China Housing Market Could Get Worse But Probably Not Cheaper

Alan Jin, PhD, CFA and Wayne Lee, CFA
Alan Jin, PhD, CFA and Wayne Lee, CFA
January 10, 2017

In our House Alarm series published from May to October 2016, we warned of a policy reversal from easing to tightening, the fading of sales momentum, and a likely housing price decline in upper-tier cities, among other risks. Some of the risks have already materialised while others have yet to be fully reflected. Our cautiousness towards the housing market remains unchanged, and we believe it will continue to deteriorate. However, the fierce sell-off seen in 4Q16, which marked the worst fourth quarter for the sector since 2008, has led us to believe that risk-reward looks favourable, as not only housing market risks but also other external risks (RMB depreciation, capital outflows) have been priced in. Meanwhile, the strong seasonality of a results season rally may once again trigger valuation normalisation. We believe current valuations are attractive to long-term investors, and think that short-sellers should cover/reduce short positions. We expect the rally to be sector wide in the next 3–4 months, and we particularly favour bellwethers and yield plays.

Bellwethers: We upgrade China Overseas Land & Investment Ltd (688 HK) (COLI) to BUY (from Neutral) following the share price correction, and make it a top pick alongside China Resources Land (1109 HK) (BUY).

High yield: We favour yield names amid unjustifiably low valuations in our view. On our research, we upgrade Guangzhou R&F to BUY (from U/P) backed by its high dividend yield (~11–12% in FY16–18) and improved fundamentals (solid margins even if the physical market softens, given low land acquisition costs).

Risk-reward not bad
  • Spring months typically best time to hold China property stocks. This year the rally may come early. Bellwethers COLI and CR Land have reported positive returns in February–April in eight out of nine years since 2008. The sharp decline in 4Q16 was the deepest since 2008, setting the stage in our view for a mean-reversion rally driven by earnings reporting, mainly in March.
  • Attractive dividend yields. The 11 developers we cover have an average expected FY16E dividend yield of 5.3%, much higher than the Hang Seng Index’s 3.7% per Bloomberg consensus data.
  • Macro risks abating. We believe part of the hit from policy curbs has already been priced in. RMB depreciation and capital outflows in the Hong Kong stock market seem to be abating, setting the backdrop for a normalisation of valuations in our view.
  • Valuations near distressed levels. With the upcoming earnings season set to be upbeat, prevailing valuations are not justified in our view. Both price-to-book and discounts to net asset value are close to 1x standard deviation below historical averages since 2009. Price/earnings ratio is 0.7x standard deviation below.

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