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Whose NAV Is at Most Risk? Stress Test Chinese Developers (II)

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Whose NAV Is at Most Risk? Stress Test Chinese Developers (II) Real Estate/Property Industry Overview Equity | China | Real Estate/Property 20 April 2010 Whose NAV is at most risk? Stress test Chinese Developers (II) Christie Ju, CFA >> +852 2536 3987 Research Analyst Merrill Lynch (Hong Kong) Tough policy headwinds—who will be the winner? [email protected] Chinese property developers have been under severe selling pressure, with more Jason Ching, CFA >> +852 2536 3953 drastic tightening measures introduced by Chinese government. After analyzing Research Analyst Merrill Lynch (Hong Kong) developers’ cash flow and debt servicing abilities, we conducted more stress tests [email protected] to examine their landbank exposure, LAT liability and NAV sensitivity. Our Matthew Chow, CFA >> +852 2161 7877 analysis suggests CR Land and Evergrande are better positioned, while R&F, Research Analyst Hopson and Country Garden are at more potential risk. Merrill Lynch (Hong Kong) [email protected] New tightening policies to curb property speculation Rong Li >> 852 2536 3417 China’s State Council released additional tightening policies over the weekend. Research Analyst Merrill Lynch (Hong Kong) For cities with highest ASP increases, banks can reject mortgage application for [email protected] rd 3 home purchase, and are restricted to grant mortgage to non-local residents without 1-year local tax proof. Tax authorities are urged to strictly enforce audit and investigate high priced property projects. Links to recent reports Key takeaways from our China Property conference call We hosted conference call with Mr. Chen Sheng, Deputy Director of China Index Stress test Chinese developers (April 16) Academy—one of the largest property research institutions in China. He expects structural changes in the residential property sector, and predicts 2010 China Property Conference call replay transaction volume to decline by 4.4-6.5%, and ASP to increase by 3.3-6%. China Property 4x4 (April 4) Stress test Chinese developers: landbank, LAT and NAV After stress testing developers” cash flow and debt servicing abilities, we carried 78 SOE to exit property market (March 19) out more stress tests on landbank exposure in high ASP growth cities, LAT liability and NAV sensitivity. We examined the potential impact to cash flow if LAT is fully collected. Under worst case scenario (20% decline in ASP and volume), our analysis shows Hopson, Evergrande and R&F trade at steepest discount. Figure 1: NAV discount Current Worst case* Worst case NAV Company Price NAV NAV premium/discount COLI 14.92 17.70 12.88 16% Country Garden 2.48 3.70 2.56 -3% Sino-Ocean 6.19 9.40 7.64 -19% Agile 8.87 16.80 12.56 -29% CR Land 14.42 24.40 20.84 -31% Yanlord 1.75 3.00 2.61 -33% R&F 10.98 22.50 18.96 -42% Evergrande 3.08 7.50 5.85 -47% Hopson 11.42 32.00 22.64 -50% Average -26% Source: Priced as of April 19 2010. Source: BofA Merrill Lynch Global Research. *factor-in 20% ASP & volume decline. >> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the FINRA rules. Refer to "Other Important Disclosures" for information on certain Merrill Lynch entities that take responsibility for this report in particular jurisdictions. Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 15 to 17. Analyst Certification on Page 14. Price Objective Basis/Risk on page 11. Link to Definitions on page 14.10929083 RM Real Estate/Property 20 April 2010 New tightening policies over the weekend China’s State Council released additional tightening measures last Saturday, after it introduced stringent down-payment requirements on April 15: For cities with highest ASP increases, banks can reject mortgage application relating to the purchase of third homes; Banks are restricted to grant mortgages to non-local residents (those without 1-year local tax proof or social security payment). Local government can temporarily limit the maximum number of flats that buyers can buy; Tax authorities will strictly enforce audit and investigate on highly-priced property projects in accordance with the relevant tax rules for tax collection; Increase supply of small-mid sized units and subsidized housing for cities which ASP saw strongest increases; Developers are restricted from misusing shareholder financing to bid for land or develop projects. SOEs whose core businesses do not include property development are strictly forbidden to participate in future property projects. More tightening for cities with high ASP increase Figure 2: Major cities with high ASP increase In 1Q10, average property prices in the top 70 large and medium-sized cities City ASP growth y/y recorded strong y/y growth of 11.7%-- the sharpest increase in recent years. Haikou 64.8% Hainan saw the highest ASP increases, with Haikou +64.8% y/y growth and Sanya 57.5% Sanya +57.5%. Guangzhou, Beijing and Shenzhen followed at 20.3%, 19%, and Guangzhou 20.3% 15.7%, respectively. Shanghai was up at a relatively moderate 11.2% y/y. Beijing 19.0% Shenzhen 15.7% Hangzhou 14.8% As State Council urged local governments to take responsibility to ensure healthy Tianjin 13.9% property markets, we believe cities with the strongest surge in ASP and high Nanjing 13.5% participation of investors/speculations are likely to see further policy headwinds. Chongqing 12.5% We believe Chinese developers with high landbank exposure these high ASP Shanghai 11.2% growth cities at risk. In our coverage universe, R&F (75%), Yanlord (61%) and Source: National Bureau of Statistics Hopson (60%) are more at risk, while Country Garden (11%), Shimao (14%) and Evergrande (15%) are less exposed. Figure 3: Landbank exposure Source: company, BofA Merrill Lynch Global Research estimate 2 RM Real Estate/Property 20 April 2010 Strict enforcement of tax to curb high prices As expected, the key focus of this round of government tightening measures is to curb high property prices. The State Council highlighted high price property projects as the targets, and urges tax authorities to strictly enforce audit and investigation, in accordance with the relevant tax rules for tax collection. Figure 4: 2009 pre-sale ASP In our view, these tax measurements may include the following: Company ASP(Rmb/sqm) Yanlord 21,300 Property tax – While there have been talks on the pilot testing property tax Hopson 13,000 in Chongqing and Shanghai, implementation is a complicated issue, as it CR Land 11,700 affects many parties and requires legislation. That said, we believe a simple R&F 10,400 version (such as property ownership tax which utilizes existing law) can be Sino Ocean 9,900 Longfor 9,700 introduced and implemented within a short period of time, if needed; Shimao 9,000 COLI 8,800 Full collection of LAT – State Administration of Taxation has reiterated the Agile 8,100 full collection of LAT before, but it has not been fully implemented due to the Evergrande 5,400 complexity of execution. While full implementation remains a challenge, we Country Garden 4,900 believe the strict enforcement of cumulative LAT or 2010 LAT could add Source: Company negatively impact developers’ cash flow. Based on our analysis, R&F, Agile, and Hopson are more at risk. Figure 5: Summary of LAT liability Company Cumulative LAT % of end-10 cash FY10E LAT % of end-10 cash R&F 2.2 73% 2.3 76% Agile 3.6 42% 1.6 19% Hopson 3.1 27% 1.4 13% COLI* 5.5 18% 2.9 10% Yanlord* 2.0 18% 1.2 11% Sino-Ocean* 1.0 12% 1.0 12% Country Garden 1.3 9% 2.1 15% CR Land* 1.3 7% 1.9 10% Evergrande 0.8 3% 3.8 14% Source: BofA Merrill Lynch Global Research Impact on speculation/investment demand - From our channel checks, as >50% of buyers require mortgage financing; the latest measures should be effective in containing speculative or investment demand, in our view; The development of social housing long term positive We believe government policy to support development of social/economic housing is long term positive for the residential property market: To help social stability over long-term – We believe an increase in subsidized housing supply will help social stability by solving the housing needs for those who cannot afford in the commodity housing market. Better social welfare system should help to create harmony in the society. As these markets are differentiated, it enables the commodity market to be more market driven; Limited impact from social/economic housing – As buyers’ profile between commodity housing and subsidized housing is different, we see limited impact to the commodity housing market over the longer-term. 3 RM Real Estate/Property 20 April 2010 Conference call key takeaways We hosted a conference with Mr. Chen Sheng, the Deputy Director of China Conference call replay dial-in info: Index Academy (one of the largest Chinese property research organizations) to China Property: The Start of Real Tightening discuss the latest policy changes and their implications to China Property market. Key takeaways are below. Background of the latest policy changes and their implications In Jan-Mar 2010, residential price across all cities saw strong increases, despite most with declining sales volumes. We believe the situation where ASP is rising but sales volume declining is due to low inventory, which is typically at less than 6-month supply in most cities.
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