Construction & real estate / China 6 July 2011
Housing China Buying times for China property stocks
• We identify the 10 key areas investors in China-property stocks should focus on to make profitable investment decisions • We expect the leading developers to benefit from positive housing-
demand growth • Developers are likely to increase their non-residential exposure
Guangzhou R&F (R&F), Glorious suggests names like China Overseas Property and Yuexiu Property Land & Investment (Coli), China (Yuexiu). For investors with long- Vanke, China Resources Land (CR term horizons (three years), our Land) and Longfor. For non-
five-factor model (scale, earnings residential plays, investors should Danny Bao, CFA efficiency, balance sheet, access to consider Franshion Properties China (852) 2773 8715 [email protected] capital and earnings sustainability) (Franshion).
Yunye Lu (852) 2848 4923 [email protected]
What to consider when investing in the China Property Sector The China Property Sector has lost much of its investor appeal over the past 12 months, due to its significant underperformance against the country index over the past two years, and the government’s tightening measures. However, we expect positive housing-demand growth over the next five years to boost the earnings of the leading developers.
We believe the current policy regime will lead to industry competition and market-share consolidation intensifying in the residential segment, but expect this to benefit the leading players. We expect more developers to increase their non- residential exposure to diversify their earnings bases.
Six-month/three-year investment considerations We believe the sector’s depressed valuations clearly make the risk/reward profile more attractive. For short-term trading ideas based on relative valuations, we recommend laggards such as Source: Daiwa
Important disclosures, including any required research certifications, are provided on the last two pages of this report.
Table of contents
Buying times for China property stocks...... 1 Part I - does policy matter for China property stocks?...... 6 Part II – soft landing or hard landing?...... 10 Part III - does public housing lead to lower industry returns? ...... 14 Part IV – do business models matter for developers?...... 18 Part V – does stock selection matter? ...... 23 Part VI - does asset class matter?...... 27 Part VII – does government backing matter?...... 31 Part VIII – what matters in the next cycle? ...... 35 Part IX – are M&A activity and privatisations on the horizon? ...... 39 Part X - what are our top picks on six-month/three-year horizons? ...... 43
Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011
Executive summary
Buying times for China property stocks In this report, we identify the 10 key areas investors in China-property stocks should focus on to make profitable investment decisions amid the government’s policies to cool home prices.
Investment thesis We expect positive residential housing-demand growth amid the Residential demand government’s public-housing initiatives to have a positive impact on the earnings of the leading developers. We expect this new trend to change the growth remains intact, industry’s growth model, and for more developers to increase their non- while government residential exposure to diversify their earnings bases. Investors with initiatives should ease shorter investment horizons (six months) should consider relative supply shortages valuations and earnings-growth expectations, while long-term investors (three years) should consider our five-factor model for stock selection. Investors should also look at certain non-residential plays.
On a six-month basis, we like R&F, Glorious Property, and Yuexiu. Meanwhile, on a three-year horizon, we like Coli, Vanke, CR Land, and Longfor, which we believe investors should try to acquire at cheaper valuations in the event of any sector weakness in the future.
Valuations The sector is trading currently at about a 35% discount to our NAV estimate, Wide divergence in stock and at about an 8.7x PER on our 2011 EPS forecasts. The recent rally in large-cap developers’ shares has caused the sector’s NAV discount to valuations implies an narrow. However, we still see plenty of value in laggard stocks in the mid- opportunity for solid and small-cap spaces. We see limited near-term upside potential for the returns large-cap names, due to the recent share-price rally.
Profit outlook We expect the sector to record positive earnings growth for the next three Earnings growth for the years. We believe the leading developers that have scale, high earnings efficiency, access to cheap capital, and reasonable balance sheets are likely leading players likely to to record stronger earnings growth than their peers over the period. We accelerate expect delivery-volume growth to drive the sector’s earnings growth. Meanwhile, we also expect the earnings contributions from non-residential assets to improve in the future.
Key stock calls
EPS (local curr.) Rating Target price (local curr.) FY1 FY2 Company Name Stock code New Prev. New Prev. % chg New Prev. % chg New Prev. % chg China Overseas Land & Investment 688 HK Buy Buy 19.00 19.00 0.0 1.434 1.434 0.0 1.746 1.746 0.0 China Resources Land 1109 HK Outperform Outperform 15.10 15.10 0.0 0.966 0.966 0.0 1.052 1.052 0.0 Country Garden 2007 HK Outperform Outperform 3.90 3.90 0.0 0.284 0.284 0.0 0.374 0.374 0.0 Guangzhou R&F Properties 2777 HK Buy Buy 13.70 13.70 0.0 1.256 1.256 0.0 1.535 1.535 0.0 Franshion Properties China 817 HK Buy Buy 2.80 2.80 0.0 0.137 0.137 0.0 0.167 0.167 0.0 Glorious Property 845 HK Buy Buy 3.50 3.50 0.0 0.310 0.310 0.0 0.404 0.404 0.0 Yuexiu Property 123 HK Buy Buy 1.96 1.96 0.0 0.150 0.150 0.0 0.221 0.221 0.0 Source: Daiwa forecasts
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Danny Bao, CFA Daiwa stock picks: six-month investment horizon (852) 2773 8715 5 Jul Target Share price % [email protected] Company Ticker Rating Currency price (HK$) Upside Guangzhou R&F 2777 HK 1 HK$ 11.26 13.70 22 Key stock ideas: six months Franshion 817 HK 1 HK$ 2.09 2.80 34 Glorious 845 HK 1 HK$ 2.52 3.50 39 Yuexiu Property 123 HK 1 HK$ 1.56 1.96 26 Source: Daiwa
China Property Sector: valuation comparison 2012 Price vs Price vs Target Target 5 Jul Mkt 2011 yr.-end current forward Target price/ price/ Share cap Current forward NAV NAV price current forward PER PBR Company Ticker Rating Currency price (US$m) NAV NAV (%) (%) (HK$) NAV NAV FY11E FY12E FY11E FY12E *Coli 688 HK 1 HK$ 17.48 18,361 22.9 22.3 (23.7) (21.6) 19.00 (17.0) (14.8) 12.2 10.0 2.1 1.7 *China Vanke - B 200002 CH 1 HK$ 10.82 15,351 11.4 13.0 (5.1) (16.8) 11.70 2.6 (10.0) 12.6 11.0 2.0 1.7 *CR Land 1109 HK 2 HK$ 15.14 10,485 20.8 21.0 (27.2) (27.9) 15.10 (27.4) (28.1) 15.7 14.4 1.6 1.4 Poly Real Estate 600048 CH NR Rmb 11.33 10,428 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 10.2 8.0 1.8 1.6 Evergrande 3333 HK NR HK$ 5.39 10,392 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.0 6.2 1.7 1.8 *Longfor 960 HK 3 HK$ 13.02 8,627 18.3 19.0 (28.9) (31.5) 12.35 (32.5) (35.0) 14.0 10.3 2.8 2.2 *Country Garden 2007 HK 2 HK$ 3.77 8,092 5.4 5.6 (30.2) (32.7) 3.90 (27.8) (30.4) 10.9 8.7 1.9 1.6 Agile 3383 HK NR HK$ 13.00 5,802 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.6 7.1 1.7 1.4 Shimao 813 HK NR HK$ 10.68 4,872 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 7.4 6.3 1.1 0.9 *SOHO 410 HK 3 HK$ 7.26 4,841 8.4 8.9 (13.6) (18.4) 6.20 (26.2) (30.3) 11.3 6.8 1.5 1.2 *Guangzhou R&F 2777 HK 1 HK$ 11.26 4,664 21.7 22.8 (48.1) (50.6) 13.70 (36.9) (39.9) 7.5 6.2 1.4 1.2 Renhe 1387 HK NR HK$ 1.48 4,056 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5.8 5.0 1.6 1.3 Shanghai Industrial 363 HK NR HK$ 28.75 3,990 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 9.8 8.3 0.9 0.9 Sino Ocean 3377 HK NR HK$ 4.36 3,176 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.0 6.6 0.6 0.6 Poly HK Investment 119 HK NR HK$ 6.27 2,908 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 12.1 8.7 0.9 0.8 *Glorious 845 HK 1 HK$ 2.52 2,524 6.8 7.0 (62.9) (64.0) 3.50 (48.5) (50.0) 6.8 5.2 1.0 0.8 *Franshion 817 HK 1 HK$ 2.09 2,461 3.7 4.0 (43.5) (47.8) 2.80 (24.3) (30.0) 12.5 11.0 1.0 1.0 Shui On 272 HK NR HK$ 3.49 2,338 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 12.3 9.7 0.6 0.5 KWG Property 1813 HK NR HK$ 5.74 2,134 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 7.6 5.8 1.0 0.9 New World China 917 HK NR HK$ 2.85 2,111 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 13.9 9.8 0.5 0.4 Yanlord YLLG SP NR S$ 1.28 2,035 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.1 6.7 0.9 0.8 Mingfa 846 HK NR HK$ 2.47 1,924 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 10.9 9.3 1.8 n.a. *Yuexiu Property 123 HK 1 HK$ 1.56 1,861 5.0 5.6 (68.8) (72.1) 1.96 (60.8) (65.0) 8.7 5.9 0.7 0.6 Kaisa 1638 HK NR HK$ 2.90 1,828 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.2 6.2 1.1 0.9 Hopson 754 HK NR HK$ 7.62 1,716 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5.1 4.9 0.4 0.4 Beijing Star 588 HK NR HK$ 1.82 1,688 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Greentown 3900 HK NR HK$ 7.58 1,597 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 4.7 3.0 0.9 0.7 Powerlong 1238 HK NR HK$ 2.28 1,192 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5.1 3.9 0.7 0.6 Shenzhen Investment 604 HK NR HK$ 2.43 1,106 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.4 7.2 0.6 0.5 C C Land 1224 HK NR HK$ 3.07 1,008 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 16.2 8.3 0.7 0.6 Fantasia 1777 HK NR HK$ 1.28 857 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5.0 4.2 0.8 0.7 Yuzhou 1628 HK NR HK$ 2.55 787 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5.0 3.1 0.5 n.a. China SCE 1966 HK NR HK$ 2.00 733 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5.0 3.8 1.1 0.9 Beijing Capital Land 2868 HK NR HK$ 2.67 707 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 4.1 3.7 0.7 0.6 Central China 832 HK NR HK$ 1.96 612 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 4.2 3.4 0.9 0.7 Minmetals Land 230 HK NR HK$ 1.33 571 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 7.1 3.7 0.7 0.6 Zhong An 672 HK NR HK$ 1.53 468 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 4.7 n.a. 0.5 n.a. Aoyuan 3883 HK NR HK$ 1.39 467 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.3 5.5 n.a. n.a. SPG Land 337 HK NR HK$ 3.30 446 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 3.3 2.6 0.6 0.5 SRE Group 1207 HK NR HK$ 0.63 357 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
China simple average (35.2) (38.3) 8.7 6.8 1.1 1.0 Mkt cap weighted average 10.3 8.3 1.5 1.3 Source: Bloomberg, Datastream, *Daiwa forecasts
Disclosure: The associate of the author of this report may be serving as an officer of Glorious Property Holding Limited (0845 HK). Daiwa Capital Markets Hong Kong Limited is making such disclosures pursuant to Paragraph 16.5 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, and in no way suggest the existence of any material conflict of interest in preparing this report.
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Daiwa stock picks: three-year investment horizon Danny Bao, CFA 5-Jul Mkt Target (852) 2773 8715 Share cap price Company Ticker Rating Currency price (US$m) (HK$) [email protected] Coli 688 HK 1 HK$ 17.48 18,361 19 China Vanke - B 200002 CH 1 HK$ 10.82 15,351 11.7 Key stock ideas: three years CR Land 1109 HK 2 HK$ 15.14 10,485 15.1 Longfor 960 HK 3 HK$ 13.02 8,627 12.35 Franshion 817 HK 1 HK$ 2.09 2,461 2.8 Source: Daiwa
Financial position comparison Net gearing (%) Cash ratio (x) EBITDA/ Number Company Ticker 2010 2009 2008 2007 2010 2009 2008 2007 gross Interest 1 China Overseas 688 HK 23.7 1.7 56.5 34.2 0.51 0.45 0.28 0.36 13.9 2 China Vanke - B 200002 CH 17.6 19.7 33.1 23.4 0.29 0.34 0.31 0.35 3.9 3 CR Land 1109 HK 52.3 19.5 49.7 45.7 0.27 0.58 0.30 0.46 8.1 4 Poly Real Estate 600048 CH 123.3 49.3 109.4 58.7 0.28 0.40 0.28 0.24 1.9 5 Evergrande 3333 HK 88.0 52.0 110.1 1274.5 0.22 0.18 0.05 0.23 5.0 6 Longfor 960 HK 43.0 22.7 250.8 145.6 0.26 0.31 0.15 0.18 5.1 7 Country Garden 2007 HK 59.1 61.1 45.6 Net Cash 0.12 0.17 0.15 0.57 4.9 8 Agile 3383 HK 70.2 51.1 50.9 60.2 0.20 0.24 0.22 0.21 6.2 9 Shimao 813 HK 73.2 53.3 66.3 37.4 0.31 0.28 0.12 0.54 4.1 10 SOHO 410 HK Net Cash Net Cash Net Cash Net Cash 0.94 0.77 1.12 1.79 15.0 11 Guangzhou R&F 2777 HK 111.0 104.3 125.3 146.2 0.16 0.22 0.06 0.05 5.0 12 Renhe 1387 HK Net Cash Net Cash Net Cash Net Cash 5.48 3.25 3.58 2.01 n.m. 13 Shanghai Industrial 363 HK 20.9 24.8 2.1 Net Cash 0.51 0.62 0.76 0.86 3.7 14 Sino Ocean 3377 HK 45.2 17.7 37.8 16.7 0.37 0.88 0.50 0.72 2.2 15 Poly HK Investment 119 HK 65.2 18.8 93.6 Net Cash 0.55 0.76 0.34 0.53 2.2 16 Glorious 845 HK 63.1 15.6 n.m. n.a. 0.23 0.56 0.03 0.30 3.0 17 Franshion 817 HK 26.2 72.4 40.5 14.0 1.03 0.24 0.34 0.63 2.9 18 Shui On 272 HK 58.8 36.5 45.9 25.3 0.56 0.33 0.21 0.32 1.6 19 KWG Property 1813 HK 60.9 58.7 52.5 Net Cash 0.34 0.24 0.17 0.50 3.6 20 New World China 917 HK 26.5 42.0 33.2 19.4 0.71 0.35 0.51 1.11 1.0 21 Yanlord YLLG SP 32.5 2.0 48.2 13.4 0.42 0.62 0.31 0.75 20.4 22 Mingfa 846 HK 46.2 Net Cash 80.8 101.9 0.24 0.53 0.02 0.03 5.2 23 Yuexiu Property 123 HK 69.0 66.0 31.4 43.8 0.33 0.39 0.25 0.36 2.3 24 Kaisa 1638 HK 35.9 48.3 187.6 112.8 0.47 0.40 0.10 0.34 4.7 25 Hopson 754 HK 51.6 32.1 n/a 53.0 0.11 0.26 n/a 0.17 3.4 26 Beijing Star 588 HK 59.6 47.8 42.8 50.9 0.28 0.54 0.53 0.29 3.5 27 Greentown 3900 HK 149.7 124.2 170.7 93.6 0.14 0.20 0.07 0.21 0.7 28 Powerlong 1238 HK 31.2 5.2 85.1 35.2 0.37 0.41 0.04 0.27 8.2 29 Shenzhen Investment 604 HK 44.4 33.6 66.3 38.7 0.40 0.70 0.53 0.68 5.1 30 C C Land 1224 HK Net Cash Net Cash 11.1 Net Cash 0.51 0.84 0.82 0.77 n.m. 31 Fantasia 1777 HK 66.3 Net Cash 76.3 Net Cash 0.35 0.73 0.10 0.67 4.9 32 Yuzhou 1628 HK 42.7 17.2 214.0 244.6 0.50 0.29 0.04 0.03 9.2 33 China SCE 1966 HK 31.2 70.0 226.0 171.4 0.35 0.11 0.01 0.03 11.2 34 Beijing Capital Land 2868 HK 18.5 25.9 76.9 56.5 0.55 0.48 0.30 0.26 4.1 35 Central China 832 HK 49.2 20.9 11.2 81.4 0.43 0.46 0.26 0.11 3.7 36 Minmetals Land 230 HK 13.0 Net Cash 0.2 Net Cash 0.38 1.58 0.48 0.54 9.4 37 Zhong An 672 HK 36.7 3.9 Net Cash Net Cash 0.24 0.54 1.08 1.08 3.6 38 Aoyuan 3883 HK 21.3 28.3 3.5 Net Cash 0.43 0.34 0.64 1.43 2.1 39 SPG Land 337 HK 96.3 77.9 62.4 34.9 0.12 0.37 0.14 0.44 2.3 40 SRE Group 1207 HK 77.5 38.5 66.8 53.4 0.25 0.28 0.12 0.23 2.8 Average 54.1 40.1 76.1 110.2 0.51 0.53 0.39 0.52 5.26 Source: Bloomberg, compiled by Daiwa
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Construction & real estate / China 3 May 2011
Part I - does policy matter for Housing China – a 10- part series China property stocks?
• Policies drive short-term sector performance • Policy-driven valuation troughs and peaks can be good times to buy or take profit
• Recent public-housing initiatives should drive competition and market-share consolidation and hence benefit selected players
Policy-driven valuation troughs In our next report, we will discuss and peaks are good times to invest our second topic: Soft landing or or take profit hard landing? The market tends to overreact to
both positive and negative news, in MSCI China & China Property
Danny Bao, CFA our view. The period following 400 (852) 2773 8715 significant policy-related share-price [email protected] 300 declines is usually a good time to 200 invest in the sector. We believe 100
share-price falls of more than 30% 0 Merits of investing in China due to unfavourable policies may
property stocks – summary Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 indicate a good buying opportunity May-06 May-07 May-08 May-09 May-10 This is the first of a series of 10 MSCI China MSCI China Prop reports that we plan to publish on for investors. On the flip side, we Source: MSCI the theme of: Housing China – believe it is a good time to cut exposure to the sector after a merits of investing in China MSCI China Property & Coli property stocks, over the next few significant rally on the back of 500 weeks. We will discuss what we supportive housing policies (this happened only in 2009). 400 consider as the 10 key subjects for 300 200 investors to make profitable Public-housing initiatives should 100 investments or trades in the China drive industry competition and 0 property space. In this report, we market-share consolidation and Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 address the impact of government hence benefit selected players Coli MSCI China Property policy on the sector’s valuation and At present, we are under the latest performance. Source: MSCI, Bloomberg policy regime to boost future public- housing supplies. At the same time, Policy drives short-term sector the government is restraining performance demand in order to cool house prices. We have studied the government’s New initiatives look set to change the housing measures over previous industry landscape. The sector has years and the corresponding share- underperformed relative to the MSCI price performance of China China Index over the past 20 months Overseas Land & Investment (Coli) to reflect the industry changes. We (688 HK, HK$14.94, 1, TP: HK$19). believe the sector reached trough We have seen four major negative valuations at the end of February policy events between 2005 and this year, due to the latest round of 2008. Following the announcement policy measures. We expect the of each event, Coli’s share price physical property market to respond dropped by between 30% and 45% to the latest measures. As such, we from its previous peak level. In 2009, think it is time for investors to play supportive housing measures led to selected China property names. We a significant recovery in Coli’s share believe Coli is one of the best- price and to a peak valuation in positioned to gain market share in December that year. the new policy environment.
Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011
The Central Economic Workshop in December 2009 set the tone for a new policy era. The government will address the housing needs of the general public over time, while the private sector will aim to satisfy mid-t0- high-end demand. We believe the current policy direction will change the industry landscape Policy matters significantly over the next decade. Large developers will have to rely on delivery volume and market-share China’s housing reforms started in 1987 growth to support earnings growth in order to offset gradually declining net-profit margins in the industry, and paved the way for significant growth in our view. We expect increasing competition in both in private residential development over the high-end and mass-market segments. the past 15 years. Recent public-housing We believe government policy changes in China do policies also look set to change the have an effect on the sector’s valuations both in the industry landscape … short term and long term. As Coli is one the key players in the sector with the longest history as a listed company, we have used Coli’s past share-price Background of policy and share- performance as a benchmark to examine the impact of price performance policies on the sector’s valuation. We have observed six major policy events which have led to positive or China’s housing market has undergone a significant negative share-price performance by Coli. transformation over the past 24 years, driven by government housing-policy reform in the late 1990s Coli: historical share-price performance and austerity measures over the past decade. In 1987, (HK$) the local Shenzhen Government conducted the first 25 public auction of a residential-land parcel. The State 4 6 Council’s housing-reform plan was introduced in the 20 5 following year. The major trend from 1987-2005 was 15 3 the privatisation of the property sector, which resulted 10 2 in the government no longer being the sole provider of 1 private houses in China. The state-sponsored housing- 5 allocation programme has been phased out over time. 0 However, the accelerated development of private Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10
housing in large cities such as Shanghai and Beijing Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 drove home prices higher. Many average-wage earners Source: Bloomberg felt they were being priced out of the market.
China: major milestones in policy direction Event 1: The PRC Government introduced a series of Phase Period Main policy austerity measures in March 2005, which followed 1 From 1987-2005 The private sector should be the main provider of housing other measures that had been introduced in 2003 and in China, while the government should monitor house 2004. By 2 June 2005, Coli’s share price had lost 33% prices. 2 From 2006-08 The government should provide welfare housing for from its previous peak. Coli’s share price recovered in citizens with low incomes, while the private sector should the second half of the year and reached a new peak at aim to cater to the other segments. the year-end. 3 From 2009 onwards The government should provide housing for the general public through welfare and public-rental housing, while the private sector aims to meet mid-to-high-end demand. Event 2: The government introduced more austerity Source: Daiwa measures in May 2006. By 22 June 2006, Coli’s share price had lost 34% from its previous peak, as a result of From 2006-08, government housing policy aimed to policy changes. At the end of the year, Coli’s share price increase the supply of welfare housing for the achieved a new record level. unprivileged, driven by rising public pressure. At the same time, the austerity measures introduced in early Event 3: In January 2007, the settlement notice of the 2003 saw limited success in cooling house prices, as Land Appreciation Tax (LAT) also caused a short-term private-led housing developments continued to drive negative performance. On 5 March 2007, Coli’s share average selling prices (ASP) higher in all the major cities. price had lost 30% from its 2006 year-end peak.
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Event 4: Coli’s and the sector’s valuations peaked in th November 2007. The government started to implement Policy in the 12 Five-Year Plan credit tightening and austerity measures in the second half of 2007. By 17 March 2008, Coli’s share price had The government’s 12th Five-Year Plan (FYP) will dropped by 45% from its peak of November 2007. The include the government’s housing policy for 2011-15. subsequent global financial crisis also had an adverse The Central Government’s plan is to boost significantly impact on the sector’s valuation and performance. Coli’s the future supply of public housing in China over the share price reached a trough level on 29 October 2008. next five years. We believe the latest government policies have two main focuses: 1) increase future Event 5: The government changed its policy stance in supplies of public housing to reduce supply pressure on early 2009, in order to protect domestic GDP growth and low-to-mid-end homes, and 2) restrain short-term minimise the impact of the financial crisis. Coli’s share growth in demand to cool house prices. We believe price rallied by 193% from its trough level reached in some of the recent policy measures, such as purchase 2008 by August 2009, due to supportive housing policies. restrictions, are likely to be short-term solutions to cap growth in demand, while the government is ramping Event 6: In December 2009, the government reversed up future public-housing supplies. its supportive housing policies and shifted its policy focus to create more public-housing supplies. Coli’s The government plans to initiate the construction of share price fell by 12.3% between 31 December 2009 about 36m units of public housing over 2011-15. Its and 31 December 2010, due to this major policy shift. specific plan for 2011 and 2012 is 10m units each year. We On 22 February 2011, Coli’s share price reached a estimate planned construction for 2013, 2014 and 2015 at trough level of HK$12.70, after the latest rounds of new about 5m, 5m, and 6m units, respectively. We forecast policy measures. annual housing-demand growth for 2011-15 at around 8- 10%. We forecast residential housing completions (including public housing) to increase at an annual rate of Relative performance 12% over the 2011-15 period. As such, we forecast residential completions for 2015 to reach 1,075m sq m, The MSCI China Property Index outperformed the MSCI while public-housing completions may reach 580m sq m. China Index in the first half of 2009, due to supportive We assume that the construction cycle for public housing policies. For the second half of 2009 and the full year is about 24 months. We believe the market share (in 2010, the MSCI China Property Index underperformed terms of annual completions) of public-housing the MSCI China index, due to a policy shift in December completions is likely to reach 40-50% in the next 2-3 2009. We have observed brief periods of short-term years. sector underperformance driven by previous austerity measures between 2006 and 2007. However, major Estimated market share of public housing completion policy changes in 2009 and 2010 led to a significant 2010 2011 2012 2013 2014 2015 Public-housing units started (m) 5.8 10 10 5 5 6 variance in performance (supportive policies drove Estimated GFA for new starts (m sq m) 290 500 500 250 250 300 positive performance, while restrictive policies led to Public-housing completions (m sq m) 110 205 395 500 375 580 negative performance). YoY change (%) 16 86 93 27 (25) 55 Total residential completions (m sq m) 612 704 810 931 1,024 1,075 Performance of MSCI China Property Index & MSCI China (%) YoY change (%) 6 15 15 15 10 5 Market share (%) 18 29 49 54 37 54 400 Source: Daiwa estimates and forecasts Note: GFA = gross floor area
300 We believe the latest housing policies and credit tightening in China are likely to drive industry 200 competition and market-share consolidation. The current policy regime should benefit the leading listed 100 developers with access to international capital markets and capacity for sales- and delivery-volume growth. 0
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 May-06 May-07 May-08 May-09 May-10 MSCI China MSCI China Prop
Source: MSCI
- 8 - Housing China 6 July 2011
Coli shares at any of the previous trough points and Conclusion held them until 29 April 2011, they would have yielded an annualised return of 12-51%. Even if investors We believe government policies in China do have an bought the shares on 22 February 2011, they would effect on the sector’s short-term and long-term have obtained a return of about 18% to date. performance. Government policy may be one of the most important considerations in investing in China Negative news flow on policy, which we have found property stocks. Major restrictive government policies generally leads to a trough sector valuation in the short usually lead to a period of negative short-term sector term, is usually a good buying opportunity. Conversely, performance, based on our observation of five of the six short-term valuation peaks driven by supportive news major events over past years. Supportive housing on policy are usually a good time for investors to take policies (we only have one example) usually lead to profit. positive short-term sector performance. Long-term policy directions such as the public-housing initiatives Knowledge of the policy direction and implications to have an impact on long-term sector performance. short-term and long-term valuation should give investors significant advantages in making profitable Our study suggests that, at the time of the previous five investment or trades. We believe Coli is well-positioned major restrictive policy events, Coli’s share price for the new policy environment and we reiterate our declined by 30-45% from its previous peak levels. A Buy (1) rating on the stock. share-price fall of more than 30% may indicate a buying opportunity, in our view. If investors bought
Coli: share-price performance after major policy events Event Policy direction Peak price (HK$) Trough price (HK$) Trough date Return (%) Trough to 29/04/2011 (%)* Annualised return (%) 1 Restrictive 1.91 1.29 2-Jun-2005 (33) 1,063 51 2 Restrictive 5.83 3.86 21-Jun-2006 (34) 287 32 3 Restrictive 10.32 7.22 5-Mar-2007 (30) 107 19 4 Restrictive 19.20 10.48 17-Mar-2008 (45) 43 12 5 Supportive 19.42 6.62 29-Oct-2008 193 126 n.m. 6 Restrictive 18.34 12.70 22-Feb-2011 (31) 18 n.m. Source: Bloomberg, Daiwa Note * Cumulative return assuming investors bought the stock at the trough level and held it to 29 April 2011
- 9 -
Construction & real estate / China 9 May 2011
Part II – soft landing or hard Housing China – a 10- part series landing?
• China's residential ASP rose at a 9.2% CAGR for the past 10 years, while coastal cities saw much faster growth rates in recent years • Recent policy regime should cool home prices in China
• Investors should consider developers with affordable home prices
homes in Shanghai, Shenzhen, with more affordable home prices Beijing, and Hangzhou are the most compared with developers with expensive in China. Our affordability higher ASPs will probably to do well study suggests that homes in coastal in the near term. Evergrande’s (Not
cities are less affordable than those rated) 2010 ASP was Rmb6,391/sq Danny Bao, CFA in other regions. m, slightly higher than the average (852) 2773 8715 [email protected] 1Q11 ASP in China. We like Country We forecast a 5% YoY ASP increase Garden (2007 HK, HK$3.07, 2) for this year, but falls of 5-10% YoY for its cheaper land cost and more coastal-city home prices Merits of investing in China affordable home prices. property stocks – summary We believe the latest government This is the second part of our series policies will cap the ASP increase in Long-term bubble risks remain of 10 reports that we plan to publish China. We forecast ASPs in the high- We believe China’s urbanisation, on the theme of: Housing China – end segment in major cities to fall by income growth, abundant money merits of investing in China about 10-25% YoY this year, as supply, rising resource prices, and property stocks, over the next few reduced investment demand since Renminbi appreciation, are likely to weeks. We discuss what we consider March this year and motivated drive up asset prices over the as the 10 key subjects for investors developers are likely to bring down coming decade. The long-term risks to make profitable investments or selling prices. Our NAV and of an asset and property bubble trades in the China property space. earnings forecasts for the China depend largely on future In this report, we address the property companies we cover have government monetary and fiscal potential direction of the physical already incorporated the above policy, in our view. residential market and implications assumptions, and as such we see for investors. limited downside risks. Weakness in In our next report, we will discuss the physical market is likely to our third topic: Does public housing Residential-property prices in prompt developers to focus on lead to reduced returns? China have risen sharply over the growth in delivery and sales volume past 10 years; coastal-city homes and price promotions. As such, this Residential ASP trend (Rmb/sq m, %) are the most expensive currently new trend is likely to reduce near- 5,000 25% The residential average selling price term policy risks. We believe the 4,000 20% 3,000 15% (ASP) in China has risen at a 9.2% mass-market segment is likely to 10% outperform the other segments. 2,000 5% CAGR over the past 10 years and 1,000 0% increased by 6.0% YoY to 0 (5%) Rmb4,724/sq m for 2010. For 1Q11, Time to consider developers with affordable home prices 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 the ASP increased by 10% YoY to ASP (LHS) Chg (RHS) Rmb5,431/sq m. We believe the Almost all the top-10 developers are primarily involved in residential Source: Soufun actual home-price increase may be faster than this data suggests. development. However, each Coastal homes in major cities are developer has its own regional and generally more expensive than those product focus. The top-10 in inland regions. Shenzhen, developers’ ASPs for 2010 ranged Shanghai, Beijing, and Hangzhou from Rmb5,465/sq m to are the most expensive housing Rmb13,600/sq m. We believe markets in China at present. Luxury regionally-diversified developers
Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011
Coastal homes in major cities are generally more expensive than those in inland regions. Shenzhen, Shanghai, Beijing, and Hangzhou are the most expensive home markets in China. Luxury homes in Shanghai, Shenzhen, Beijing, and Hangzhou are the most expensive in China. We detail the ASP trends for Soft landing or hard April in the table that follows. landing? ASPs of 10 major cities for April 2011 (100 city price index) ASP Highest sample City MoM change (%) YoY change (%) (Rmb/sq m) ASP (Rmb sq M) Multiple (x) Average residential home prices in China Shenzhen 0.57 8.75 25,398 150,000 5.9 Chongqing 0.35 6.60 6,732 30,000 4.5 enjoyed considerable growth over the Wuhan 0.33 6.91 7,307 35,000 4.8 past 10 years. However, home prices Shanghai 0.32 2.03 23,662 165,000 7.0 Hangzhou 0.22 5.84 20,845 83,333 4.0 have been driven up by the accelerated Nanjing 0.17 3.85 12,350 50,000 4.0 development of private housing in large Chengdu 0.15 8.52 8,102 25,000 3.1 Guangzhou 0.06 8.65 15,131 68,000 4.5 coastal cities such as Shanghai and Beijing (0.14) 4.41 22,862 120,000 5.2 Tianjin (0.35) 4.36 12,077 40,000 3.3 Beijing. Many average-wage earners felt Average 0.13 5.99 15,802 n.m. n.m. they were being priced out of the market. Source: Soufun Recent government policy to boost public Note: multiple = highest sample ASP/city ASP housing supply and restrain demand should facilitate a soft landing of the Variance of mortgage physical market. affordability for first-time buyers
Our mortgage-affordability study of first-time buyers in Past-10-year price trend major cities in China suggests significant variances in housing affordability. The affordability scores in the China’s residential-property ASP has risen at a 9.2% table that follows are expressed as a mortgage burden CAGR over the past 10 years and increased by 6.0% as a percentage of household income for first-time YoY to Rmb4,724/sq m for 2010. For 1Q11, China’s home buyers of homes with a surface area of 90 sq m. A average ASP increased by 10% YoY to Rmb5,431/sq m. high score indicates low affordability, while a low score We believe the actual home-price rise may be faster indicates good affordability. In major coastal cities than this data suggests. For example, the 100 city price such as Beijing, Shanghai, Guangzhou, Shenzhen and index released by Soufun suggests that the ASP for Hangzhou, the mortgage burden accounts for at least April 2011 was Rmb8,773/sq m. The ASP of the 10 59% of household income currently, according to our major cities increased by 0.13% MoM to Rmb15,802/sq study. m for April. Mortgage burden as % of household income for first-time China: quarterly residential-ASP trend buyers 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 (Rmb/sq m) China 32.0 32.9 33.0 30.7 33.8 31.3 27.0 27.1 32.2 6,000 Beijing 49.7 52.4 60.9 63.5 74.8 88.0 64.4 52.5 71.3 Tianjin 34.6 35.7 39.0 33.5 37.9 38.3 36.8 36.1 33.4 5,000 Shanghai 46.4 57.4 57.9 60.5 59.3 65.3 60.7 48.4 58.3 Chongqing 20.7 22.7 22.0 22.7 23.0 24.8 22.1 24.1 25.9 4,000 Guangzhou 36.3 34.0 37.1 46.2 41.0 41.9 32.9 42.1 39.3 3,000 Nanjing 29.4 30.9 36.2 34.7 37.5 41.9 32.7 40.2 36.2 Shenzhen 51.3 55.9 88.4 71.6 102.1 63.5 81.2 75.9 75.0 2,000 Hangzhou 43.1 47.2 48.4 55.6 52.8 64.6 59.3 59.8 59.4 Wuhan 30.8 33.9 32.4 33.7 33.7 32.8 28.4 29.7 35.0 1,000 Chengdu 30.2 30.0 30.5 30.2 33.0 37.2 27.4 31.0 33.1 0 Source: Daiwa
4Q00 2Q01 4Q01 2Q02 4Q02 2Q03 4Q03 2Q04 4Q04 2Q05 4Q05 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10 4Q10 Source: Soufun
- 11 - Housing China 6 July 2011
We believe the residential housing bubble is most Our current NAV and earnings forecasts have already evident in the major coastal cities and the luxury incorporated the above assumptions. We see limited segment, while overall home prices in China remain downside risks to our NAV and EPS forecasts, should fairly reasonable. We believe the luxury markets in the the physical market go through a soft landing in the major coastal cities are more vulnerable to major near- next few months. Weakness in the physical market is term price contractions than the mass market and likely to prompt developers to focus on growth in other areas, on the back of recent government delivery and sales volume and price promotions. As measures. such, this new trend is likely to reduce the near-term policy risks, in our view. Near-term policy regime should drive a soft landing of the Investors should consider physical property market developers with affordable home prices We believe the latest government policies have two main focuses: 1) increase future supplies of public Almost all the top-10 developers are primarily involved housing to reduce supply pressure on low-to-mid-end in residential development. However, each developer homes, and 2) restrain short-term growth in demand to has its own regional and product focus. The top-10 cool house prices. We believe the physical market will developers’ ASPs ranged from Rmb5,465/sq m to probably respond to the latest measures, as more Rmb13,600/sq m for 2010. We believe regionally- developers cut prices to accelerate cash flow. We diversified developers with more affordable home estimate the probability of a soft landing for the prices compared with developers with higher ASPs are physical market in the next 6-9 months at about 50%. likely to do well in the near term. Evergrande’s ASP for We believe the probabilities of a hard landing or a 2010 was Rmb6,391, slightly higher than the average bubble-inducing scenario are 30% and 20%, 1Q11 ASP in China supplied by the National Bureau of respectively. Statistics (NBS). We like Country Garden for its cheaper land costs and more affordable home prices Probability of physical market scenario in 6-9 months compared with those of its peers. Hard landing Soft landing Bubble-inducing Probability (%) 30% 50% 20% ASPs of top-10 major developers (2010) ASP change < -15% (-15% to 15%) > 15% Sales-volume change < -20% (-20% to 10%) > 10% Longfor Source: Daiwa R&F Shimao We believe the latest government policies will cap the Coli increase in ASPs in China. We forecast an ASP increase Agile of about 5% YoY for 2011, and a contraction of 5-10% Vanke YoY in major coastal cities. We forecast the ASP of the CR Land high-end segment in major cities to fall by about 10- Poly Real Estate 25% YoY this year, as reduced investment demand Evergrande since March and motivated developers are likely to Country Garden bring down selling prices. 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 (Rmb/ sq m)
China: ASP forecasts for selected cities and overall (%) Source: Companies, Daiwa City 2011E ASP change 2011E high-end ASP change China 5 0 Shenzhen (10) (15) Chongqing 5 (5) Wuhan 5 (10) Shanghai (10) (25) Hangzhou (10) (20) Nanjing (5) (10) Chengdu 0 (5) Guangzhou (5) (10) Beijing (10) (20) Tianjin (5) (10) Source: Daiwa forecasts
- 12 - Housing China 6 July 2011
M2 money supply
(US$bn) Long-term bubble risks remain 12,000
10,000 Daiwa’s Chief Economist for Greater China, Mingchun Sun, believes five major factors are likely to drive asset 8,000 prices higher over the coming decade, although we 6,000 expect some near-term falls in property prices due to 4,000 the government’s recent tightening policies. 2,000
• Massive urbanisation. Daiwa forecasts the urban 0 population to increase by about 155m over the 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 coming decade, which should create strong and China Japan UK US sustained demand for residential property. Source: CEIC, Daiwa • Rapid income growth. Per-capita income should more than double, if not triple, between now and For these reasons, an asset-price bubble seems almost 2020 (according to Daiwa), improving the inevitable in China over the coming decade, in our view, purchasing power of households and creating more especially during 2011-15. Government near-term demand for households’ asset allocation and policy initiatives to curb home price may lead to a soft diversification. landing of the property price in China. However, excess liquidity is likely to lead to inflation pressure in other • Monetary conditions. China’s M2 money supply assets. The long-term risks of an asset and property reached US$11tn for 2010, surpassing that of Japan bubble depend largely on future government monetary and the US and becoming the ‘largest’ currency in and fiscal policy, in our view. the world. Under the current ‘neutral’ monetary
policy, which targets 15-16% M2 growth a year, M2
in China should double in five years’ time and
quadruple in 10 years. If this happens, it would most
probably not only create more demand for asset
diversification but also fuel inflation expectations,
which should in turn create more demand for
investment in real or financial assets as an inflation
hedge, in our view.
• Rising resource prices. Limited land supply and the rising costs of construction and production, as a result of sharply rising commodity prices and labour expenses, should provide more reasons for asset prices (especially property prices) to rise.
• Currency appreciation. If the Renminbi appreciates
by 3% per year against US Dollar, it would gain
about 30% over 10 years (from Rmb6.6:US$ to
Rmb4.8:US$). Such a prolonged period of
appreciation should make Renminbi assets more attractive to investors globally and fuel capital inflows into China, in our view.
- 13 -
Construction & real estate / China 17 May 2011
Part III - does public housing lead Housing China - a 10- part series to lower industry returns?
• We believe the supply of public housing will peak in 2013, capping the industry's net-profit margin • HK and Singapore experiences suggest that increases in public
housing do not always result in negative returns for developers • Our advice: investors should pick the industry leaders
benefit a few of the country’s shares of the private-housing market. industry leaders. China’s current residential- property-development market is Experiences in Hong Kong and highly fragmented, with the largest
Singapore offer hope to investors developer controlling only about a Danny Bao, CFA We have analysed the share-price 1.2% share of the country’s market. (852) 2773 8715 [email protected] performances of most of the major The government’s latest public- Hong Kong and Singapore-listed housing initiatives are likely to drive private developers at times when industry competition and market- Merits of investing in China public housing increased. Past data share consolidation, in our view. We property stocks – summary suggests that the increase in public believe investors should stick with This is the third part of a series of 10 housing in Hong Kong from 1975-85, the industry leaders, as they are reports that we plan to publish on and in Singapore from 1975-90, did likely to capture increasing shares of the theme of: Housing China – not result in negative returns for the the market, while retaining merits of investing in China private developers. Most of the profitability. Our top pick in the property stocks, over the next few private developers enjoyed positive sector is China Overseas Land & weeks. We discuss what we consider returns during these periods. Investment (Coli) (688 HK, as the 10 key subjects for investors HK$14.88, 1 [Buy]). to make profitable investments or As such, we believe investors should trades in the China property space. not be overly concerned by the MSCI performance (YTD) In this report, we address the increase in public housing in China. 115 110 potential impact of the PRC We believe the sector’s current 105 valuation has priced in fully the 100 Government’s public-housing 95 potential risks of the government’s 90 initiatives on sector returns. 85 public-housing policy. Given the 80 Supply of public housing should sector’s valuation weakness over the Apr 8, 11 May 6, 6, May 11 Apr 22, 11 Jan 14, 11 Jan 14, 11 Jan 28, Feb 11, 11 Feb 25, 11 Mar 11, 11 Mar 25, 11 peak in 2013 and decline in 2014-15 past two weeks, the MSCI China Dec 31, 10 MSCI China The government initiated the Property Index has trailed the MSCI MSCI China/Real Estate Management & Development - Index construction of about 5.8m public- China Index by only about 2.3% Source: MSCI housing units in 2010. In addition, it YTD. We believe the experiences of plans to initiate the construction of Hong Kong and Singapore suggest about 36m units over the 2011-15 that the current risk-reward profiles period. We expect the delivery of for investing in China property these public-housing units to peak stocks are clearly favourable for in 2013, accounting for about 54% of investors. China’s total 2013 residential completions. The increase in public Pick the industry leaders housing over the next few years is We believe the market size and likely to cap the industry’s net potential demand for residential margin, compelling developers to property in China is much greater undertake delivery-volume-growth than that in Hong Kong and/or strategies, in our view. We expect Singapore. Hence, we think there accelerating industry competition will be room for more private and market-share consolidation to developers to capture increasing
Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011
about 14% for 2013, as we expect less profitable public- housing projects to account for a larger proportion of the industry’s total housing projects.
China residential market: segmentation for 2013 residential completions Public housing Low- Public Double- rental Economic rental restriction Private Luxury Segment housing housing housing housing homes homes Total Forecast 2013E 14 20 20 10 31 5 100 The government’s plans to boost market share (%) Forecast 2013E public housing significantly over the next 130 196 196 98 304 49 973 market size (m sq m) five years are likely to have a negative Forecast developer's’ 2013E net-profit 5 10 10 15 20 25 14 impact on the industry’s net margin … margin (%) Source: Daiwa forecasts
Construction under way The recent share-price weakness of China’s listed developers suggests to us that investors are concerned The government plans to build about 36m public-housing that the increase in public housing could lead to lower units during 2011-15. Specifically, it plans to build 10m sector returns. However, we believe the Hong Kong and units in both 2011 and 2012. We forecast planned Singapore experiences could offer some insight. construction for 2013, 2014 and 2015 of about 5m, 5m, and 6m units, respectively, and for annual housing- demand growth to increase by about 8-10% annually for The Hong Kong experience the 2011-15 period. We forecast residential-housing completions (including public housing) to rise at an Hong Kong's public-housing policy dates back to 1953, annual rate of 12% for 2011-15. As such, we forecast when a major fire prompted the Hong Kong residential completions for 2015 of 1,075m sq m, and for Government to provide shelter for the poor. From public-housing completions to reach 250m sq m. We 1953-73, about 348,000 public-rental-housing units assume the public-housing construction cycle is about 18- were built. In 1973, the government announced a 10- 24 months, and believe the market share (in terms of year plan to provide further units. During that 10-year annual completions) of public-housing completions is period, more than 220,000 public-housing units were likely to reach 40-50% over the next 2-3 years. built, benefiting more than 1m people. On the flip side, in 1976, the government introduced the Home China residential market: completions and sales Ownership Scheme, which aimed to allow low-income 2010 2011E 2012E 2013E 2014E 2015E earners to own their homes. As at the end of 2010, Public-housing units started (m) 5.8 10 10 5 5 6 public housing accounted for 49.1% of Hong Kong’s Estimated GFA for new commencement (m) 290 500 500 250 250 300 Public-housing completions (m sq m) 110 205 395 500 375 250 total residential housing stock. YoY change (%) 16 86 93 27 (25) (33) Residential completions (m sq m) 612 704 810 931 1,024 1,075 We have analysed the share-price performance of the YoY change (%) 6 15 15 15 10 5 Hong Kong property stocks since the introduction of Market share (%) 18 29 49 54 37 23 Private completions (m sq m) 502 499 415 431 649 825 the 1973 public-rental housing plan (with exception of YoY change (%) 4 (1) (17) 4 51 27 the 1973-74 period, due to the stock market crash). We GFA sales 931 884 928 975 1,023 1,074 believe a sharp increase in public housing does not YoY change (%) 9 (5) 5 5 5 5 necessarily result in a decline in developers’ share Source: Daiwa estimates prices. During the 1975-85 period, Hong Kong’s property developers saw positive share-price We believe the number of public-housing completions performances. The share prices of the Hong Kong will potentially peak in 2013, accounting for about a property developers peaked in late 1981, after which 54% share of the residential market (based on our they declined significantly due to concerns related to forecasts). For the next three years, we forecast public- the handover of sovereignty between the UK and China housing completions to replace about 10-30% of the in 1997. After 1983 the share prices of the Hong Kong current private market. We believe the potential supply property stocks recovered gradually, as concerns about of public housing will cap the industry’s net-profit the handover of Hong Kong eased. margin, accelerate industry competition, and market- share consolidation. As such, we forecast the industry’s net-profit margin to decline from 15-20% for 2010 to
- 15 - Housing China 6 July 2011
Hong Kong property stocks: share-price performance
(Jan 1, 1975 = 100) 7,000
6,000
5,000
4,000
3,000
2,000
1,000
0 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 SHKP CK NWD Wharf HKL Swire
Source: Datastream
Singapore property stocks: share-price performance
(S$) 4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91
City Development UOL Group
Source: Datastream
9% of the population for 1960 to 87% for 1990. The build-up was most intense during the 1976-80 (average The Singapore experience annual completions of 26,196 units) and 1981-85 (average annual completions of 37,860 units) periods. The Singapore residential market also had a similar experience. The Housing Development Board (HDB) After 1990, the HDB build-up stabilised, although the was set up on 1 February 1960, during a housing crisis, HBD’s objective to provide an affordable, new first when much of the population lived in slums and home for married couples at a government-subsidised crowded squatter settlements. At the time, about 9% of price has not changed. Propelled by the country’s rising Singaporeans lived in government flats, provided by affluence and Singaporean’s desire to upgrade to HDB’s predecessor, the Singapore Improvement Trust. privately-owned homes, the number of people living in HDB flats has moderated to about 82% of the Backed by strong government support and with a ‘total’ population as at the end of 2010. planning approach, involving design, land assembly, construction, allocation, management and estate We have analysed the share-price performances of maintenance, the HDB ramped up the construction of some of the property developers in Singapore from public-housing units. The number of Singapore 1975-90. During that period, our sample of the residents living in HDB flats increased steadily from
- 16 - Housing China 6 July 2011
Singapore developers enjoyed positive returns despite For 2010, the top-10 listed developers generated the sharp increase in public housing. combined core earnings of about Rmb45.8bn, with Coli ranking No.1, in terms of core earnings. In addition, Coli is the most profitable developer in China, Pick the industry leaders in China recording a 2010 net-profit margin of 22.1% – much higher than the 15.7% average 2010 net-profit margin We believe the experiences of Hong Kong and of the top-10 developers. Singapore suggest that public-housing initiatives do not necessarily result in negative returns for private We believe the government’s public-housing initiatives developers. China’s current residential-property will clearly change China industry’s landscape, development market is highly fragmented, with the although we expect the major listed developers to largest developer controlling only about a 1.2% share of sustain their earnings growth via delivery-volume and the country’s market. China’s latest public-housing market-share expansion. Hence, we recommend initiatives should drive industry competition and investors pick the industry leaders that look likely to market-share consolidation, in our view. As such, we benefit from the market-share consolidation that we recommend that investors pick the industry leaders. expect. We believe the sector’s recent share-price Our top pick for the sector is Coli. weakness represents a good opportunity to buy quality developers at what we see as attractive valuations.
Top-10 developers: 2010 core earnings and net-profit margins Core earnings Core Core Net-profit Target earnings (m) earnings (Rmb m) margin (%) Rank Company Bloomberg code Price Rating Currency FY10 FY10 FY10 1 *Coli 中海 688 HK 19.0 1 HK$ 9,807 8,173 22.1 2 *China Vanke – B 万科 200002 CH 11.7 1 Rmb 6,821 6,821 14.3 3 Evergrande 恒大 3333 HK n.a. NR Rmb 5,510 5,510 12.0 4 Poly Real Estate 保利 600048 CH n.a. NR Rmb 4,905 4,905 13.7 5 Country Garden 碧桂园 2007 HK 3.7 2 Rmb 4,229 4,229 16.1 6 *CR Land 华润 1109 HK 15.1 2 HK$ 4,268 3,557 16.6 7 Agile 雅居乐 3383 HK n.a. NR Rmb 3,577 3,577 17.4 8 *Guangzhou R&F 富力 2777 HK 13.7 1 Rmb 3,518 3,518 14.3 9 Shimao 世茂 813 HK n.a. NR Rmb 2,917 2,917 13.4 10 Longfor 龙湖 960 HK n.a. NR Rmb 2,570 2,570 17.1 Total 45,776 15.7 Source: Companies, Daiwa
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Construction & real estate / China 24 May 2011
Part IV – do business models Housing China – a 10- part series matter for developers?
• We evaluate developers' performance by their scale, net-profit margins, and earnings efficiency • Daiwa Quadrants should help investors find industry winners
• Our advice: investors should pick the best-in-class developers
Properties, are likely to outperform product quality, strong branding, their smaller peers in terms of and effective project execution. earnings growth over the next three years. Pick the best in class
We have constructed Daiwa Danny Bao, CFA All about margin and volume Quadrants to help investors to identify (852) 2773 8715 [email protected] Developers’ business models are the industry’s best business models. centred on maximising profit margins We prefer best-in-class developers, and sales or delivery volume. We have which can increase sales volume while Merits of investing in China found that, generally, there is a preserving net-profit margins. property stocks – summary positive relationship between average This is part IV of a series of 10 selling prices (ASP) and net-profit Daiwa Quadrants for developers’ business models reports that we are publishing on margins. However, high ASPs do not the theme of: Housing China – always result in high net-profit merits of investing in China margins for developers. Developers Margin leader Best in class such as Coli (688 HK, HK$15.62, Buy property stocks. We discuss what High>>> we consider as the 10 key subjects [1]) have been able to generate higher for investors to make profitable net-profit margins than their peers investments or trades in the China without having the highest ASPs over <<
Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011
Country Garden, China Resources Land (CR Land) (1109 HK, HK$13.52, Outperform [2]), and Guangzhou R&F Properties (R&F) (2777 HK, HK$10.28, Buy [1], are likely to capture more market share and outperform their smaller rivals in terms of earnings growth over the next three years. Finding the right business model Category A and B developers: 2010 deliveries (sq m) CR Land Longfor The listed China property universe is Shimao over-crowded with residential-property Agile Guangzhou R&F developers, due to significant demand China Vanke - B growth over the past 10 years. We believe Poly Real Estate investors should pick developers with the Coli Country Garden optimal business models. Evergrande
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We measure developers by scale Source: Company data
The residential-property-development market in China is highly fragmented at present, with the largest Do higher ASPs lead to higher developer in China, Evergrande (Not rated) controlling net-profit margins? only about 1.2% of market share (by 2010 GFA deliveries). We believe the best way to classify In general, investors prefer developers with the highest residential developers in China is by their scale. Based net-profit margins. One of investors’ common on developers’ 2010 GFA delivery volume, we classify misconceptions, in our view, is that higher ASPs translate developers into four categories (A, B, C, D): mega-sized, into higher net-profit margins for developers. We have large-sized, mid-sized, and developing. found that, in reality, higher ASPs do not always result in higher net-profit margins, due to the progressive nature Daiwa categorisation of residential-property developers of the land appreciation tax (LAT) and also company- Daiwa Daiwa classification category Daiwa measurement Developers specific factors. Mega A Annual deliveries Coli, China Vanke – B, Evergrande, Poly exceeding 4m sq m Real Estate, Country Garden We have analysed the top-10 developers in our A and B Large B Annual deliveries of about China Resources Land, Agile, 2m sq m Guangzhou R&F Properties, Shimao, categories by their ASPs, core earnings and net-profit Longfor margins for 2010. We discovered generally positive Mid C Annual deliveries of about Sino Ocean, Greentown, Hopson, New correlation between ASP and net-profit margins. 1m sq m World China Developing D Annual deliveries Shui On Land, Yanlord, Glorious However, we would note that there are some anomalies significantly below 1m sq m Property, KWG, Yuexiu, with this approach. For example, R&F and Shimao Source: Daiwa (Not rated) had higher ASPs but lower net-profit Note: deliveries are of GFA margins than Country Garden for 2010. Eight of the top-10 developers’ ASPs for 2010 were very close to We believe our four-category scheme can help Rmb12,000/sq m. investors to assess developers’ relative operational and financial performances, as well as their valuations. We believe the current policy regime will facilitate industry competition and market-share consolidation among the developers, and should benefit selected players. Hence, we would advise investors to focus on industry leaders. We believe the government’s latest public- housing initiatives will also cap net-profit margins in the industry for the next two years and prompt developers to undertake strategies focusing on delivery-volume growth. We estimate that developers such as Coli, Vanke (200002 CH, HK$9.80, Buy [1], - 19 - Housing China 6 July 2011
Developers matrix by ASP and net-profit margin (2010) Top-10 developers: EE scores (based 2010 data)
25% Coli Evergrande Country Garden 20% Country Garden CR Land Agile Longfor Poly Real Estate Longfor 15% R&F Shimao Poly Vanke Shimao 10% Evergrande China Vanke - B
Net-profit margin Guangzhou R&F 5% Agile CR Land 0% 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 Coli 2010 ASP (Rmb/sqm) 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800
Source: Company data Source: Company data
In this group of eight developers, Coli, Agile (Not rated), The EE score itself does not give that much additional and CR Land did have better profitability than their information about developers’ performances. peers for 2010, considering their relatively higher ASPs. Consequently, we have also analysed developers’ 2010 Country Garden and Evergrande’s 2010 ASPs were core earnings and GFA delivery volumes. Developers in close to Rmb6,000/sq m. Country Garden had better category B are clustered closely, while developers in profitability, considering relative ASP. Our scatter-plot category A are widely disbursed. Evergrande led the analysis indicates that Coli, Country Garden, CR Land, sector with its 2010 GFA deliveries, while its core- and Agile had better-than-average profitability for earnings performance lagged those of Coli and Vanke. 2010, considering their ASP levels relative to their Our scatter-plot chart that follows suggests that Coli peers. and Vanke stand out in terms of core earnings relative to their GFA deliveries for 2010. However, this method may not be entirely fair to those developers that cater Earnings efficiency and volume to the mass market, such as Country Garden and expansion give us more insight Evergrande. We believe the alternative method is to replace the core earnings with the net-profit margin. In our view, the best developers can enjoy sales-volume Developers deliveries and core earnings (2010) growth while preserving their net-profit margins. In this report, we introduce our Daiwa EE scores for 9,000 8,000 developers, to help investors identify the industry Coli winners. Our EE score is the core earnings per square 7,000 metre booked. Our EE score is an alternative way of 6,000 Vanke 5,000 looking at the developers’ net-profit margins, by Agile Poly Evergrande 4,000 CR Land R&F factoring in delivery volumes. Developers should aim to 3,000 Shimao Country Garden increase both sale and delivery volume, while retaining 2,000 a high EE score. Based on the data for 2010, Coli has Longfor
2010 Core earnings (Rmb m) 1,000 the highest EE score, while Evergrande has the lowest 0 EE score In general, developers with higher ASPs 0.0 2.0 4.0 6.0 8.0 10.0 command higher EE scores compared with those with 2010 Delivery (m sqm) lower ASPs. Source: Company data, Daiwa
The average 2010 net-profit margin for the developers in our A and B categories was 15.7%, while average GFA deliveries for 2010 were 3.7m sq m. Our refined scatter-plot chart indicates that Coli and Country Garden beat the average performances for both 2010 delivery volume and net-profit margins. Vanke, Poly (Not rated), and Evergrande only beat the average delivery volume. Longfor (Not rated), CR Land, and Agile only beat the average net-profit margin.
- 20 - Housing China 6 July 2011
Developers matrix by deliveries and net-profit margins (2010) We believe investors should avoid developers with low 25% net-profit margins and delivery volume. Low Coli sales/delivery volume and net-profit margins usually 20% Longfor indicate that there are corporate-governance problems. Agile Country Garden 15% CR Land R&F Poly Developers business model Vanke Shimao 10% Evergrande
5% Margin leader Best in class 2010 net-profit margin
0%
0.0 2.0 4.0 6.0 8.0 10.0 High>>> 2010 Delivery (m sqm)
Source: Daiwa
<< developers. The top-10 developers have tended to Margin Volume << Our advice: pick the best in class Category A developers: share-price performance YTD (31 Dec, 2010 = 100) We believe developers’ business models are very 170 important for investors. We can divide developers 150 further into four quadrants, based on the criteria of net-profit-margins and delivery volume. Volume 130 leaders focus primarily on delivery-volume growth, 110 with a limited emphasis on profit margins. Very often, 90 volume leaders will have lower ASPs, and hence lower 70 profit margins compared with their peers, to support 9-Apr 1-Jan 7-May 23-Apr 15-Jan 29-Jan 12-Feb 26-Feb 12-Mar 26-Mar their delivery-volume-growth strategies. Margin 21-May leaders generally focus more on the bottom-line Coli China Vanke - B Evergrande metrics such as net-profit margins, with a limited Poly Real Estate Country Garden emphasis on delivery-volume growth. This latter Source: Datastream strategy is generally favoured by the Hong Kong property developers. Developers that focus on the high- Amongst the category B developers, Longfor and Agile end segment generally adopt this strategy as well. have outperformed their peers in share-price Developers usually have to sacrifice delivery-volume in performance in 2011 year-to-date. Our Daiwa Quadrant order to retain high profit margins. analysis suggests that Evergrande, Longfor, and Agile did not meet the best-in-class conditions, based on the We believe the best-in-class developers have a balanced average net-profit margins and delivery volume among approach to delivery volume and profit margins. These of the developers group. developers can usually achieve delivery-volume growth without sacrificing profit margins. We believe the key attributes for these developers are generally excellent product quality, strong branding, and effective project execution. - 21 - Housing China 6 July 2011 Category B developers: share-price performance YTD (31 Dec, 2010 = 100) 130 120 110 100 90 80 70 Apr 9 Jan 1 May 7 Apr 23 Jan 15 Jan 29 Feb 12 Feb 26 Mar 12 Mar 26 May 21 CR land Agile Guangzhou R&F Shimao Longfor Source: Datastream We recommend that investors pick what we see as the best-in-class developers. Our top picks in the sector are Coli and Country Garden. - 22 - Construction & real estate / China 2 June 2011 Part V – does stock Housing China - a 10- part series selection matter? • Selected stocks' significant absolute return in 2010 and year-to- date illustrates the importance of stock selection • Investors should take note of past valuation ranges and avoid chasing performance • Our advice: look for relative valuation and positive surprises differentiated approach to strata-title always make good investments. Our office development also yielded a less advice is to avoid chasing significant negative policy impact compared with positive performance, especially for residential developers. good companies. For example, Longfor’s share price was up 56.3% Danny Bao, CFA The sector’s 3.8% absolute return for over the past 12 months, as at 31 May (852) 2773 8715 [email protected] the first five months of 2011 matched 2011. However, much of this the MSCI China Index’s return for the impressive return was achieved before same period. The top-10 developers in April. Its returns have been -0.61% for Merits of investing in China our categories A and B (based on 2010 the past two months and -0.5% for the property stocks – summary gross-floor-area [GFA] deliveries of 4 past one month. Longfor’s share price This is part V of a series of 10 sq m and 2 sq m, respectively,) has traded in a range of HK$13.28- reports that we are publishing on achieved an average return of 9.6%, 11.62 over the past two months. We the theme of: Housing China – beating the country and sector indices. believe investors should avoid chasing merits of investing in China Our category A developers achieved a after performance. property stocks. We discuss what better return of 16.2%. Evergrande we consider as the 10 key subjects (Not rated) has been the best- Our advice: look for relative for investors to make profitable performing stock, with a return of valuation and positive surprises investments or trades in the China 45% YTD. This 2010 and year-to-date We believe investors can maximise property space. In this report, we outperformance of selected stocks their alpha returns (stock-selection- address the importance of stock illustrates to us the importance of based returns) by paying more selection for investors. stock selection. attention to undervalued names. We believe potentially positive surprises Selected stocks beat the Take note of past average ranges for contract sales, earnings, and benchmark in 2010 and year-to- and avoid chasing performance liquidity conditions may drive stock date We believe investors should review reratings and positive returns. The China property sector the sector’s average NAV discount underperformed the MSCI China over the past five years and discount Our top pick is Guangzhou R&F Index by about 16.75% over 2010. The range over the past few years. The Properties (R&F) (2777 HK, MSCI China Index achieved a 2.7% sector is trading currently at a 43% HK$10.82, Buy [1]), as it is trading at positive return, while the MSCI China discount to our end-2011 NAV a discount to its peers in terms of end- Property index declined by 13.4%. As forecasts, wider than its past-five-year 2011E NAV and PER. We believe the such, investors with underweight average discount of 24%. We believe company’s recent debt financing has positions in the property sector the sector’s current valuation looks dispelled concerns in the market achieved positive performances reasonable compared with its past- about its liquidity. We believe a relative to the benchmark country five-year average discount, which potential improvement in its contract index. Two of the stocks in the sector smoothes out the peak and trough sales over the next few months should beat the MSCI China index last year. valuations. drive share-price appreciation. Longfor Properties (Longfor) (960 HK, HK$12.32, Hold [3]) and Soho China Many investors like to buy ‘good’ (410 HK, HK$6.7, Hold [3]) achieved companies (ie, companies that they absolute returns of 23.7% and 37.6%, believe offer good fundamentals) after respectively, due to better-than- significant share-price performance. expected contract sales. Soho China’s We believe good companies do not Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011 Daiwa category B developers: share-price performance (2010) (Dec 31, 2009 = 100) 140 130 120 110 100 90 Valuations matter 80 70 60 Many investors treat the China Property 50 31-Jul 30-Apr 31-Oct 30-Jun 31-Jan 28-Feb 31-Mar 31-Aug 30-Sep 30-Nov 31-Dec 31-Dec Sector as a sector play. Asset allocation 31-May has always been a key factor for investors. CR Land Agile Guangzhou R&F We assess the importance of the stock Shimao Longfor selection and relative valuation. Source: Datastream For 2010, our Daiwa category B developers beat the Tiered approach to valuation average share-price performance of the Category A developers, thanks to Longfor’s exceptional return. In our previous Housing China report, we argued that we The China property sector underperformed the MSCI believe it is best to evaluate listed developers by their China Index by 16.75% for 2010. The MSCI China scale. As such, we believe a tiered approach, such as Index achieved a 2.7% positive return, while the MSCI our Daiwa Category method, helps to improve the China Property Index fell by 13.4%. As such, investors valuation-driven stock-selection process. We also with underweight positions in the sector achieved believe recent government policies will facilitate positive performances relative to the benchmark industry competition and market-share consolidation, country index. Two of the stocks in the sector beat the and hence should benefit selected industry leaders. MSCI China Index last year. Longfor and Soho China achieved absolute returns of 23.7% and 37.6%, respectively, due to better-than-expected contract sales Positive year-to-date returns for 2010. Soho China’s differentiated approach to strata-title office development also yielded a less negative policy impact compared with residential For the first five months of 2011, the sector’s 3.8% developers. return matched that of the MSCI China index for the same period. The top-10 developers in our categories A Daiwa category A developers: share-price performance (2010) and B achieved an average return of 9.6%, beating both the country and sector indices. (Dec 31, 2010 = 100) 130 The category A developers achieved a better return of 110 16.2% YTD. Evergrande was the best-performing stock, 90 with a return of 45% YTD. Poly Real Estate (Not rated) 70 is the only stock in our category A that saw a negative return. 50 30 Regarding the developers in our category B, Longfor and Agile (Not rated) saw positive share-price 31-Jul 30-Apr 31-Oct 31-Jan 30-Jun 28-Feb 31-Mar 31-Dec 31-Aug 30-Sep 30-Nov 31-Dec 31-May performances of 17% YTD and 13.9% YTD, respectively. Coli China Vanke - B Evergrande Poly Real Estate Country Garden Most of the other category B developers saw negative return and underperformance. Soho China, a niche Source: Datastream strata-title office developer, also saw a positive return of 15.9% YTD. Stock selection can enhance investors’ portfolio returns significantly, while sector allocation remains important We believe the weakness of the physical property for investment decisions, in our view. For 2010, most market over the past few months also reduces the near- of our Daiwa category A developers underperformed term policy risks. This, in turn, has improved investor the MSCI China Index. Only Country Garden (207 HK, sentiment and risk appetite. HK$3.44, Outperform [2]) beat the country index modestly, with a 3.1% positive return. Longfor was the only stock in our category B that beat the country index. - 24 - Housing China 6 July 2011 Daiwa category A developers: share-price performance YTD Developers: trend in discount to current NAV (Dec 31, 2010 = 100) 100% 170 80% 160 150 60% 140 40% 130 20% 120 110 0% 100 (20%) 90 (40%) 80 70 (60%) (80%) 9-Apr 1-Jan 7-May 23-Apr 15-Jan 29-Jan 12-Feb 26-Feb 12-Mar 26-Mar 21-May Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sep-07 Sep-08 Sep-09 Sep-10 Coli China Vanke - B Evergrande May-07 May-08 May-09 May-10 May-11 Poly Real Estate Country Garden China Historical average Source: Datastream Source: Daiwa estimates and forecasts Significant differences in share-price performances We believe the sector’s current valuation (in terms of among both the category A and B developers show the discount to NAV) is reasonable, compared with its importance of stock selection in investing in the China past-five-year average level, which smoothes out the property sector, in our view. peak and trough valuations. Daiwa Category B developers: share-price performance YTD (Dec 31, 2010 = 100) Avoid chasing after performance 130 120 Many investors like to buy ‘good’ companies, ie, those 110 that they believe offer good fundamentals, after 100 significant share-price appreciation. However, we 90 believe good companies do not always make good 80 investments. As such, we advise investors to avoid 70 chasing after significant positive share-price performance, especially for companies perceived as 9-Apr 1-Jan 7-May 23-Apr 15-Jan 29-Jan 12-Feb 26-Feb 12-Mar 26-Mar 21-May being good ones. For example, Longfor’s share price CR Land Agile Guangzhou R&F has risen by 56.3% for the past 12 months, as at 31 May Shimao Longfor 2011. Source: Datastream However, we note that much of Longfor’s impressive return was achieved before April 2011. Over the past Take note of past ranges two months, the return was -0.61%, while over the past one month it was -0.5%. Over the past two months, We believe investors should look at the sector’s past- Longfor’s share price has traded in a range of five-year average NAV discount and range for the past HK$13.28-11.62. few years. The sector is trading currently at an average discount to NAV of 43% based on our end-2011 Longfor: 12-month share-price performance forecasts, a greater discount than its past-five-year 14.00 average discount of 24%. During the peak period of November 2007, the sector traded at about a 78% 12.00 premium to NAV at one point, due to investors’ 10.00 irrational expectations about earnings growth, in our 8.00 view. In October 2008, the sector traded at about a 71% 6.00 discount to NAV at one point, due to investors’ fears 4.00 related to the global financial crisis. We believe these recent valuation peak and trough are unlikely to be 2.00 breached again in the foreseeable future, barring other 0.00 extraordinary events. Jul-10 Apr-11 Oct-10 Jun-10 Jan-11 Feb-11 Mar-11 Aug-10 Sep-10 Nov-10 Dec-10 May-10 May-11 Source: Datastream - 25 - Housing China 6 July 2011 In general, it is fairly easy to find good-quality Looking at the relative valuations among the category A companies, in our view. However, it is not that easy developers, Evergrande and Poly Real Estate are find a good entry point to buy shares at a reasonable trading currently at lower PERs than their peer group. price. The experience of past years tells us that patience However, their respective 2011 PBRs based on our and discipline usually yield very good results. Longfor’s BVPS forecasts are not significantly lower than the peer share price fell by about 21% at one point in late average of 1.7x. We still see significant upside potential February, after the recent government policies. for China Overseas Land & Investment (Coli) (688 HK, HK$16.26, Buy [1]) and Country Garden, based on our Policy-related valuation troughs are usually a good NAV-derived six-month target prices for both stocks. entry point for selected stocks. Please refer to our Part I report for a more detailed discussion of this topic. Our top pick at present is R&F, as it is trading currently at a discount to its peers. We believe recent debt financing removes the liquidity concern. We believe Our advice: focus on relative potential improvement in its contract sales in the next valuation and potential surprises few months will drive share price improvement. to market expectations Our target price for Coli is based on a 15% discount to our 2012 NAV forecast. Our target price for Country We believe investors can maximise their alpha returns Garden is based on a 30% discount to our 2012 NAV (stock-selection-based returns) by focusing on forecast. Our target price for R&F is based on a 40% undervalued names. We believe potential positive discount to our 2012 NAV forecast. We see the key surprises on contract sales, earnings, and liquidity risks for Coli, Country Garden, and R&F as government conditions may drive stock reratings and positive policy changes, and significantly lower-than-expected returns. One example is Evergrande’s strong share- contract sales and deliveries. price performance year-to-date. Daiwa category A and developers: valuation comparison 2012 Price vs. Price vs. Target Target Share Mkt 2011 year-end current forward Target price/ price/ Price cap current forward NAV NAV price current forward PER (x) PBR (x) Company Ticker Rating Currency 31-May-11 (US$m) NAV NAV (%) (%) (HK$) NAV NAV FY11E FY12E FY11E FY12E *Coli 688 HK 1 HK$ 16.26 17,078 22.9 22.3 (29.0) (27.1) 19.0 (17.0) (14.8) 11.3 9.3 1.9 1.6 *China Vanke - B 200002 CH 1 HK$ 10.70 15,180 11.4 13.0 (6.1) (17.7) 11.7 2.6 (10.0) 12.4 10.8 2.0 1.7 Evergrande 3333 HK NR HK$ 5.48 10,564 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.2 6.4 1.8 1.9 Poly Real Estate 600048 CH NR Rmb 9.39 8,616 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.3 6.5 1.5 1.3 *Country Garden 2007 HK 2 HK$ 3.44 7,383 5.4 5.6 (36.3) (38.6) 3.9 (27.8) (30.4) 10.1 7.7 1.6 1.2 *CR Land 1109 HK 2 HK$ 13.98 9,680 20.8 21.0 (32.8) (33.4) 15.1 (27.4) (28.1) 14.8 13.6 1.6 1.4 Longfor 960 HK 3 HK$ 12.32 8,162 18.3 19.0 (32.7) (35.2) 12.4 (32.5) (35.0) 13.3 9.7 2.7 2.1 Shimao 813 HK NR HK$ 10.36 4,726 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 7.2 6.0 1.0 0.9 Agile 3383 HK NR HK$ 13.38 5,972 n.a. n.a. n.a. n.a. n.a. n.a. n.a. 8.8 7.3 1.8 1.5 *Guangzhou R&F 2777 HK 1 HK$ 10.82 4,481 21.7 22.8 (50.1) (52.5) 13.7 (36.9) (39.9) 7.3 5.9 1.3 1.2 Category A average (23.8) (27.8) 10.1 8.1 1.7 1.5 Category B average (38.5) (40.4) 10.3 8.5 1.7 1.4 Source: Bloomberg, Thomson Reuters, *Daiwa forecasts - 26 - Construction & real estate / China 8 June 2011 Part VI - does asset class matter? Housing China – a 10- part series • Residential has been the dominant property-asset class and earnings driver for the past five years • Interesting themes are developing in the non-residential asset classes • Our advice: increase retail-property exposure developers’ earnings growth over the Daiwa asset-class profile next few years. Retail Residential 5 1) Residential: growth in public Recreation and High>>> 4 Retirement housing should benefit niche Office Hotel Danny Bao, CFA construction contractors 3 (852) 2773 8715 << Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011 to other real-estate asset classes, such as office and retail. Growth in GFA completions in the office and commercial segments in China over the past few years has also been evident. As such, we believe investors should focus on the developing themes in the key real- estate asset classes in China. Non-residential asset exposure to increase China: non-residential GFA completions (‘000 sq m) 90,000 80,000 The listed China property universe is 70,000 60,000 over-crowded with residential-property 50,000 developers, due to significant demand 40,000 30,000 growth over the past 10 years. We believe 20,000 developers are likely to increase their 10,000 non-residential asset exposure over the 0 next few years. 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Office Commercial others Source: CEIC Reliance on residential development over past five years Key developing Daiwa themes China’s residential gross-floor-area (GFA) completions Residential: public-housing growth to have risen at a 7% CAGR over the past five years. The major listed developers have recorded a much faster benefit niche construction contractors rate of earnings growth compared with the overall The government plans to boost public-housing market for the same period, on the back of market- construction over the next five years. We expect share expansion and improved access to capital. As deliveries of these public-housing units to peak in 2013, such, developers’ earnings growth over the past five accounting for about 54% of China’s total residential years has also depended heavily on the residential asset completions for 2013. We believe the public-housing class. The MSCI China Real Estate Management and plan is likely to continue under the 13th Five-Year Plan MSCI Development Index’s market capitalisations are (2016-20). The increase in the public-housing supply also dominated by the residential developers. As such, over the next few years should benefit niche investors have tended to focus mainly on the construction contractors. residential developers. Investors have been pursuing actively names like China China: residential GFA completions (‘000 sq m) State Construction International Corp (3311.HK, HK$7.72, Buy [1]) and BBMG Corporation (Not rated), 700,000 due to a limited number of investment candidates. We 600,000 expect to see other specialised construction contractors 500,000 list in the next 2-3 years, amid government plans to 400,000 boost public-housing supplies. 300,000 Retail: domestic consumption growth 200,000 should drive retail-space demand in China 100,000 The retail asset class remains our top pick for non- 0 residential exposure. China’s retail sales rose at a CAGR of 15.8% over the past 20 years. We expect this strong trend 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 to continue in the new few years. Expectations of a rising Source: CEIC rate of income growth among citizens, along with a potential improvement in social welfare, should continue The PRC Government’s continuous scrutiny of the to support retail sales growth in China. We recommend residential market over the past few years has encouraged developers to diversify their earnings bases - 28 - Housing China 6 July 2011 that investors consider adding exposure to developers CBRE reports indicate that average prime office rents with significant retail assets in China. for 3Q10 in Shanghai and Beijing were about 45% lower than those in Singapore. In turn, average office China: retail-sales trend (Rmb bn) rental rates for Shanghai and Beijing were about 71% 18,000 35% and 77%, respectively, lower than those in Tokyo and 16,000 30% Hong Kong. As such, we believe high-quality office 14,000 25% owners should be well-positioned to capture the rental 12,000 20% 15% upside potential in the Shanghai and Beijing office 10,000 10% markets. 8,000 5% 6,000 0% New office completions in Beijing and Shanghai peaked 4,000 (5%) 2,000 (10%) in 2008. The contributions of these two cities to total 0 (15%) office completions in China have declined over the past two years. We expect new office-development activities 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 to slow significantly in Shanghai and Beijing going Retail sales YoY growth forward, while development activities in major second- Source: CEIC tier cities should gain momentum. We expect major developers to secure high-quality city-centre projects in For our retail themes, investors may take into major second-tier cities. consideration the following stocks: China Resources Land, Wharf, Capital Retail China Trust (CRCT SP, Beijing and Shanghai office completions as % of total China S$1.220, Buy [1]), Mingfa (Not rated, Powerlong (Not office completions rated), and Renhe Commercial (Not rated). 35% 30% Office: high-quality asset owners in tier- one cities should enjoy positive rental rent 25% reversion, development activities should 20% shift to major second-tier cities 15% The office segment offers what we see as attractive risk- 10% adjusted returns for investors, due to it being subject to 5% less policy risk than the residential segment, the 0% prospect of positive rental reversions, and the potential Renminbi appreciation. We expect China’s re- 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 orientation toward domestic-consumption-driven GDP Source: Soufun growth to drive demand for prime office space in Shanghai and Beijing over the next three years. Limited In the office segment, we believe investors should new supply in Beijing in 2011 should continue to boost consider Franshion, given its high exposure to office- rents, while new office supply in Shanghai in 2011 is investment property assets. likely to be delayed. We forecast prime office rents in Beijing and Shanghai to rise by 10% YoY and 5% YoY, Hotel: hotel owners in tier-one cities respectively, for 2011. should enjoy positive RevPAR growth, development activities should shift to Prime office rents for major markets in Asia smaller cities Singapore Developers in China usually acquire hotel assets Tokyo CBD through their integrated development model. Most HongKong, Central developers adopt the build-to-operate (BTO) model Shanghai, Puxi and outsource the management function to Shanghai, Pudong international hotel-management companies. Hotel Beijing, Finance Street assets are typically carried at cost and depreciated over Beijing, ZGC time. Beijing, Jianguomen The overall number of hotels and total hotel revenue in 0 2 4 6 8 10 12 14 16 China has risen over the past eight years. However, the Prime office rent (US$ psf/month) growth rates have decelerated over recent years. For Source: CBRE, as of 3Q10 2009, the number of hotels in China increased by only - 29 - Housing China 6 July 2011 1% YoY to 14,237, while hotel revenue rose by 3.2% YoY to Rmb182bn. We expect luxury hotels in tier-one cities to enjoy high RevPAR growth over the next three years. Our advice: increase retail- We expect the pace of new developments in large property exposure coastal cities to slow, while carefully selected new development projects in inland regions should yield We believe the retail-property asset class offers the best good returns for developers. risk-reward profile for developers and investors. Retail remains our top pick among the non-residential asset China: number of hotels and hotel revenue classes. This real-estate asset class has not been a 16,000 200,000 major factor for developers yet, due to significant 14,000 180,000 160,000 growth in residential demand over the past 10 years. 12,000 140,000 We believe its importance will increase significantly 10,000 120,000 over time, amid government efforts to boost public 8,000 100,000 housing supplies in China. 6,000 80,000 60,000 4,000 40,000 Daiwa profile of major real-estate asset classes 2,000 20,000 0 0 Retail Residential 5 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Recreation and No. of hotels Hotel revenue (Rmb m) High>>> 4 Retirement Source: CEIC Office Hotel In the hotel segment, we believe investors should 3 consider Franshion, given its significant exposure to high-quality hotel-investment property assets. << Other: retirement homes and recreation 1 projects may bring developers a new 1234 5 earnings-growth driver Growth potential Execution risks << - 30 - Construction & real estate / China 15 June 2011 Part VII – does government Housing China - a 10- part series backing matter? • Central government-backed developers tend to have better three- year returns than local government-backed developers • Government backing generally leads to lower funding costs • Our advice: company-specific factors are still more important Government backing leads to Our advice: investors should not lower funding costs rely too much on government Low funding costs are one of the backing but consider other advantages for developers with company-specific factors government backing versus private We have found that government Danny Bao, CFA developers. Our look at the average backing does give developers some (852) 2773 8715 2010 borrowing costs for the top-10 advantage in terms of borrowing costs, [email protected] especially Hong Kong-listed developers in China shows that the three state-owned enterprises (SOE) developers. However, government backing does not always result in Merits of investing in China had average borrowing costs of about superior returns for investors. We property stocks – summary 5.13%, lower than the 6.76% for the believe other company-specific factors This is part VII of a series of 10 top-10 developers. Above all, Hong are still more important reports that we are publishing on the Kong-listed SOEs such as China considerations for investors. theme of: Housing China – merits Overseas Land and Investment (Coli) of investing in China property (688 HK, HK$15.62, Buy [1]) and We believe investors should consider stocks. We discuss what we consider China Resources Land (CR Land) factors such as scale, business model, as the 10 key subjects for investors to (1109 HK, HK$13.02, Outperform [2]) asset exposure, and product make profitable investments or trades have the lowest average funding costs positioning, in the bottom-up stock in the China property space. In this among the top-10 developers at selection process. We like Coli for its report, we address the importance of present. We believe access to lower- strong balance sheet, low-cost funding, government backing. cost funding is the main benefit for and what we regard as its high developers with government backing. Developers with central earnings efficiency. government backing have achieved Hong Kong-listed developers also better three-year returns than have access to the international New-debt profile for selected names those with local government capital markets for funding. Among 12.0 10.0 Coli backing Shimao the top-10 developers, two onshore 8.0 CG Many investors believe developers listed developers, namely China 6.0 CR Land Longfor 4.0 with government backing generate Vanke (200002 CH, HK$10.11, Buy Maturity R&F 2.0 Evergrande better investment returns than private [1]) and Poly Real Estate (Not rated), 0.0 developers. From our assessment of have not raised any offshore financing 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% the past-three-year returns of various Cost of new debt in 2011 year-to-date, due to the developers, we have found that those restrictions by the China Securities Source: Bloomberg, Daiwa with government backing have not Regulatory Commission (CSRC). Most always produced superior returns over of the other developers have raised their private peers. However, capital over the past 6-7 months. Agile developers with central government Property (Agile) (Not rated) raised backing achieved better returns over capital through convertible debt in the three-year period to 31 May 2011 April 2011. The new-debt maturities than developers with local range from three to 10 years. Two government backing. SOEs including Coli and CR Land also have lower borrowing costs than their private peers. Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011 by local governments. We present details of the developers’ backing, along with their stock performances, in the following tables. We have found that, generally, the central government-backed developers such as Coli, CR Land and Poly Real Estate, have much larger market capitalisations currently than Government backing developers that are backed by local municipalities. Many of the listed developers have We have found that, in general, SOE developers have not produced better share-price performances central and local government backing. Do compared with private developers over the past two developers with government backing years. We also note that the developers with central have advantages over their private peers? and local government backing have not shown significant differences in share-price performances. Does government backing translate into positive returns for investors? With regards to three-year investment returns to 31 May 2011, the three major SOE developers in the top- 10 group did achieve better returns on average than the Central and local government other developers. We believe developers with central backing government backing do have a very small advantage in terms of their nationwide expansion compared with the Many of the listed property developers have some form local government-backed developers. However, this of government backing. Some, such as Coli and CR advantage does not appear significant over their Land, are backed by the central government, while private peers. others, such as Beijing Capital Land (Not rated) and Yuexiu Property (123 HK, HK$1.45, Buy [1]) are backed Developers with government backing Mkt cap Company Ticker Rating Currency (US$m) Backing Parent company Interest owned (%) *Coli 688 HK 1 HK$ 17,086 Central Government China State Construction Engineering Corporation 53.1 *CR Land 1109 HK 2 HK$ 8,621 Central Government China Resources National Corporation 65.4 Poly Real Estate 600048 CH NR Rmb 9,684 Central Government China Poly Group Corporation 46.3 Shanghai Industrial 363 HK NR HK$ 3,936 Shanghai municipal government Shanghai Industrial Investments (Holdings) Co., Ltd 53.6 *Franshion 817 HK 1 HK$ 2,547 Central Government Sinochem Corporation 62.9 Poly HK Investment 119 HK NR HK$ 2,780 Central Government China Poly Group Corporation 48.0 *Yuexiu Property 123 HK 1 HK$ 1,946 Guangzhou municipal government Guangzhou Yue Xiu Holdings Limited 48.6 Beijing Star 588 HK NR HK$ 1,642 Beijing municipal government Beijing North Star Industrial Group 34.5 Shenzhen Investment 604 HK NR HK$ 1,111 Shenzhen municipal government Shum Yip Holdings Company Limited 43.1 Beijing Capital Land 2868 HK NR HK$ 670 Beijing municipal government Capital Group 47.3 Minmetals Land 230 HK NR HK$ 575 Central Government China Minmetals Corporation 61.9 Source: Bloomberg, Daiwa Note: ratings are as at 15 June 2011, other data is as at 31 May 2011, * denotes companies under Daiwa’s coverage Performance comparison Market cap Share-price performance (%) Company Ticker Rating Currency (US$m) 1M 3M 6M 1YR 2YR 3YR 2011 YTD *Coli 688 HK 1 HK$ 17,086 8.8 25.9 9.0 5.9 (0.5) 16.1 13.1 Poly Real Estate 600048 CH NR Rmb 8,621 (7.1) (1.3) 0.7 10.5 (25.8) 19.3 (3.9) *CR Land 1109 HK 3 HK$ 9,684 4.3 10.6 0.4 (5.0) (22.3) 5.7 (1.5) Shanghai Industrial 363 HK NR HK$ 3,936 (7.5) 1.6 (13.4) (13.2) (7.7) (1.7) (15.6) Poly HK Investment 119 HK NR HK$ 2,547 (11.6) (11.6) (24.2) (31.5) 44.1 23.4 (27.8) *Franshion 817 HK 2 HK$ 2,780 (2.5) 8.8 (3.3) (0.8) (18.3) (31.0) 0.9 *Yuexiu Property 123 HK 1 HK$ 1,946 0.0 0.0 (20.1) (1.6) 0.4 14.8 (21.6) Beijing Star 588 HK NR HK$ 1,642 (5.3) (5.3) (12.6) (6.7) (31.6) (40.8) (14.7) Shenzhen Investment 604 HK NR HK$ 1,111 0.4 0.8 (10.9) 6.6 (26.9) (24.2) (10.0) Beijing Capital Land 2868 HK NR HK$ 670 (4.9) 3.7 (10.0) 9.5 (12.8) (5.6) (2.7) Minmetals Land 230 HK NR HK$ 575 (4.3) (4.3) (16.8) 1.5 28.6 (7.6) (16.8) SOEs average (2.7) 2.6 (9.2) (2.3) (6.6) (2.9) (9.1) SOEs in top 10 2.0 11.7 3.4 3.8 (16.2) 13.7 2.5 MSCI China (0.1) 6.2 3.1 16.0 29.8 (2.8) 3.77 MSCI China property 1.7 13.1 4.7 7.1 (11.9) (15.8) 3.77 Source: Bloomberg, Daiwa Note: ratings are as at 15 June 2011, other data is as at 31 May 2011, * denotes companies under Daiwa’s coverage - 32 - Housing China 6 July 2011 New-debt profiles for selected developers SOEs versus private developers 12.0 10.0 Coli Shimao Low funding costs give developers with government 8.0 CG backing an advantage compared with their private Maturity 6.0 peers. From our look at the average 2010 borrowing CR Land Longfor 4.0 costs of the top-10 developers in China, we note that Evergrande R&F the average borrowing costs for the three SOEs were 2.0 5.13%, lower than the 6.76% on average for the top-10 0.0 developers. More importantly, Hong Kong-listed SOEs 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% such as Coli and CR Land had the lowest average Cost of new debt funding costs amongst the top-10 developers. We believe access to low-cost funding is the key benefit for Source: Bloomberg, Daiwa developers with government backing. Top-10 developers: average 2010 borrowing cost Company-specific factors are still *Coli *CR Land more important Shimao *Guangzhou R&F We have found that government backing does give Longfor developer some advantages in terms of borrowing costs, Poly Real Estate especially Hong Kong-listed companies. However, CG government backing does not always result in superior Agile returns for investors. Other company-specific factors *China Vanke - B are still more important considerations for investors Evergrande than government backing, in our view. 0% 2% 4% 6% 8% 10% For example, the three SOE developers had an average Source: Company data, Daiwa Note: *= companies under Daiwa’s coverage net-profit margin for 2010 of about 17.5%, higher than the top-10 developers’ average margin of 15.7%. This Hong Kong-listed developers also have access to the reflects the three SOE developers’ lower financing costs international capital markets for funding. Among the and the contribution from Coli (which has an elevated top-10 developers, two onshore listed developers, net-profit margin). Excluding Coli, the average 2010 China Vanke and Poly Real Estate, have not raised any net-profit margin of CR Land and Poly Real Estate is in offshore financing this year so far, due to the CSRC’s line with that of the top-10 developers. restrictions. Most of the other developers have raised Top-10 developers: net-profit margins (2010) capital over the past 6-7 months. Agile raised capital through convertible debt in April 2011. The new-debt Evergrande maturities range from three to 10 years. Two SOEs Shimao (Coli and CR Land) also have lower borrowing costs Poly Real Estate than their private peers. *Guangzhou R&F *China Vanke - B Country Garden *CR Land Longfor Agile *Coli 0% 5% 10% 15% 20% 25% Source: Company data, Daiwa Note: * = companies under Daiwa’s coverage - 33 - Housing China 6 July 2011 Among the top-1o developers by gross-floor-area (GFA) deliveries for 2010, only three have government backing. Their 2010 total GFA deliveries only accounts Our advice: company-specific for about 30% of the top-ten total deliveries. As such, factors are still more important we believe government backing is not a major driver of capacity leadership. We believe government backing is only a relevant factor in terms of developers’ funding costs. We Top-10 developers: GFA deliveries (2010) recommend that investors do not place too much 2010 delivery m sq m emphasis on this attribute. We believe investors should *CR Land focus on other company-specific factors such as scale, Longfor business model, and asset exposure, in the bottom-up Shimao stock-selection process. Among the SOE developers, we Agile *Guangzhou R&F like Coli given its strong balance sheet, access to low- *China Vanke - B cost funding, and what we regard as its high earnings Poly Real Estate efficiency. *Coli Country Garden Evergrande 0123456789 Source: Company data, Daiwa Note: * = companies under Daiwa’s coverage Asset turnover is also a key benchmark to compare the various developers, in our view. For 2010, the SOE developers achieved an average asset-turnover ratio of 27.3%, much lower than the top-10 developers’ average ratio of 32%. As such, we believe government backing does not always result in superior asset turnover. Top-10 developers: asset turnover (2010) *CR Land Longfor *China Vanke - B Shimao Poly Real Estate *Coli *Guangzhou R&F CG Agile Evergrande 0% 10% 20% 30% 40% 50% 60% Source: Bloomberg Note: * = companies under Daiwa’s coverage - 34 - Construction & real estate / China 23 June 2011 Part VIII – what matters in the Housing China - a 10- part series next cycle? • Scale and earnings efficiency are the most important factors for developers • Balance sheets, offshore listings, and sustainability are also key • Our advice: look beyond the current cycle Daiwa’s EE (earnings efficiency) Many of the listed developers have score is an alternative way of looking short track records of core-earnings at the developers’ net-profit margins, growth. We believe sustainability by factoring in delivery volume. The will be very important in the next developers should aim to increase cycle. We measure sustainability by Danny Bao, CFA both sales and delivery volume, the number of consecutive years (852) 2773 8715 [email protected] while retaining a high EE score. with core-earnings growth following listing. China Overseas Land & We now introduce an adjusted- Investment (COLI) (688 HK, Merits of investing in China earnings-efficiency (AEE) score, to HK$15.90, Buy [1]) and CR Land property stocks – summary neutralise the impact of differences stand out on this measure. This is Part VIII in a series of 10 in selling prices. We believe our AEE reports that we are publishing on the score is a better way of comparing Our advice: look beyond the theme of ‘Housing China –the merits the major developers. Based on our current cycle of investing in China property stocks’. calculations, China Resources Land We believe the current government We discuss what we consider to be the (CR Land) (1109 HK, HK$12.64, housing policies will facilitate a soft 10 key subjects for investors to make Outperform [2]) had the highest landing for the physical market over profitable investments or trades in the AEE score for 2010, followed by the near term. The risk of a long- China property space. In this report, Country Garden (2007 HK, term property-price correction we look at the factors that will be HK$3.32, Outperform [2]) and Agile remains, however, and depends on important for companies to weather Property (Not rated). the government’s future monetary the next cycle. and foreign-currency policies. Balance sheets, offshore listings, Scale and earnings efficiency and sustainability also important As such, we recommend investors matter in this cycle as much as We believe the developers must not look beyond the current cycle, in they will do in the next only survive the current credit- their bottom-up stock selection We believe developers with scale and tightening environment, but also process. We believe scale, earnings high earnings efficiency will achieve potential home-price falls before the efficiency, balance sheets, offshore the best earnings growth in the next property cycle. As such, listings, and sustainability will matter current cycle. We expect the balance-sheet health is an extremely in the next property cycle. These advantages they have over their peers important factor for them. measures should help investors find to continue in the next property cycle. the industry winners over the long For the first five months of this year, We believe the offshore listed term. On this basis, we like COLI and the top-10 developers for 2010 in developers in general have better CR Land among the stocks we cover. terms of GFA delivery achieved funding advantages than their contract sales of about 21.9m sq m, onshore peers. We expect this Top-10 developers: AEE score about 7.4% of total residential GFA advantage to be sustained over the Longfor Evergrande sales. This suggests that that major next few years, amid government Poly Real Estate Guangzhou R&F developers continued to gain market austerity measures to cool home Shimao China Vanke - B share, even though government prices. Access to international Coli Agile policies have led to a slowdown in capital will be one of the key Country Garden market demand. advantages for the offshore listed CR Land developers, in our opinion. 0 500 1,000 1,500 2,000 Source: Daiwa Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011 the major developers continued to gain market share, even though government policies have led to a slowdown in market demand. Private- and public-housing completions (m sq m) (m sq m) What matters in the 1,200 next cycle? 1,000 800 We expect government policies to boost 600 public-housing supply and cool home 400 prices in China to continue. This should 200 0 lead to accelerating industry 2010 2011E 2012E 2013E 2014E 2015E consolidation. We believe the following Public-housing completions Private-housing completions characteristics are important for the next Source: 2010 completion based on Soufun data, all other data based on Daiwa estimates cycle. The developers that cannot compete on scale should adopt a niche strategy, in our view, by focusing on a Scale matters particular product or asset specialisation. Renhe Commercial (Not rated), a developer of underground Evergrande Real Estate Group (Evergrande) (Not rated) retail/wholesale malls, is a good example of a developer became the largest developer in China with a 2010 GFA following such a strategy. delivery of 8.1m sq m. China Vanke (Vanke) (200002 CH, HK$10.11, Buy [1]) had claimed the top spot for Earnings-efficiency matters many years prior to that. For 2011, we expect the No.1 spot to be taken by Evergrande, Vanke, or COLI. In Part IV of our Housing China series, we introduced The residential-property-development market in China the concept of the Daiwa EE score. Our EE score is an is highly fragmented, with the largest developer in alternative way of looking at the developers’ net-profit China, Evergrande, accounting for only about 1.2% of margins, by factoring in delivery volume. The the market share (in terms of 2010 GFA delivery). The developers should aim to increase both sales and government’s public-housing initiatives will accelerate delivery volume, while retaining a high EE score. industry competition and market-share consolidation. We believe the major developers with proven delivery Based on the data for 2010, COLI had the highest EE growth will account for the biggest market shares in the score, while Evergrande had the lowest. In general, future. those developers with high average selling prices (ASP) have higher EE scores compared with those with lower Scale is likely to remain a very important factor in the ASPs. However, the raw EE score method may not be next property cycle. The developers with scale will be entirely fair to those developers that cater to the mass able to increase their earnings through organic market, such as Country Garden and Evergrande. expansion as well as acquisitions. We measure scale predominantly by GFA completion or delivery. For We now introduce our AEE score, to neutralise the example, the top-10-listed developers accounted for impact of differences in selling prices. We believe our about 6% of the market for 2010 (in terms of GFA AEE scores are a better way of comparing the major delivery). We expect their market shares to expand developers. Our AEE scores for the top-10 developers over the next few years. are listed in the following tables. Based our calculations, CR Land had the highest AEE score for 2010, followed Contract sales usually lead physical delivery by about by Country Garden and Agile Property. Evergrande and 12-24 months in China. Therefore, contract sales are Longfor Group (960 HK, HK$11.5, Hold [3]) had the usually a leading indicator of future delivery. For the lowest AEE score, suggesting a relatively lower earning first five months of this year, the top-10 developers efficiency. We believe our AEE scores provide a single achieved contract sales of about 21.9m sq m, about point of data comparison among the major developers. 7.4% of total residential GFA sales. This suggests that - 36 - Housing China 6 July 2011 Top-10 developers: EE and AEE scores In addition to financial leverage, the cost of debt is very Developer EE score AEE score important to the balance sheet. A reduction in funding CR Land 1,699 1,738 costs will improve the return to equity holders. Country Garden 858 1,649 Agile Property 1,669 1,533 Reduced financial leverage usually also leads to a fall in COLI 1,706 1,494 total borrowing costs. The average 2010 blended China Vanke - B 1,543 1,475 borrowing cost for the top-10 developers was about Shimao 1,511 1,317 6.76%. Guangzhou R&F 1,560 1,237 Poly Real Estate 1,071 1,171 Evergrande 678 1,114 Top-10 developers: average borrowing costs (2010) Longfor 1,428 1,103 COLI Source: Daiwa CR Land Shimao Guangzhou R&F Balance-sheet matters Longfor Poly Real Estate We believe the current credit tightening onshore will Country Garden exert liquidity pressure on the developers, especially Agile small private developers with limited financing China Vanke - B channels. Many China-based developers have switched Evergrande to higher-cost onshore bank trust vehicles to secure 0% 2% 4% 6% 8% 10% funding; and we have seen increasing trust activity in recent months. The Hong Kong-listed developers have Source: Daiwa estimates raised money through debt or convertible securities. We believe the developers must not only survive the Offshore listing matters current credit-tightening environment, but also potential home-price falls before the next property We believe onshore listed developers will continue to cycle. As such, balance-sheet health is an extremely face government scrutiny of their debt and equity important factor for them. financing, as the housing austerity measures are likely to continue for the next few years. Offshore listed Reasonable financial leverage improves the return to developers, meanwhile, have better access to the equity holders. However, extended leverage will international capital markets for funding. Among the increase the solvency risk. At the end of 2010, the top-10 developers, two onshore listed developers – average net gearing of the top-10 developers was about China Vanke and Poly Real Estate (Not rated) – have 66%. We believe the developers should aim to maintain not raised any offshore financing so far this year, due to net-gearing levels at below 60%. restrictions by the China Securities Regulatory Commission. Most of the other developers have raised Top-10 developers: average net gearing (2010) capital over the past 6-7 months. Agile Property raised China Vanke - B capital through convertible debt in April 2011. The COLI maturities of the new debt range from three to 10 years. Longfor New-debt profile for selected names CR Land Country Garden 12.0 Agile 10.0 Coli Shimao Shimao 8.0 Evergrande CG 6.0 Guangzhou R&F Maturity CR Land Longfor Poly Real Estate 4.0 Evergrande R&F 0% 20% 40% 60% 80% 100% 120% 140% 2.0 Source: Bloomberg 0.0 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% Cost of new debt Source: Bloomberg - 37 - Housing China 6 July 2011 We believe the offshore listed developers in general have better funding advantages than their onshore peers. We expect this advantage to be sustained over the next few years, amid government austerity measures to cool home prices. Access to international capital will be one of the key advantages for the offshore listed developers, in our opinion. Sustainability matters Many of the listed developers have short track records of core-earnings growth. We believe sustainability will be very important in the next cycle. We measure sustainability by the number of consecutive years with core-earnings growth following listing. COLI and CR Land stand out by this measure. Number of years with consecutive core earnings following listing No. of years Longfor Country Garden Agile China Vanke - B Evergrande Shimao Guangzhou R&F Poly Real Estate CR Land COLI 0123456789 Source: Bloomberg, compiled by Daiwa Our advice: look beyond the current cycle We believe the current government housing policies will facilitate a soft landing for the physical market over the near term. The risk of a long-term property-price correction remains, however, and depends on the government’s future monetary and foreign-currency policies. As such, we recommend investors look beyond the current cycle, in their bottom-up stock selection process. We believe scale, earnings efficiency, balance sheets, offshore listings, and sustainability will matter in the next property cycle. These measures should help investors find the industry winners over the long term. On this basis, we like COLI and CR Land among the stocks we cover. - 38 - Construction & real estate / China 28 June 2011 Part IX – are M&A activity and Housing China - a 10- part series privatisations on the horizon? • More credit tightening in China increases the likelihood of acquisitions • We see many potential candidates for privatisation • We recommend investors consider selected small- and mid-cap developers We expect more privatisations in led to significant valuation discounts the future due to the depressed for the small- and mid-cap valuations of many stocks developers. We believe the current Many small- and mid-cap valuation gaps are wide enough for developers are still trading at certain investors to consider Danny Bao, CFA significant discounts to their 2011E selected names. (852) 2773 8715 PBRs. In January 2011, the parent [email protected] company of Shanghai Forte Land Co We believe acquisition and (Shanghai Forte) (Not rated), Fosun privatisation values should also be International Ltd (Fosun) (Not M&A activity for listed considered when evaluating a developers is likely, but would rated), announced it would privatise developer’s standalone value. This be difficult to complete the company at a price of HK$3.48 a would, in our view, give investors an There has been limited M&A activity share, or about a 30% premium to additional edge in making a in China over the past few years, the 20 January closing price. The profitable investment in the China which has usually involved private transaction was completed in May Property sector. project-level companies. M&A 2011. This is the first privatisation transactions involving listed targets deal in the China Property space, 2011E PBR for selected developers have also been rare – the controlling paving the way for future deals, in Hopson our view. New World China shareholders of the listed China Zhong An property companies are usually SPG Land unwilling to lose control of their We believe the key criteria for Yuzhou potential privatisation deals are: Sino Ocean companies. However, potential Shui On financial and operational difficulties depressed underlying equity Shenzhen valuations, wealthy controlling Central China usually increase the possibility of Beijing Capital such M&A activity. shareholders, and long listing C C Land histories. From our list of developers, Powerlong Minmetals Land We believe China’s current credit- we have excluded companies with Yuexiu Property tightening environment will increase government backing or those having Poly HK Investment the industry’s capital intensity and a Hong Kong developer parent, due 0.0 0.2 0.4 0.6 0.8 to the low motivation of controlling competition. As such, the Source: Bloomberg possibilities of M&A activity will also shareholders vis-à-vis privatisations. increase, in our view. Financially- We believe the possible candidates distressed companies are more for future privatisation in China are likely to negotiate or accept Hopson (Not rated), Shui On Land acquisition offers. We believe the (Not rated), and CC Land (Not rated). overall risk of our listed universe Investors with a high risk tolerance being acquired remains low, given and longer investment horizons may the low previous success rates, and consider these names, in our view. the lack of motivation of most controlling shareholders. In our Our advice: time to consider view, investors should be more selected small- and mid-cap developers concerned with potential solvency We believe investors’ over-reliance risks than the upside risks relating on large-cap developers in China has to any potential acquisitions. Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011 Industry average net gearing (%) 80 70 60 More deals ahead? 50 40 30 In May 2011, Fosun completed the 20 privatisation of Shanghai Forte. In the 10 same month, the Kwok family also 0 2007 2008 2009 2010 announced its plan to privatise the Source: Compiled by Daiwa, based on data from Bloomberg Singapore-listed Allgreen Properties (Not rated). Should investors expect more Overall, the industry’s leverage is lower than that in deals in the future? 2007 and 2008. We believe the highly-leveraged developers are more vulnerable to potential liquidity pressures. Based on data from Bloomberg, Greentown More credit tightening in China (Not rated), Poly Real Estate (Not rated), Guangzhou R&F (2777 HK, HK$10.36, Buy [1]), and SPG Land raises the likelihood of (Not rated) have relatively higher leverage than their acquisitions peers. Guangzhou R&F’s recent debt issuance should improve its cash ratio and short-term liquidity needs. There has been limited M&A activity in China over the past few years, which has usually involved private These four developers had an average 2010 cash ratio project-level companies. M&A transactions involving of 0.18%, much lower than the sector average of 0.51%. listed targets have also been rare – the controlling The average EBITDA/gross interest multiple of 2.5x shareholders of the listed China property companies was also lower than the sector average of 5.26x. We are usually unwilling to lose control of their companies. believe the market sizes of Poly Real Estate and However, potential financial and operational Guangzhou R&F mean these two companies are difficulties usually increase the possibility of such unlikely to be potential M&A deal candidates. We activities. believe having a high level of financial leverage, a low cash and interest coverage ratio, and a depressed In January 2010, Shanghai Industrial Holdings equity valuation usually increase the risk of being Limited (SIHL) (Not rated) took a controlling stake of acquired by other developers. Shanghai Industrial Urban Development Limited (SIUD), formerly known as Neo-China Land Group In our view, the overall risk of our listed universe being (Not rated). SIHL has retained SIUD’s separate listing acquired remains quite low, given the low previous status. This deal is one of the very few M&A deals success rates, and unmotivated controlling within the China Property space over the past few years. shareholders. Investors should be more concerned with the potential solvency risks than the upside risks We believe China’s current credit-tightening measures relating to any potential acquisitions. will increase the industry’s capital intensity and competition. As such, the possibility of M&A activity will also increase, in our view. Financial position for selected developers Net gearing (%) Cash ratio (%) EBITDA/ Number Company Ticker 2010 2009 2008 2007 2010 2009 2008 2007 gross interest (x) 1 Greentown 3900 HK 149.7 124.2 170.7 93.6 0.14 0.20 0.07 0.21 0.7 2 Poly Real Estate 600048 CH 123.3 49.3 109.4 58.7 0.28 0.40 0.28 0.24 1.9 3 Guangzhou R&F 2777 HK 111.0 104.3 125.3 146.2 0.16 0.22 0.06 0.05 5.0 4 SPG Land 337 HK 96.3 77.9 62.4 34.9 0.12 0.37 0.14 0.44 2.3 Average 120.1 88.9 117.0 83.3 0.18 0.30 0.14 0.24 2.50 Source: Bloomberg, compiled by Daiwa - 40 - Housing China 6 July 2011 We believe the listed developers without financial and operational stress are unlikely to accept potential take- Large deep-value universe over offers from other listed developers, due to the increases the chance of perceived prestige in the market of having a listing status, and the pride of the controlling owners. privatisation Furthermore, potential downside risks relating to highly-geared developers outweigh the potential upside Many listed developers are trading currently at for acquisition premiums. As such, we do not see this significant discounts to their book values, based on 27 M&A theme as a profitable trade for active fund June 2011 closing share prices. This suggests to us that managers. the capital market has not factored in any going- concern values for these companies. If this situation Developers with reasonable leverage, but without a persists for an extended period of time, the controlling controlling shareholder are also vulnerable to being insider might choose to privatise the company to taken over, in our view. For example, Sino Ocean Land increase the value of the company’s underlying assets. (Not rated) had a 2010 year-end net gearing of about Shanghai Forte was a good example of this scenario. 45%. However, its implied 2011E PBR is about 0.5x, based on the Bloomberg consensus. The largest Shanghai Forte was trading at a 2010 PBR of 0.72x, shareholder of Sino Ocean Land is a financial investor, and was trading at that before the deal announcement China Life (2628 HK, HK$26.40, Buy [1]). The second- date. On 20 January 2011, Shanghai Forte’s parent largest shareholder is a strategic investor, Nan Fung company, Fosun, announced its plans to privatise the Group (Not listed), a private developer from Hong company at the price of HK$3.48 a share, or about a Kong. Sino Chem (Not listed) and other shareholders 30% premium to the closing share price on 20 January. own the rest of the company. We estimate that the capital required to take a 33.3%-controlling stake of Forte: PBR (x) Sino Ocean Land would be about US$1.21bn, assuming (x) a 30% controlling premium. We believe most of the 1.3 top-10 developers in China have the financial capacity 1.2 to carry out a take-over. 1.1 1.0 Sino Ocean Land: shareholder profile 0.9 0.8 0.7 China Life 0.6 24.1% 0.5 Jul-09 Jul-10 Apr-10 Apr-11 Oct-09 Oct-10 Jun-09 Jan-10 Jun-10 Jan-11 Feb-10 Mar-10 Feb-11 Mar-11 Aug-09 Sep-09 Nov-09 Dec-09 Aug-10 Sep-10 Nov-10 Dec-10 May-09 May-10 Nan Fung Group Source: Bloomberg 11.7% Other 61.2% The Forte deal is the first privatisation in the China Sino Chem property sector, and should pave the way for future 3.0% transactions. There are about 15 Hong Kong-listed developers trading at a 2011E PBR of less than 0.75x, Source: Bloomberg as at 27 June 2011, based on the Bloomberg-consensus forecasts. We believe it is unlikely that the government- The possibility of such a transaction depends largely on backed developers will be privatised, due to the low the willingness of current management, and China Life motivation of the parent companies. (the largest shareholder). If Sino Ocean Land’s share price continues to trade at such a low PBR, the risk of a Furthermore, we believe it is unlikely that the Hong take-over would remain, in our view. Kong property developers, such as New World Development (Not rated), will privatise their China subsidiaries. We believe the key criteria for potential privatisation deals are: depressed underlying equity valuations, wealthy controlling shareholder, and long listing history. - 41 - Housing China 6 July 2011 2011E PBRs of selected developers Our advice: investors should also consider small- and Hopson mid-cap listed developers, as we see plenty of value for New World China Zhong An these developers. Based on the market capitalisations SPG Land for 27 June, 20011 and the Bloomberg-consensus Yuzhou Sino Ocean forecasts, developers with market caps of less than Shui On US$2bn were trading at an average 2011E PER of 6.4x, Shenzhen Central China much lower than the sector average of 8x. The 2011E Beijing Capital PBR for these developers was about 0.76x, also lower C C Land Powerlong than the sector average of 1.0x. Minmetals Land Yuexiu Property Poly HK Investment We believe the current depressed valuations of the 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 developers in the small- and mid-cap space increase the chance of privatisation in the future. Investors Source: Bloomberg should consider selected names with attractive valuations, solid landbanks, and good fundamentals, as We see the possible China privatisation candidates as well as the potential upside of being privatised. Hopson, Shui On Land, and CC Land. Investors with high risk tolerance and longer investment horizons may consider these names, in our view. Small/mid-cap developers: comparison sheet 2012 Price vs. Price vs. 27 Jun Mkt 2011 yr.-end current forward share cap current forward NAV NAV PER (x) PBR (x) Company Ticker Rating Currency price (US$m) NAV NAV (%) (%) FY11E FY12E FY11E FY12E Renhe 1387 HK NR HK$ 1.47 4,025 n.a. n.a. n.a. n.a. 5.8 5.0 1.6 1.3 Shanghai Industrial 363 HK NR HK$ 27.95 3,876 n.a. n.a. n.a. n.a. 9.5 8.0 0.9 0.8 Sino Ocean 3377 HK NR HK$ 3.87 2,802 n.a. n.a. n.a. n.a. 7.1 5.8 0.5 0.5 *Glorious 845 HK 1 HK$ 2.39 2,392 6.8 7.0 (64.9) (65.9) 6.5 5.0 0.9 0.8 *Franshion 817 HK 1 HK$ 1.99 2,341 3.7 4.0 (46.2) (50.3) 11.9 10.5 1.0 0.9 Poly HK Investment 119 HK NR HK$ 4.98 2,308 n.a. n.a. n.a. n.a. 9.2 6.6 0.7 0.7 Shui On 272 HK NR HK$ 3.28 2,195 n.a. n.a. n.a. n.a. 11.5 9.2 0.5 0.5 New World China 917 HK NR HK$ 2.77 2,050 n.a. n.a. n.a. n.a. 13.9 10.4 0.4 0.4 KWG Property 1813 HK NR HK$ 5.29 1,965 n.a. n.a. n.a. n.a. 6.9 5.3 1.0 0.8 Yanlord YLLG SP NR S$ 1.23 1,929 n.a. n.a. n.a. n.a. 8.1 6.7 0.9 0.7 Mingfa 846 HK NR HK$ 2.40 1,868 n.a. n.a. n.a. n.a. 9.7 8.0 1.8 n.a. Kaisa 1638 HK NR HK$ 2.73 1,720 n.a. n.a. n.a. n.a. 7.6 5.8 1.0 0.9 *Yuexiu Property 123 HK 1 HK$ 1.44 1,717 5.0 5.6 (71.2) (74.3) 8.0 5.4 0.7 0.6 Beijing Star 588 HK NR HK$ 1.76 1,646 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Greentown 3900 HK NR HK$ 7.46 1,570 n.a. n.a. n.a. n.a. 4.6 3.0 0.9 0.7 Hopson 754 HK NR HK$ 6.61 1,488 n.a. n.a. n.a. n.a. 4.5 4.4 0.3 0.3 Powerlong 1238 HK NR HK$ 2.20 1,149 n.a. n.a. n.a. n.a. 4.8 3.7 0.6 0.6 Shenzhen Investment 604 HK NR HK$ 2.27 1,032 n.a. n.a. n.a. n.a. 7.9 6.7 0.5 0.5 C C Land 1224 HK NR HK$ 2.82 925 n.a. n.a. n.a. n.a. 14.9 7.8 0.6 0.6 Yuzhou 1628 HK NR HK$ 2.48 764 n.a. n.a. n.a. n.a. 4.8 3.0 0.5 n.a. Fantasia 1777 HK NR HK$ 1.20 751 n.a. n.a. n.a. n.a. 4.7 3.9 0.8 0.7 China SCE 1966 HK NR HK$ 2.01 736 n.a. n.a. n.a. n.a. 5.1 4.1 1.3 1.0 Beijing Capital Land 2868 HK NR HK$ 2.47 653 n.a. n.a. n.a. n.a. 3.8 3.4 0.6 0.5 Central China 832 HK NR HK$ 1.80 561 n.a. n.a. n.a. n.a. 3.9 3.2 0.6 0.7 Minmetals Land 230 HK NR HK$ 1.23 527 n.a. n.a. n.a. n.a. 6.6 3.4 0.6 0.5 Aoyuan 3883 HK NR HK$ 1.33 446 n.a. n.a. n.a. n.a. 7.9 5.3 n.a. n.a. Zhong An 672 HK NR HK$ 1.45 443 n.a. n.a. n.a. n.a. 4.5 n.a. 0.5 n.a. SPG Land 337 HK NR HK$ 2.87 387 n.a. n.a. n.a. n.a. 2.7 2.2 0.5 0.4 SRE Group 1207 HK NR HK$ 0.60 332 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Simple average (60.8) (63.5) 7.3 5.6 0.8 0.7 Mkt cap weighted average 7.6 5.9 0.8 0.6 Source: Bloomberg, Datastream, *Daiwa forecasts - 42 - Construction & real estate / China 6 July 2011 Part X - what are our top picks on Housing China - a 10- part series six-month/three-year horizons? • The sector outperformed the country index in 1H11 • Investors with a six-month investment horizon should focus on relative valuations • Five-factor model stocks and selected non-residential names for long-term investment valuations. We believe investors can For non-residential exposure, profit from this trend. investors should consider Franshion. We believe Franshion’s exposure to We believe the sector’s current high-quality office and hotel assets valuations already reflect the in the major cities of China offers Danny Bao, CFA market-share consolidation trend, diversification benefits for investors (852) 2773 8715 [email protected] with the top-10 developers trading in the China property space. at a 23.5% premium to the sector’s Another player with non-residential 2011E average PER, and 62.2% exposure is Renhe Commercial Merits of investing in China above its average 2011E PBR, as at 5 Holdings, which has first-mover property stocks – summary June 2011. We believe investors advantage in the underground This is the final part in our series of could see stronger returns by buying retail/wholesale mall development 10 reports on the theme of ‘Housing laggard stocks trading at lower space, and projects in major cities in China – the merits of investing in valuation multiples. China. China property stocks’. We discuss what we consider to be the 10 key Among the stocks we cover, R&F, MSCI China property YTD return Franshion, Glorious Property, and subjects for investors to make 115 Yuexiu offer the most upside 110 profitable investments or trades in the 105 100 China property space. In this section, potential to our six-month target 95 90 we identify our top stock picks on prices. In addition, Shimao, Sino 85 80 both six-month and three-year Ocean, and Poly HK Investment are investment horizons. trading currently at PERs of below Apr 30, 11 Apr Jan 31, 11 Jun 30, 11 Mar 31, 11 Mar Feb 28, 11 Dec 31, 10 Dec 9x on the 2011 Bloomberg- 31, 11 May consensus EPS forecasts. MSCI China June sector results drive 1H11 MSCI China / Real Estate Management & Development -IND outperformance The MSCI China Property Index Investors should consider our Source: MSCI finally outperformed the country five-factor model stocks and index by 2.2% for the month of June, certain non-residential names after tracking the MSCI China Index We believe current valuations are very closely for the first five months less important for investors with of the year. We believe attractive three-year horizons, whose objective valuations, strong contract sales for is to identify the long-term winners the leading developers, and limited in the residential and non- new policy updates contributed to residential segments. For residential this. We expect the sector’s property developers, we believe valuation to continue to improve in scale, earnings efficiency, balance 2H11, barring any significant new sheet, access to capital, and earnings sustainability are very important. government tightening measures. Based our Daiwa five-factor model, Relative valuation is key to our we have identified Vanke, Coli, CR six-month investment calls Land, and Longfor as the potential The recent rally in the share prices long-term industry winners. of the large-cap developers has led to a significant divergence in stock Important disclosures, including any required research certifications, are provided on the last two pages of this report. Housing China 6 July 2011 As at 30 June 2011, we estimate the sector NAV discount was about 35%, well below its average since September 2008 of 25%. The top developers that we cover are trading currently at about a 32% discount to our NAV estimate. Our top picks Sector NAV discount/premium 100% Investors with different investment 80% 60% horizons tend to favour different types of 40% property stocks. We set out our key stock 20% 0% ideas based on six-month and three-year (20%) investment horizons. (40%) (60%) (80%) Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Sector finally outperformed the Sep-07 Sep-08 Sep-09 Sep-10 May-07 May-08 May-09 May-10 May-11 country index in June China Historical average Source: Daiwa The MSCI China Property Index finally outperformed the country index by 2.2% for the month of June, after Looking forward, we expect the sector’s valuation to tracking the MSCI China Index very closely for the first continue to improve over the remainder of this year. five months of the year. We believe attractive We do not foresee a policy inflection point in the near valuations, strong contract sales for the leading future, as the government is still keen to keep the developers, and limited new policy updates contributed housing market in check. However, we believe the to this. policy risks have been factored into the sector’s current valuation. Investors should focus on bottom-up stock MSCI China Index year to-date performance selection to enhance their portfolio returns. 115 110 105 Relative valuation is the key to 100 our short-term picks 95 90 85 We believe contract sales will remain a very important 80 share-price catalyst this year. Companies with good contract sales this year are likely to see their earnings visibility improve in 2011 and 2012. We believe the top Apr 8, 11 Jun 3, 11 May 6, 11 Apr 22, 11 Jan 14, 11 Jan 28, 11 Jun 17, 11 Feb 11, 11 Feb 25, 11 Mar 11, 11 Mar 25, 11 Dec 31, 10 May 20, 11 listed developers will continue to gain market shares of MSCI China contract sales and GFA delivery. For the first five MSCI China / Real Estate Management & Development -IND months, eight of the top-10 developers recorded Source: MSCI positive GFA contract-sales growth; only Shimao and R&F saw contractions. In earlier parts of our Housing China series, we discussed the potential implications of the Top-10 developers: YoY changes in GFA sales (%) government’s public-housing initiatives. We believe GFA sales change YoY Jan Feb Mar Apr May YTD these new initiatives and credit tightening will result in *Vanke 216 160 65 7 72 93 *COLI 65 51 20 7 48 35 industry competition, as well as market-share EVERGRANDE 140 300 37 51 77 92 consolidation, intensifying, and expect this trend to *CR LAND 28 28 50 (24) 133 27 benefit certain leading listed developers. We attribute *R&F (29) (53) (45) (8) 60 (23) the large-cap listed developers’ recent share-price Agile 19 76 15 11 105 38 recovery mainly to the pick-up in the sector’s *Country Garden 86 6 (9) (22) 104 31 Poly Real Estate 22 3 52 0 32 23 performance. Shimao (10) 59 28 (36) 29 (2) *Longfor n.a. n.a. n.a. n.a. n.a. n.a. Source: Company data, compiled by Daiwa, *Daiwa coverage - 44 - Housing China 6 July 2011 Year-to-date share-price performances also reflect this Daiwa five-factor model weights trend, with the top-10 developers outperforming the sector and country indices. The best-performing Sustainability property stocks, such as Evergrande, Coli, Country 10.0% Scale Capital Access 25.0% Garden, Longfor, and Vanke B have recorded very 10.0% strong contract sales so far this year. Top-10 developers: YTD share-price performances Market cap Share performance (%) B/S Company Ticker Rating Currency (US$m) 1M 3M 6M 20.0% *Coli 688 HK 1 HK$ 17,519 2.6 5.4 16.0 Earnings *China Vanke - B 200002 CH 2 HK$ 14,426 (2.1) 2.7 9.2 Efficiency Poly Real Estate 600048 CH NR Rmb 10,113 17.0 (18.2) (13.5) 35.0% *CR Land 1109 HK 2 HK$ 9,749 0.7 (3.3) (0.8) Longfor 960 HK NR HK$ 7,923 (2.9) (8.8) 10.5 Source: Daiwa Evergrande 3333 HK NR HK$ 9,773 (7.5) 18.5 34.1 *Country Garden 2007 HK 2 HK$ 7,340 (0.6) 0.6 14.8 For the residential developers, we have considered Shimao 813 HK NR HK$ 4,379 (7.3) (12.9) (18.2) Agile 3383 HK NR HK$ 5,382 (9.9) (1.6) 5.4 scale (25% weight), earnings efficiency (35% weight), *Guangzhou R&F 2777 HK 1 HK$ 4,390 (2.0) (8.5) (4.7) balance-sheet strength (20% weight), capital access Top Ten Average (1.2) (2.6) 5.3 (10% weight), and earnings sustainability (10% weight). MSCI China (4.5) (3.5) (0.9) MSCI China property (2.3) (3.2) 1.4 For scale, we have awarded 10 points for Daiwa Source: Bloomberg Category A developers (more than 4m sq m delivered in 2010), while we have assigned five points for Daiwa We believe the sector’s current valuations already Category B developers (about 2m sq m delivered in reflect the market-share consolidation trend, with the 2010). top-10 developers trading at a 23.5% premium to the sector’s 2011E average PER, and 62.2% above its average 2011E PBR, as at 5 June 2011. We believe For earnings efficiency, we have award 10 points for developers with close to 1,500 EE scores, seven points investors could see stronger returns by buying laggard for developers with EE scores of close to 1,000, and five stocks trading at lower valuation multiples. points for developers with EE scores of around 800. Daiwa stock picks: six-month investment horizon Share Target For balance-sheet strength, we have awarded 7-10 Price price % points to companies whose net gearing is significantly Company Ticker Rating Currency (5-Jul-11) (HK$) Upside lower than the sector average, five points for those with Guangzhou R&F 2777 HK 1 HK$ 11.26 13.70 22 close-to-average net gearing, and three points for those Franshion 817 HK 1 HK$ 2.09 2.80 34 Glorious 845 HK 1 HK$ 2.52 3.50 39 with high leverage. Yuexiu Property 123 HK 1 HK$ 1.56 1.96 26 Source: Daiwa For capital access, we have assigned three points for onshore listed developers, five points for offshore listed Among the stocks we cover, R&F, Franshion, Glorious developers, and 10 points for large state-owned- Property, and Yuexiu offer the most upside potential to enterprise (SOE) developers. our six-month target prices. In addition, Shimao, Sino Ocean, and Poly HK Investment are trading currently Top-10 developers: weighted score at PERs of below 9x on the 2011 Bloomberg-consensus Earnings Capital Scale efficiency Balance sheet access Sustainability Total EPS forecasts. Vanke 2.5 3.50 2 0.30 - 8.3 COLI 2.5 3.50 2 1.00 1.00 10.0 EVERGRANDE 2.5 1.75 0.6 0.50 - 5.4 Company-specific factors behind CR LAND 2.5 3.50 1.4 1.00 1.00 9.4 R&F 1.25 3.50 0.6 0.50 - 5.9 our three-year picks Agile 1.25 3.50 1 0.50 - 6.3 Country Garden 1.25 1.75 1 0.50 - 4.5 We believe current valuations are less important for Poly Real Estate 2.5 2.45 0.6 0.30 0.50 6.4 Shimao 1.25 3.50 1 0.50 - 6.3 investors with three-year horizons, whose objective is Longfor 1.25 3.50 2 0.50 - 7.3 to identify the long-term winners in the residential and Source: Daiwa non-residential segments. - 45 - Housing China 6 July 2011 Based on the above five-factor model, we have identified four developers (Vanke, Coli, CR Land, and Longfor) with the highest weighted scores. We believe these developers are likely to be the winners in the residential segment three years from now. Investors with three-year horizons should consider these names. Among the non-residential property developers, we like Franshion. Franshion’s share price is down 15% in the first half of this year. We believe the company’s exposure to high-quality office and hotel assets in the major cities of China offer diversification benefits for investors in the China property space. Another player with non-residential exposure is Renhe Commercial Holdings, which has first-mover advantage in the underground retail/wholesale mall development space, and projects in major cities in China. Daiwa top picks: three-year investment horizon 5-Jul Mkt Target Share cap price Company Ticker Rating Currency price (US$m) (HK$) Coli 688 HK 1 HK$ 17.48 18,361 19 China Vanke - B 200002 CH 1 HK$ 10.82 15,351 11.7 CR Land 1109 HK 2 HK$ 15.14 10,485 15.1 Longfor 960 HK 3 HK$ 13.02 8,627 12.35 Franshion 817 HK 1 HK$ 2.09 2,461 2.8 Source: Daiwa - 46 - Housing China 6 July 2011 Share-price performances: as at 30 June 2011 Market cap *Share-price performance (%) Company Ticker Rating Currency (US$m) 1M 3M 6M 1Y 2Y 3Y 2011 YTD *Coli 688 HK 1 HK$ 17,519 2.6 5.4 16.0 13.6 (7.3) 35.4 16.0 *China Vanke - B 200002 CH 2 HK$ 14,426 (2.1) 2.7 9.2 28.0 (6.4) 5.3 9.2 Poly Real Estate 600048 CH NR Rmb 10,113 17.0 (18.2) (13.5) 7.4 (60.6) (18.5) (13.5) *CR Land 1109 HK 3 HK$ 9,749 0.7 (3.3) (0.8) (4.9) (18.0) 30.4 (0.8) Longfor 960 HK NR HK$ 7,923 (2.9) (8.8) 10.5 51.8 n.a. n.a. 10.5 Evergrande 3333 HK NR HK$ 9,773 (7.5) 18.5 34.1 125.3 n.a. n.a. 34.1 *Country Garden 2007 HK 2 HK$ 7,340 (0.6) 0.6 14.8 63.6 (5.3) (32.4) 14.8 Shimao 813 HK NR HK$ 4,379 (7.3) (12.9) (18.2) (21.7) (36.3) 7.3 (18.2) Agile 3383 HK NR HK$ 5,382 (9.9) (1.6) 5.4 49.1 8.3 77.4 5.4 *Guangzhou R&F 2777 HK 2 HK$ 4,390 (2.0) (8.5) (4.7) 6.1 (39.1) (27.1) (4.7) *SOHO 410 HK 3 HK$ 4,634 3.7 4.2 20.2 52.4 44.8 63.5 20.2 Shanghai Industrial 363 HK NR HK$ 3,969 0.9 (4.0) (14.9) (8.2) (8.3) 24.9 (14.9) Renhe 1387 HK NR HK$ 4,111 7.9 3.4 10.3 (8.0) (6.3) n.a. 10.3 Sino Ocean 3377 HK NR HK$ 2,884 (3.9) (17.8) (22.2) (30.2) (55.4) (10.0) (22.2) Poly HK Investment 119 HK NR HK$ 2,374 (6.7) (29.7) (32.6) (33.8) 4.5 43.4 (32.6) *Franshion 817 HK 2 HK$ 2,331 (16.1) (11.6) (15.4) (8.3) (25.3) (33.3) (15.4) Shui On 272 HK NR HK$ 2,284 (0.9) (4.7) (8.8) 0.6 (35.8) (47.5) (8.8) Yanlord YLLG SP NR S$ 1,904 (10.4) (20.5) (28.6) (30.6) (47.6) (35.1) (28.6) New World China 917 HK NR HK$ 2,059 (3.1) (5.1) (4.8) 14.4 (35.5) (31.2) (4.8) *Glorious 845 HK 1 HK$ 2,434 7.5 13.6 (9.0) 8.5 n.a. n.a. (9.0) KWG Property 1813 HK NR HK$ 1,926 (6.8) (17.6) (12.5) 6.6 (7.2) (7.5) (12.5) *Yuexiu Property 123 HK 1 HK$ 1,754 (9.8) (15.0) (29.3) (14.0) (14.5) 24.6 (29.3) Mingfa 846 HK NR HK$ 1,931 (3.1) 2.1 (0.4) 11.7 n.a. n.a. (0.4) Hopson 754 HK NR HK$ 1,574 (3.1) (20.7) (16.4) (27.9) (41.8) (20.3) (16.4) Kaisa 1638 HK NR HK$ 1,796 (3.7) 4.4 23.4 86.3 n.a. n.a. 23.4 Beijing Star 588 HK NR HK$ 1,672 1.1 (5.2) (13.7) (4.7) (29.7) (13.3) (13.7) Greentown 3900 HK NR HK$ 1,572 (7.9) (8.8) (13.3) (10.6) (34.8) 23.7 (13.3) Powerlong 1238 HK NR HK$ 1,166 (3.0) (11.5) (12.2) (4.3) n.a. n.a. (12.2) Shenzhen Investment 604 HK NR HK$ 1,060 (4.5) (10.0) (14.0) 3.1 (27.9) (17.1) (14.0) C C Land 1224 HK NR HK$ 959 (2.0) 10.2 11.5 11.5 (42.1) (39.8) 11.5 Fantasia 1777 HK NR HK$ 764 0.0 (5.4) (8.3) (6.9) n.a. n.a. (8.3) China SCE 1966 HK NR HK$ 733 (4.3) (2.0) (9.1) (10.7) n.a. n.a. (9.1) Yuzhou 1628 HK NR HK$ 768 1.2 6.0 2.9 (0.4) n.a. n.a. 2.9 Beijing Capital Land 2868 HK NR HK$ 683 2.0 (10.1) (0.8) 16.2 (23.2) 21.1 (0.8) Minmetals Land 230 HK NR HK$ 528 (8.2) (15.2) (23.6) (23.6) 6.0 (17.4) (23.6) Central China 832 HK NR HK$ 583 (6.0) (13.4) (19.0) 5.6 (27.0) (19.7) (19.0) SPG Land 337 HK NR HK$ 420 (0.3) (14.8) (18.2) (4.3) 3.3 (16.8) (18.2) Zhong An 672 HK NR HK$ 459 (8.0) (14.8) (20.6) (24.2) (51.9) (50.8) (20.6) Aoyuan 3883 HK NR HK$ 453 (2.2) (2.9) (8.8) 17.4 (27.8) (22.4) (8.8) SRE Group 1207 HK NR HK$ 337 (4.7) (14.1) (21.8) (20.8) (38.4) (27.4) (21.8) Top-10 (1.2) (2.6) 5.3 31.8 (20.6) 9.7 5.3 MSCI China (4.5) (3.5) (0.9) 9.9 19.8 6.4 (0.9) MSCI China Property Index (2.3) (3.2) 1.4 6.3 (19.2) 4.4 1.43 Source: Bloomberg, Daiwa - 47 - Daiwa’s Asia Pacific Research Directory Hong Kong Regional Research Head Nagahisa MIYABE (852) 2848 4971 [email protected] Regional Research Co-head Christopher LOBELLO (852) 2848 4916 [email protected] Head of Product Management John HETHERINGTON (852) 2773 8787 [email protected] Product Management Tathagata Guha ROY (852) 2773 8731 [email protected] Head of China Research; Chief Economist (Greater China) Mingchun SUN (852) 2773 8751 [email protected] Macro Economy (Hong Kong, China) Kevin LAI (852) 2848 4926 [email protected] Regional Chief Strategist; Strategy (Regional) Colin BRADBURY (852) 2848 4983 [email protected] Strategy (Regional) Mun Hon THAM (852) 2848 4426 [email protected] Head of Hong Kong Research; Regional Property Coordinator; Jonas KAN (852) 2848 4439 [email protected] Co-head of Hong Kong and China Property; Property Developers (Hong Kong) Automobiles and Components (China) Jeff CHUNG (852) 2773 8783 [email protected] Head of Greater China FIG; Banking (Hong Kong, China) Grace WU (852) 2532 4383 [email protected] Banking (Hong Kong, China) Queenie POON (852) 2532 4381 [email protected] Insurance Jennifer LAW (852) 2773 8745 [email protected] Capital Goods –Electronics Equipments and Machinery; IT/Electronics – Tech Hardware Joseph HO (852) 2848 4443 [email protected] (Hong Kong, China) Consumer, Pharmaceuticals and Healthcare (China) Hongxia ZHU (852) 2848 4460 [email protected] Consumer/Retail (Hong Kong, China) Peter CHU (852) 2848 4430 [email protected] Consumer/Retail (China) Nicolas WANG (852) 2848 4963 [email protected] Head of HK and China Gaming and Leisure; Hotels, Restaurants and Leisure – Casinos Gavin HO (852) 2532 4384 [email protected] and Gaming (Hong Kong); Capital Goods – Conglomerate (Hong Kong) Regional Head of IT/Electronics; IT/Electronics – Semiconductor and Solar Pranab Kumar SARMAH (852) 2848 4441 [email protected] (Regional, Taiwan, Singapore, Hong Kong and China) Co-head of Regional IT/Electronics; IT/Electronics – Semiconductor/IC Design (Regional) Eric CHEN (852) 2773 8702 [email protected] IT/Technology Hardware – PC Hardware (Taiwan) Calvin HUANG (852) 2773 8782 [email protected] IT/Electronics - Semiconductor/IC Design (Taiwan) Ashley CHUNG (852) 2848 4431 [email protected] Regional Head of Materials; Materials/Energy (Regional) Alexander LATZER (852) 2848 4463 [email protected] Materials (China) Felix LAM (852) 2532 4341 [email protected] Head of Hong Kong and China Property; Property Developers (Hong Kong, China) Danny BAO (852) 2773 8715 [email protected] Property (Hong Kong, China) Yannis KUO (852) 2773 8735 [email protected] Regional Head of Small/Medium Cap; Small/Medium Cap (Regional) Mark CHANG (852) 2773 8729 [email protected] Small/Medium Cap (Regional) John CHOI (852) 2773 8730 [email protected] Regional Head of Telecommunications; Telecommunications (Regional, Greater China); Marvin LO (852) 2848 4465 [email protected] Internet (China) Transportation – Aviation, Land and Transportation Infrastructure (Regional) Kelvin LAU (852) 2848 4467 [email protected] Transportation –Transportation Infrastructure; Capital Goods – Construction and Edwin LEE (852) 2532 4349 [email protected] Engineering (China) Regional Head of Clean Energy and Utilities; Utilities; Power Equipment; Dave DAI (852) 2848 4068 [email protected] Renewables (Hong Kong, China) Head of Custom Products Group; Custom Products Group Justin LAU (852) 2773 8741 [email protected] Custom Products Group Philip LO (852) 2773 8714 [email protected] Custom Products Group Jibo MA (852) 2848 4489 [email protected] Custom Products Group Kenji SERIZAWA (852) 2532 4159 [email protected] South Korea Head of Research; Strategy; Banking/Finance Chang H LEE (82) 2 787 9177 [email protected] Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel Sung Yop CHUNG (82) 2 787 9157 [email protected] Banking/Finance Anderson CHA (82) 2 787 9185 [email protected] Capital Goods (Construction and Machinery) Mike OH (82) 2 787 9179 [email protected] Consumer/Retail Sang Hee PARK (82) 2 787 9165 [email protected] IT/Electronics (Tech Hardware and Memory Chips) Jae H LEE (82) 2 787 9173 [email protected] IT Electronics (Tech Hardware) Steve OH (82) 2 787 9195 [email protected] Materials (Chemicals); Oil and Gas Daniel LEE (82) 2 787 9121 [email protected] Small/Medium Cap; Insurance Yumi KIM (82) 2 787 9838 [email protected] Telecommunications; Software (Internet/Online Games) Thomas Y KWON (82) 2 787 9181 [email protected] Custom Products Group Shannen PARK (82) 2 787 9184 [email protected] - 48 - Taiwan Head of Taiwan Research; Strategy Alex YANG (886) 2 2345 3660 [email protected] Consumer/Retail Yoshihiko KAWASHIMA (886) 2 8780 5987 [email protected] IT/Technology Hardware (Communications Equipment); Software; Small/Medium Caps Christine WANG (886) 2 8788 1531 [email protected] IT/Technology Hardware (Handsets and Components) Alex CHANG (886) 2 8788 1584 [email protected] IT/Technology Hardware (PC Hardware - Panels) Chris LIN (886) 2 8788 1614 [email protected] IT/Technology Hardware (PC Components) Jenny SHIH (886) 2 8780 1326 [email protected] Materials; Conglomerates Albert HSU (886) 2 8786 2212 [email protected] India Head of India Equities Strategy Jaideep GOSWAMI (91) 22 6622 1010 [email protected] Deputy Head of Research; Strategy; Banking/Finance Punit SRIVASTAVA (91) 22 6622 1013 [email protected] All Industries Fumio YOKOMICHI (91) 22 6622 1003 [email protected] Automobiles Ambrish MISHRA (91) 22 6622 1060 [email protected] Capital Goods; Utilities Jonas BHUTTA (91) 22 6622 1008 [email protected] Materials Vishal CHANDAK (91) 22 6622 1006 [email protected] Pharmaceuticals and Healthcare; Consumer Kartik A. MEHTA (91) 22 6622 1012 [email protected] Real Estate Amit AGARWAL (91) 22 6622 1063 [email protected] Singapore Chief Economist, Asia Ex-JP; Macro Economy (Regional) Prasenjit K BASU (65) 6321 3069 [email protected] Global Director of Quantitative Research; Quantitative Research Deep KAPUR (65) 6321 3079 [email protected] Quantitative Research Josh CHERIAN (65) 6499 6549 [email protected] Quantitative Research Suzanne HO (65) 6499 6545 [email protected] Regional Head of Banking/Finance; Banking; Property and REITs David LUM (65) 6329 2102 [email protected] Banking (ASEAN) Srikanth VADLAMANI (65) 6499 6570 [email protected] Consumer; Food and Beverage; Small/Medium Cap (ASEAN) Pyari MENON (65) 6499 6566 [email protected] Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore) Adrian LOH (65) 6499 6548 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India) Ramakrishna MARUVADA (65) 6499 6543 [email protected] Australia Resources/Mining/Petroleum David BRENNAN (61) 3 9916 1323 [email protected] - 49 - Daiwa’s Office Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. 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Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research. - 51 - United Kingdom This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority (“FSA”) and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. 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Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. 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"1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Capital Markets Co. Ltd.) If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc. When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Capital Markets Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.109 Memberships: Japan Securities Dealers Association, Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association - 52 -