China Property:The Physical Market, the Margins, and the Valuations

We expect the physical market conditions (e.g., ASP,sales) to deteriorate further in the coming monthsand cap near-term share prices. We adopt highercost assumptions, cut GPM to 29-30%, lower NAVsby 4% and PTs by 17%. We maintain our In-Lineindustry view; downgrade Yuexiu Property to EW.

    Cut average NAV by 4%, PT by 17%: We adopt awider project ASP range amid a more diverse physicalmarket and higher cost assumptions. The NAVs ofYuexiu Property (-20%), Poly (-16%) and Agile (-16%)have the biggest downward revisions. The new landbank helps raise the NAVs of R&F (10%), Shimao (10%)and COLI (8%). We also adopt a higher bear-caseprobability in our PT formulas to reflect the rise in tailrisks. Yuexiu’s PT is cut the most, by 45%, to HK$1.80,and we downgrade the stock to EW. R&F is the onlystock to see an increase in PT (by 2%, to HK$12.90).

    The physical market will get worse before it getsbetter: We maintain our view that the property austeritymeasures will continue to normalize at a gradual pace,which may disappoint rising market expectations aboutthe relaxation/abolition of home purchase and mortgagerestrictions. We expect the physical market conditions tomoderate further, especially ASP and sales, which maybegin to record MoM and YoY declines in the comingmonths and cap near-term share prices.

    The margins – normalizing at 29-30%: We haveraised our 2014 construction cost growth forecast to 6%for 2014 and cut our 2014-16E GPM to 29-30% amid theland and construction cost inflation. We expect the GPMof Vanke (26-27%), COLI (33%) and Longfor (28-31%)to be stable/recover in 2013-16E while that for CCRE,CG, Agile may decline further over the same period.

    The base- and bull-case baskets: Our top picks underour base case are Vanke, Shimao and CG. However, ifthe physical market conditions are more robust than ourforecasts, R&F and KWG could see over 40% upside.