By Thomas Streater
That China's real estate market might be weakening isn't exactly
breaking news. But as investors browse for bargains among
beaten-down property stocks, which ones should they avoid?
Performance of Hong Kong-listed property stocks have differed
wildly this year: China South City's shares ( 1668.HK), for
example, are up a whopping 70%, while Agile Property's ( 3383.HK)
have lost half their value. Generally, however, the larger
developers have outperformed their smaller peers - thanks to a
widely-held perception that the bigger developers have better
operations and stronger balance sheets.
Yet bigger isn't always better. Some large developers -- whose
stocks tend to be more widely-held by global investors - are
increasingly at risk if capital flows out of Hong Kong and China
index benchmarked funds were to pick up. And such an exodus of
funds could well occur if China's economy slows, or if the U.S.
Federal Reserve withdrew its monetary support more quickly than
expected, driving investors to more defensive stocks with lower
debt levels.
New World Development ( 17.HK) and China Resources Land (
1109.HK) are two of the household names whose stock-market returns
have been lackluster this year. Of the top Hong Kong listed
developers, they appear to be most at risk from macro scares or
capital flight.
For a start, both have less stellar balance sheets compared to
top-tier peers and, as such, are more vulnerable should interest
rates rise. The ratio of total debt to total assets is 33.2% for
New World Development and 25.9% for China Resources Land --
compared to 19.1% for the Hang Seng Index's property average, or
other top-tier Hong Kong-listed property peers.
On top of that, New World Development trades at a 49% discount
to its net asset value, and China Resources Land is at a 27%
discount, using Barclay's calculations. Both have been discounted
less by the market than this year's unloved underperformers, many
of which are suffering discounts of roughly 60% to their net asset
values. As such, both stocks could have further selling
pressure.
Of course, the case for investing in Chinese property stocks is
well-known, and there are ways in which China's housing sector is
different from the U.S.'s housing bubble of 2006, as Goldman Sachs
recently pointed out. First, a rise in the number of urban
households and the push to move up to better residences is still
apparent and much needed. The construction boom of the last 15
years was due to the privatization of housing and real demand, not
the "irrational exuberance, " seen in bubbly markets. Second, given
the lack of investment opportunities in China, owning property is a
surrogate for savings. Finally, generally low household leverage
dampens the potential damage of negative equity seen during the
U.S. subprime crisis. The Peterson Institute for International
Economics believes the property market downturn should "prove to be
merely cyclical" so long as appropriate policies are adopted.
Yet low household leverage will provide scant comfort to
investors in the more highly-leveraged property firms. Bears argue
that rising property prices in the past decade have been a kind of
self-fulfilling prophecy: Price increases spurred potential home
owners and investors to buy property as soon as possible - before
prices got away from them. Now that the trend has finally turned,
the opposite may be true. When China Overseas Land & Investment
( 688.HK) reported earnings yesterday, it made a rueful point that
summed up the current sentiment: "Relaxation in the tightening
measures toward the China property market continued, but
improvement in both the transaction volume and home prices has yet
to be seen."
This matters to stock-market investors because developers face
pressure to cut prices or hold back inventory, or risk taking
write-downs on balance sheet assets.
Email: thomas.streater@barrons.com
Comments? E-mail us at asiaeditors@barrons.com