and Sino Land.

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