Sep11 Oct11 Nov11 Dec11 Jan12 Feb12 Mar12 Apr12 May12 Jun12 Jul12 Aug12 September 27, 212 Yuexiu Property [123.HK] INITIATE COVERAGE: VALUE TO UNLOCK We initiate coverage of Yuexiu Property with a BUY recommendation at a target price (TP) of HK$2.78, a 3% discount to our RNAV estimate. This represents a potential return of about 46% and a dividend yield of 7%. The Guangzhou developer is primarily owned by Guangzhou Municipal Government, while it is also the sponsor of the Hong Kong- listed REIT - Yuexiu REIT (45.HK). Investment highlights: The twin engines of residential and commercial property have diversified risk from housing policy. Ownership of the REIT vehicle allows Yuexiu Property to unlock the capital value of its investment properties, while at the same time maintain the rental annuity and potential capital gain exposure. Key focus of asset turnover improvement to raise asset turnover by 4.7ppt in 3 years to 22% in 214E and maintain high core profit growth at 3- year CAGR of over 2% in 212-14E, based on our estimation. In addition, Yuexiu Property will continue to dispose of its non-core investment property and focus on its core development business at existing locations. Earnings and valuations: We estimate Yuexiu Property to grow at a 3-year CAGR of 22.2% in 212-14E based on our estimate of 26% growth in contracted sales, 14% growth in recognized revenue and gross profit margin of 42-57% for the forecast period. We estimate Yuexiu Property s RNAV at HK$4./ share by using discounted cash flow methodology with a WACC of 7.9%. Near-term catalyst and risk: Near-term catalyst will be stronger contracted sales than 212 target of RMB1bn. Yuexiu Property has a high concentration risk given 5% of its land bank is in Guangzhou. BUY Close: HK$1.9 (Sep 25, 212) TP: HK$2.78 (+46%) Price Performance (HK$) 2.5 2. 1.5 1..5. Market Cap (US$m) 2,264 Shares Outstanding (m) 9,293 Auditor Real Estate Sector PWC Free Float (%) 5.1 52W range (HK$).94-1.99 3M average daily T/O (US$m) 4. Major shareholder Source: Bloomberg Turnover (RHS) Price (LHS) (HK$ million) 4 35 3 25 2 15 1 5 Yuexiu Enterprise (49.9%) RMB m 21 211 212E 213E 214E Total revenue 6,13 9,676 1,748 12,731 14,318 Core profit 735 1,618 2,949 2,96 2,936 Core profit margin 12. 16.7 27.4 22.8 2.5 EPS (RMB).1.17.32.31.32 BVPS (RMB) 1.71 2.19 2.4 2.62 2.84 P/E (x) 18. 5.2 5. 5.1 5. P/B (x) 1..4.7.6.6 Dividend yield (%) n/a 4.4 7. 7. 7. Janus Chan, CFA (852) 3698-632 januschan@chinastock.com.hk John Mulcahy (852) 3698-6889 johnmul@chinastock.com.hk 1 Source: Company, CGIHK estimates
I. TWIN ENGINES OF GROWTH Land bank comprises 7% residential and 3% commercial Yuexiu Property has a total land bank of 12m m 2 (including presold but undelivered area) for development as at 2th September 212, up from 11.5m m 2 as at 3 th June 212 after three new land plots were acquired in 2H12. Most of the area (about 7%) is for residential use while the rest is for commercial purposes. This combination of land reserves benefits Yuexiu Property in: gaining from both market segments during bull market; and diversifying sources of income when one market underperforms the other. Figure 1: Distribution of Yuexiu s land bank as at 3 th June 212 Source: Company Product diversification allows Yuexiu Property to maintain sales momentum and profitability amid housing market tightening Recent developments in the residential market show the importance of commercial property development. Yuexiu Property focuses on the mid-to-high end residential market and most of its residential projects are subject to home purchase restrictions (HPR). Therefore, despite the higher cost in commercial property development in terms of higher land cost, higher construction cost and the longer construction period, this combination of land reserve diversifies Yuexiu Property from the housing policy risk in the residential segment. Resilient interim results and year-to-date contracted sales confirmed the importance of product diversification. In the 1H12 result commercial properties accounted for 4% of revenue and residential property sales accounted for 6%. Due to the higher margin of commercial properties and the recognition of high-end residential projects, gross profit margin (GPM) increased from 41.8% in 211 to 57% in 1H12. In addition, Yuexiu Property achieved total contracted sales growth of 178% year-on- 2
Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-11 Dec-11 Mar-12 Jun-12 year (YoY) to RMB9.6bn. The strong sales growth was also a result of sales combination between commercial (~4%) and residential property. Price reaction to housing measures in Guangzhou has been less drasticd than other Tier-1 cities due to lower housing prices VIEW ON GUANGZHOU PROPERTY MARKET Little chance of additional housing measures in Guangzhou. Guangzhou s housing market in ten major districts has been restricted by the Home Purchase Restriction (HPR) since 21. The same has also been applied across more than 3 Chinese cities, including three other Tier-1 cities. Despite a fall in gross floor area (GFA) transacted in all four Tier-1 cities, ASP has been holding up relatively well (see figure 2) till early this year. However, Guangzhou s new home price index has only recorded a fall since March-12 versus other three which started recording price declines in January or February 212. This could be due to fact that the average ASP (RMB15,16/m 2 ) in Guangzhou was 33-41% lower than the other three cities in the first eight months of this year. Figure 2: Transaction volume growth (bar) vs change price index (line) for tier-1 cities 12 Guangzhou 6 12 Beijing 3. 3 Shanghai 3 1 Shenzhen 5 1 5 1 2.5 2 2 8 4 8 4 8 2. 1 1 6 3 6 3 6 1.5 4 2 4 2 4 1. -1-1 2 1 2-2 -4-6 1-1 -2-3 2-2 -4-6.5. -.5-1. -1.5-2 -3-4 -5-6 -2-3 -4-5 -6-2 -4-6 -8-1 -2-3 -4 Area ASP Area ASP Area ASP Area ASP Source: Wind, CGIHK Research (Left axis vol YoY growth, Right axis ASP YoY change) Figure 3: Year-to-date ASP of Beijing, SH, GZ and Shenzhen Source: Wind, CGIHK Research 3
We are positive to Guangzhou s residential market in long term due to supply shortage Outlook bullish near term. The better than expected Guangzhou residential market is likely to be extended into Golden September, Silver October. The longer Golden Week holiday in October, which lasts for eight days and covers two Sundays as the Mid-Autumn Festival falls right before the National Day versus seven days and one Sunday in 211, is likely to have a positive impact on transactions (transactions on weekends were 6.3% higher than weekdays for the period of 1-Jul to 13-Sep this year in Guangzhou). On the supply side, developers will also have more new launches during this period. In the mid-to-long term, we expect residential supply to fall behind demand even though the latter should remain robust on the relatively easy monetary stance. This is mainly because of the continuous shortage of supply in Guangzhou. Figure 4 shows that total floor space of residential buildings sold is on average 13.8m m 2 per annum for 28-11 (including primary and secondary home markets). However, annual planned GFA for land transacted has only been 2.8m m 2 per annum. The low land transactions year-to-aug resulted in potential supply of only 1.4m m 2. Figure 4: Guangzhou s residential housing transaction and supply Source: Wind, CGIHK Research Guangzhou s office sector to slow down in near term due to poor economic sentiment Office sector: some deceleration before light shines again: Guangzhou s Grade-A office market has been held up relatively well year-to-date despite abundant supply in Zhujiang New Town. Office projects in ZJNT we visited recently have shown relatively strong sell-through rate (e.g. Yuexiu Property s Fortune Century Square, launched in September last year, recorded a sell-through rate of 9% for its office block) while GZIFC occupancy has ramped up quickly from only c.5% to close to 7% by mid- September. However, the sudden change in local sentiment may affect near-term demand growth for prime office space together with the continuous release of new supply this year. We expect average rental rate (ARR) of Guangzhou s Grade-A office space to increase by an average of 5-1% p.a. in 212E after a 17.7% YoY increase in 211. However, as investors are still restricted from buying residential properties, the sales market is likely to recover faster than the leasing market. 4
II. A PLATFORM FOR UNLOCKING CAPITAL VALUE Only Chinese developer with a REIT Ownership of Yuexiu REIT allows Yuexiu Property to unlock capital value of investment property and concentrate its workforce on property development Yuexiu Property is the only Hong Kong-listed Chinese developer that owns a listed REIT platform in Hong Kong - Yuexiu REIT. Yuexiu REIT has five investment properties (IPs) in Guangzhou and its portfolio will be expanded into six after the acquisition of Guangzhou International Finance Center (GZIFC) is completed later this year. All these IPs were from its sponsor Yuexiu Property. We believe the major benefit to Yuexiu Property from owning Yuexiu REIT are: Unlock capital value but enjoy rental annuity and capital gain: Property investment is more capital intensive than property development in the sense of capital size and the time needed to recover the investment. However, the potential return, including rental and capital gain, could be significant if the project is held provided it is a good asset with significant demand. Developers have to balance their investment portfolio and their development portfolio given the limited capital available. The REIT platform will give Yuexiu Property more flexibility in terms of property investment. On the one hand, Yuexiu Property could sell its investment property to Yuexiu REIT to unlock its unrealized gain from balance sheet to actual cash flow. On the other hand, by holding the REIT platform, Yuexiu Property will continue to receive annual rental income from the sold assets on its stake given that REIT has to distribute at least 9% of its distributable earnings to unit holders. In addition, any potential change in capital value will also be partly reflected in Yuexiu Property s balance sheet. Separation of duties: The Yuexiu Group has set out a clear strategic position for Yuexiu Property and Yuexiu REIT with the former to focus on property development and the latter to be the commercial property management arm of Yuexiu Property. With Yuexiu REIT s expertise in property management, we believe Yuexiu Property could benefit from i) concentrating its manpower in property development; and ii) potentially better rental return based on Yuexiu REIT s track record (please see figure 5/6) managing the Metropolis following its acquisition since 28. Figure 5 : Yuexiu REIT portfolio capital value and rental Figure 6: change in Metropolis s rental income and capital value (acquired in May-8) Source: Yuexiu REIT 5
III. ASSET TURNOVER AND CORE BUSINESS FOCUS Yuexiu Property enters second phase of long-term development plan Prudent track record in delivering. Since the new management joined in 28, Yuexiu Property has set out a long-term plan, which is broken down into three phases (please see figure 7). The company has just completed the first phase for 28-211, which included adjustment in asset structure, acceleration in investment and geographical expansion outside Guangzhou. As a result, ROE has improved by 4 percentage points (ppts) in 211 from 28, ROA by 1.6ppts, gross profit margin (GPM) by 1.2ppts and operating margin by 13.8ppts for the same period. Figure 7: Yuexiu Property s long term development plan from 28-15 Source: Company 6
Figure 8 : Change of margins and return indicators (28-211) 45 4 35 3 25 2 15 1 5 28 29 21 211 1 9 8 7 6 5 4 3 2 1 28 29 21 211 Gross margin (%) Operating margin (%) ROE (%) ROA (%) Source: Company Yuexiu Property targets RMB2bn contracted sales by 215, up from RMB1bn in 212. Emergence of new phase to continue the rapid growth. Yuexiu Property has stepped into phase two of its long-term development plan this year. Phase two emphasizes rapid growth through raising asset turnover. The company aims to achieve contracted sales of over RMB2bn by 215, which is equivalent to a 3-year CAGR of 26%. This compared with RMB9bn contracted sales in 211. We believe this is achievable given: The company s track record in delivering results in phase one. This is also reflected in its achievement of its contracted sales target, with completion rate ranging between 11-139% in 29-11; Large land bank of 12m m 2, enough for 6-7 years of development. This is estimated based on its long-term growth plan; Yuexiu Property has shortened its completion cycle from about 5 years to about 3 years from acquisition to completion of projects; The new start will be maintained at about 2m m 2 (1.8m m 2 in 212); and Capacity to raise capital following the sale of GZIFC as net gearing will fall to less than 4%. Yuexiu believes a net gearing ratio at 8-9% to be reasonable. Based on the above we expect Yuexiu s asset turnover to increase to 22% in 214E from 17% in 211; while core earnings to maintain at over 2% 3-year CAGR RMB2.9bn by 214E. 7
IV. EARNINGS GROWTH AND VALUATIONS Core profit growth will be driven by increasing contracted sales and maintenance of high gross profit margin Balance sheet to improve after sale of GZIFC RNAV estimated at HK$4. based on discounted cash flow with a WACC of 7.9% We estimate Yuexiu Property to grow its core profit at a 3-year CAGR of 22% for 212-14E. This is based on: Contracted sales growth at 3-year CAGR of c.26% to RMB18bn by 214E. This is in line with the company s three-year plan to achieve contracted sales of RMB2bn by 215. The current land bank of 12m m 2, which is available for the company s 6-7 years of development, is sufficient to achieve the target. On the demand side, the brand Yuexiu is highly recognized in Guangzhou, enabling the company to demand higher selling prices most of the time. Recognized revenue growth at 3-year CAGR of 14%. This is broadly in line with the contracted sales growth. As most of Yuexiu s land bank is located in the southern part of China, the company should experience minimal construction disruption in winter. Yuexiu Property will keep construction start at around 2m m 2 every year. Our estimation of gross profit margin of 42-57% in 212-14E, higher than company s target of over 3%. One of the criteria in land acquisition by Yuexiu Property is gross profit margin (GPM) to be over 3%. While 212E is a blip for Yuexiu Property (we estimate 212E GPM at 57% due to higher margin from commercial property which account for about 4% of total revenue), we believe Yuexiu Property will be able to keep the GPM at or above 4% for 213-14E. This is due to the company s ability to secure land at relatively low cost in most of its projects. Balance sheet will remain healthy. Yuexiu Property s net gearing ratio (net debt: total equity) will be improved significantly from over 8% to less than 4% after the sale of GZIFC, according to the company. This will give more room for the company to gear up its balance sheet again for the development business. This is based on the company s new land acquisition of four land parcels with total consideration of RMB1.3bn up to 2 th September this year, and the relative high construction expenditure of RMB6bn per year during the forecast period. Therefore, we expect the net gearing ratio to stay around 5-65%. Valuation. We estimate Yuexiu Property s RNAV of HK$4./share based on the expected selling price and a change of 2-8% per annum for the next 8 years. We also take into account the projected construction cost, land appreciation tax (LAT) and corporate tax, followed by discounting with a WACC of 7.9%. We set our target price (TP) at HK$2.78 based on the 3% discount to our RNAV estimate. This is in line with current market valuation on other state-owned enterprise (SOE) at 17-25% discount of consensus RNAV. With dividend yield of 7%, we expect a total return of 53% for first year, and we recommend BUY. 8
Key Company Metrics Figure 9: Revenue, rentable area and ARR Figure 1: Revenue by products 2, 18, 16, 14, 12, 1, 8, 6, 4, 2, Revenue (RMB'm) Volume (m 2 ) x1 ASP (RMB/sq. m) 1% 8% 6% 4% 2% % 21 211 212E 213E 214E 21 211 212E 213E 214E Residential Office Retail Figure 11: Contracted sales Figure 12: Profit margin 2, 18, 16, 14, 12, 1, 8, 6, 4, 2, Contracted sales (RMB'm) GFA sold (m 2 ) x 1 ASP (RMB/sq. m) 21 211 212E 213E 214E 7 6 5 4 3 2 1 % 21 211 212E 213E 214E Gross margin Core profit margin Figure 13: Cost structure 1% 8% 6% 4% 2% % 21 211 212E 213E 214E Cost of properties Other direct costs SG&A Finance expenses Income tax expense Figure 14: Net gearing 9 85 8 75 7 65 6 55 5 % 21 211 212E 213E 214E Net gearing Source: Company, CGIHK Research 9
Key Financials 1
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