By V. Phani Kumar
HONG KONG (MarketWatch) -- Things might get worse for Chinese
property developers over the next several months before they get
better, making selectivity key to investors in the sector, say
analysts.
China's unexpected interest-rate increase Tuesday and
expectations of more hikes over the next year will likely prolong
the spell of weakness for residential property developers,
tempering demand on one hand and inflating costs on the other, say
analysts.
Analysts at Goldman Sachs wrote in a note to clients that
Chinese property prices are likely to fall 20% from current levels
over the next 12 months because of the macro-policy environment, a
change in home buyers' sentiment, and developers' weakening balance
sheets. They said shares of developers doing a high volume of
business might outperform within the sector under this
scenario.
"We believe price recovery in future will be limited by
government policies until a meaningful scale of social housing is
built. Consequently, we believe achieving asset turnover will
become more important than price when it comes to driving earnings
growth and stock valuations," Goldman analysts led by Yi Wang wrote
in the note released Thursday.
The People's Bank of China's quarter-point rate hike on Tuesday
came amid Beijing's struggle to rein in property prices, which have
been stubbornly high in recent months despite a number of
tightening measures.
Last week, an index measuring property prices across 70 cities
in China showed a 0.5% increase in September from August. The
increase marked the first month-on-month rise in prices since May.
The index rose 9.1% from its level in September 2009.
Goldman Sachs said developers that are expanding their exposure
to the relatively less developed provinces in central and western
China, as well as those with a strong balance sheet and execution
skills, were more likely to improve their earnings visibility "amid
a prolonged industry slowdown."
The brokerage listed Evergrande Real Estate Group and China
Vanke Co. as their top buys in the sector, and upgraded Country
Garden Holdings Co. and Sino-Ocean Land Holdings to buy
ratings.
Some analysts said the rate hikes would temper investment demand
in the property market, which has been quite strong because of
negative real interest rates -- a condition where inflation is
higher than the returns investors get from their bank deposits.
UBS Investment analysts said that amid expectations of further
interest-rate increases, investment returns on property -- in the
form of rent -- might fall further as compared to mortgage rates,
thereby discouraging demand for property.
At the same time, the financial profile of developers is also
expected to deteriorate. "Besides poorer cash flow on weaker
property sales, a direct consequence of the rate hikes, we think
developers' funding costs will rise as well," they said.
"Combined with rising inventory heading into the year-end,
developers will likely have to cut property prices sooner rather
than later," UBS said.
They preferred commercial developers -- such as Soho China --
and Hong Kong developers with exposure to Chinese commercial
property -- such as Sun Hung Kai Properties and Henderson Land
Development Co. -- to Chinese residential property developers.
In Thursday's trading, shares of China Vanke (CVKEY) rose 0.2%,
Poly Real Estate Group Co. was little changed, and Gemdale Corp.
gained 0.3% on mainland Chinese bourses.
But Chinese property shares were broadly weaker in Hong Kong,
where Agile Property Holdings (AGPYY) dropped 3%, China Overseas
Land & Investment [(CAOVY) shed 0.6%, and Guangzhou R&F
Properties Co. (GZUHY) lost 3%.
Hong Kong-based property developers also lost ground, with Sun
Hung Kai (SUHJY) slipping 0.3% and Henderson (HLDCY) sliding
1.2%.
In wider market action, China's Shanghai Composite fell 1.3% to
2,964.97, Hong Kong's Hang Seng Index declined 0.2%, Japan's Nikkei
Stock Average gave up 0.3%, Taiwan's Taiex dropped 0.2% and
Australia's S&P/ASX 200 was little changed.
