Research Ideas
Country Garden (2007 HK) – Taking a cautious stance
• Contracted sales fell 2.2% in 2022
• Not ruling out dilution risks from potential equity fund raising
• Lower fair value to HKD6.15
2021 contracted sales fell 2.2% to RMB558b – Country Garden’s (Stock code: 2007 HK) attributable contracted sales jumped 76.1% YoY to RMB22.6b in Dec 2021. This was driven by an increase in GFA sold by 96.6% to 2.9m sqm, but partially offset by a 10.4% dip in ASP to RMB7,813 per sqm. However, for the full-year 2021, Country Garden’s attributable contracted sales reached RMB558.0b, which was a decline of 2.2% and fell short of our RMB616.3b forecast. The negative growth was attributed to both volume (GFA sold – 1.4%) and ASP (-0.9%).
Equity fund raising remains a possibility – Country Garden was able to repurchase/redeem some of its notes/bonds over the past month. This includes repurchasing USD14.1m of its 7.125% senior notes due 2022 on 30 Dec 2021, repurchasing a principal amount of USD26.3m of its 5.625% senior notes due 2026 on 15 Dec 2021 and redeeming HKD4.5b of its 4.5% secured guaranteed convertible bonds due 2023 on 6 Dec 2021. However, we believe there remains market concerns over the liquidity position of Country Garden. For example, media reports said that Country Garden was not able to garner sufficient investor interest for a potential USD300m convertible bond, though the company has come out to refute the report. We believe overall credit conditions remain tight within China’s property sector. As such, we do not rule out the possibility of an equity fund raising exercise by Country Garden.
Cut fair value on lower earnings forecasts and P/E target multiple – We cut our FY21F and FY22F core PATMI forecasts by 17.8% and 19.0%, respectively, to take into account a weaker contracted sales and margins outlook. We also assume a lower dividend payout ratio of 25% (previously 30%). Given our concerns over Chinese developers which have larger lower-tier city exposure and continued weak investor sentiment on non-SOE developers, we lower our target price-to-earnings (P/E) ratio peg from 4.1x to 3.6x, which represents one standard deviation below Country Garden’s 10-year average and subsequently applying an ESG valuation discount. Consequently, our fair value estimate dips from HKD8.72 to HKD6.15.
ESG Updates
Country Garden’s ESG rating was upgraded in May 2021. This upgrade was driven by methodology enhancements to Corporate Behaviour theme which resulted in greater emphasis on business ethics practices and exposure to risks of corruption, of which Country Garden’s approach to address these risks appear to be on par with industry average practices. Furthermore, 35% of Country Garden’s portfolio are green certified, and this was higher than the industry average of 23%. However, Country Garden lags its peers in board and ownership structures, with its board lacking an independent majority. It also lags peers in adopting safety measures for its contractors and employees and its quality control system can be further improved. HOLD. (Research Team)
China Strategy – Common prosperity lends support to domestic consumption
The policymakers place “Common Prosperity” as a key policy motivation for the shifts in regulation and governance framework, which we believe would guide economic growth and investment themes. In this note, we will address domestic consumption which would be a key beneficiary in light of the government’s policy priority to raise the income of low-income group and to groom a sizeable middle-income class. This would provide support for both consumer staples, such as household durables, food products, and apparel, and overall consumption demand over the medium term in light of a more efficient wealth and income distribution, especially in autos, consumer durables, and services. It should be structurally positive for sustainable consumption upgrade, especially making the premiumization of fast-moving consumer goods categories accessible to massive consumers at low-tier cities.
We have identified four key trends will drive Chinese consumption this year and they are i) regulatory headwinds and tailwinds, ii) cost inflation and pricing power, iii) adjusting to Covid-zero policy, and iv) demand recovery towards 2H22. We believe the consumer sector will be in a tug of war between the current soft fundamentals and the expectation of recovery towards 2H this year. We expect softness in fundamentals will persist in the near-term and the upcoming announcement results season is likely to see further consensus earnings downgrade. Despite that fundamentals are in or below the mid-cycle for many consumer stocks currently, most leading consumer companies are trading around or above the midcycle level.
We will focus on companies that are relatively better in managing cost and margin. Towards 2H22, we expect demand recovery to pan out, thanks to potential policy easing impact to filter through and a more favourable base effect. We prefer companies that i) can deliver earnings growth despite softness in macro environment, and ii) would be core holdings with long-term structural outlook. We like dairy, home appliance, sportswear and selected auto and food players. Our preferred picks are Geely, Great Wall Motor, Haier Smart, Li Ning, Mengniu, Midea, Minth & Tingyi. We have a cautious stance on education and Macau gaming given ongoing sector uncertainties and advise clients to switch out in view of a prolonged period of overhang expected. (Research Team)