China's property sector has reached a "tipping point" and is about to turn "unfavourable," according to a new report from the Asia-focused brokerage CLSA.
Watch out for those Chinese property stocks, in other words. They've been investor darlings in the past -- but their bull run may be coming to an end, as sales slow and cash proves ever harder to come by.
Investors will have noted the skyrocketing price of shares in the China Evergrande Group (EGRNY) , China's biggest property developer by sales last year. The stock price of the notoriously heavily indebted developer has more than quintupled this year, up 540% through Tuesday's trade.
That's certainly looking like rarified air. Investors have been cheered by Evergrande's decision to list shares in the mainland, where shares trade at higher multiples than they do in Hong Kong, site of Evergrande's primary listing. It has just raised 60 billion yuan ($9.1 billion) from six cornerstone investors, led by the appliance maker Suning SH:002024 and a company owned by the government of Shandong Province.
Taking on stakes in Chinese developers now, though, looks extremely risky.
CLSA has slashed its recommendation on Country Garden Holdings (CTRYY) , which produces mass-market homes on a massive scale.
The brokerage has also downgraded China Vanke HK:2022, which was top dog in China until Evergrande surpassed its sales last year, as well as China Resources Land (CRBJY) .
Why? Property prices turned south a while back in China's Big Four cities (normally called Tier 1): Beijing, Shanghai, Guangzhou and Shenzhen.
Secondary sales are now down for two straight months in Beijing, the worst run since 2014. The drops have hit for three months straight in Shenzhen, and four months in a row in Shanghai.
The declines seem to have stopped in Guangzhou. But the other three cities continue to correct in "second-hand" home sales. Those are a more accurate depiction of what's going on with underlying demand, since the government tinkers non-stop with loan rules for new homes and what kind of development permissions it grants.
Besides Beijing, Shanghai and Shenzhen, a raft of Tier 2 cities (typically provincial capitals) are also seeing secondary prices slide: Haikou, the capital city of the "Chinese Hawaii" of Hainan Island; sprawling Jinan, which is the capital of Shandong Province; Alibaba (BABA) 's home, Tianjin, which is gradually being swallowed by Beijing; the coastal city of Xiamen, where prices were on a runaway tear; Yichang near the Three Gorges Dam; and Zhengzhou, which is the capital of central Henan Province.
That's a very diverse set of cities, geographically, all going through similar stages of development. It's hard to generalize about China, because it's so many countries in one: principally, the highly automated, teched-up, highly paid cities of the east coast; and the poor hinterland, which gets poorer the further you go inland.
Pretty soon, poor secondary sales inevitably impact buyers in the primary market. Property is incredibly sentiment-driven in China, where in the big cities most apartments are pretty similar and treated like commodities, more than homes.
Thanks to China's chronic undersupply of land, raw land is currently often sold at a similar price to the sales price of completed homes -- or even in some cases, at a premium.
That's true in Foshan, near me across the border in central Guangdong Province, as well as the former capital of Nanjing. The average cost for land on the open market is 111% that of the average sales price for a home in Foshan, and 107% in Nanjing.
Ningbo, with a raw-land price at 95% that of completed homes, is almost as bad, as is Wuhan, at 86%. More Tier 2 cities to avoid.
That leaves the developers in those cities at risk. Unless they see rapidly rising prices, they're going to struggle to sustain profitable sales. If they don't get them, they're left looking at tight margins or even losses on homes. Of course, they can always sit tight on their completed projects, but that leaves them short of cash flow, busy paying interest out the nose.
That's another problem. Borrowing is getting tougher and tougher as the government cracks down on home prices. Developers as of the end of 2016 have to get government approval to issue either offshore or domestic bonds. That's proving tougher and tougher to get.
The onshore bond market collapsed in size by 57% in the third quarter, compared with the same time last year. Developers have been turning to bonds of 364 days or less in duration, which escape the regulatory requirement.
But this leaves them looking at very short-term debt that they must service and quickly pay off. Greenland Holdings SH:600606 recently tapped 364-day loans in May and then July, paying a yield of first 3.85% and then 4.5%. Fantasia Holdings Group HK:1777 made the same move in June, paying 5.5%. Central China Real Estate HK:0832 did it in July, forking out the most, at a 6.0% yield.
They need cash quick, in other words. Everything must go. Sale, sale, sale.
Vanke and Country Garden have the smallest land banks compared to their size. Vanke could last for 3.0 years on its current stock of land; the figure is 3.9 years for Country Garden. The next-lowest among the ranks of major Chinese developers is China Overseas Land (CAOVY) at 4.8 years.
Guangzhou R&F Properties (GZUHY) may be spared the worst, because the declines in the secondary market in that city appear to have stopped. CLSA has upped its target price for the Guangzhou developer, from its original HK$16 to HK$17.60. It's currently trading at HK$16.88. So that would be a pretty modest 4.3% boost, to be honest.
Guangzhou R&F is also particularly well-stocked with land, able to survive for virtually a decade (9.3 years) on the land bank that it has now in hand. That's a figure beaten only by Sunac China Holdings HK:1918, at 9.6 years -- a company that is however trading well ahead of its peers in terms of price to book value, at 5.9 times.
The vast majority of competitors have price-to-book ratios of less than 2.0. Evergrande, after its massive run-up in price, is an exception at 3.5 times book -- as, again, are Country Garden at 3.0 times and Vanke at 2.1 times book.
It's the triple whammy to be short on land, looking at tougher profits, but with a share price trading well above average. Guangzhou R&F's price-to-book is only 1.1 times -- another factor where it looks to come out a winner.
If the tipping point has already passed, how long will this down cycle run? Many of the shares are trading at records after heady outperformance. But that's only typically lasted for three to 12 months.
CLSA is calling a "reset" on property-developer share prices. Investors may want to sit out of the market -- and brave ones short it, as you can do with Hong Kong listings -- until that reset happens.
CLSA is more encouraged by the metrics at China Overseas Land, Shimao Property Holdings (SHMAY) and KWG Property Holding HK:1813. "However, a re-rating can only happen after a reset," it concludes, on a negative note for them, too.
It was noteworthy that, during his recent three-and-a-half hour address to the Communist Party congress, Chinese President Xi Jinping got his loudest and longest ovations for his assertion that "houses are built to be inhabited, not for speculation."
The sustained applause suggests that the Communist Party has reached a consensus. Developers and investors have been making a scandalous amount of money, and it has to stop. Regular folks should be moving in next door. And shareholders should be moving on.