Shanghai Shimao Co Ltd:Poor execution,expensive valuation

Initiating with Sell and a target price of CNY6.01We initiate coverage of Shanghai Shimao with a Sell rating and TP of CNY6.01.

    After listing on the Shanghai Stock Exchange in 1994, the company haddelivered strong revenue and earnings growth (62% CAGR) till 2015. However,due to poor sales in 2016 (-16% y-y) and a margin squeeze since 2015,earnings visibility is low (core profit at -35% y-y in FY16F). In addition, as acommercial property developer and operator, it has failed to improve rentalincome over the past few years. The company currently trades at 13.1x FY17FP/E and a 21% discount to NAV, which is not cheap versus its peers.

    Sales declined in 2016 with little improvement in rental incomeShanghai Shimao’s property sales declined 16% in 2016 to CNY14.9bn, whichis disappointing considering that property sales in China were up 35% last yearand the country’s major developers had even higher sales growth. In addition,as a leading property developer and operator, Shanghai Shimao’s rentalincome stayed low at CNY478mn in 2015 (426mn in 2014), accounting for only3% of revenue. We believe improvements in asset churn and investmentproperty operations are needed – these would boost its earnings visibility andbrand equity in the development of new offices, hotels and shopping malls.

    Low ROE and expensive valuationDue to poor execution and asset churn, its ROE was 8% in 2015A and shouldrange 5-6% over 2016F-2018F, much lower than its holding company Shimao’s(0813.HK) 11-12%, and other investment property operators like CR Land’s(1109.HK) 12-13% and Longfor’s (0960.HK) 12-13%. Shanghai Shimao’s stockis trading at 13.1x FY17F P/E, versus Vanke A’s 9.6x, Poly A’s 7.0x andGemdale’s 11.4x. We attribute its low ROE to relatively poor execution, whichis reflected in its valuation, in our view.

    Valuation and investment risksOur CNY6.01 target price is based on a 35% discount to our estimated end-2017 NAV of CNY9.24, which incorporates CNY2.16 from investmentproperties, CNY7.98 from development properties, and -CNY0.89 from netdebt. Upside risks include: 1) higher-than-expected sales due to improvingsentiment in the retail market and service apartment investment in T1 cities;and 2) a much higher gross margin, with ASP up 36% in 2016F.