Deutsche Bank Markets Research Asia Hong Kong Property Property Industry China Property Date 7 August 2015 Industry Update Anticipate soft earnings in upcoming interim results; Buy SOE developers Gross margin likely to see further compression; net gearing to rise further ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. Tony Tsang Research Analyst (+852) 2203 6256 tony.tsang@db.com Jason Ching, CFA Research Analyst (+852) 2203 6205 jason.ching@db.com Foo Leung Research Associate (+852) 2203 6239 foo.leung@db.com Top picks COLI (0688.HK),HKD24.20 Buy China Resources Land (1109.HK),HKD21.20 Buy Greentown China (3900.HK),HKD7.56 Buy Joy City Property (0207.HK),HKD1.38 Buy Franshion (0817.HK),HKD2.48 Buy Source: Deutsche Bank Companies Featured COLI (0688.HK),HKD24.20 Buy China Resources Land (1109.HK),HKD21.20 Buy Greentown China (3900.HK),HKD7.56 Buy Joy City Property (0207.HK),HKD1.38 Buy Franshion (0817.HK),HKD2.48 Buy Sunac (1918.HK),HKD6.80 Sell Shimao Property (0813.HK),HKD13.64 Sell Evergrande (3333.HK),HKD5.09 Sell Yuexiu Property (0123.HK),HKD1.51 Sell Yanlord Land (YNLG.SI),SGD0.96 Sell Agile Property (3383.HK),HKD4.55 Sell Gemdale Corp (600383.SS),CNY11.72 Sell Country Garden Holdings (2007.HK),HKD3.00 Sell Source: Deutsche Bank We anticipate the upcoming interim result announcements for Chinese developers to be rather soft in general, with gross margins likely to see further compression. On the other hand, we expect net gearing for many developers to rise, despite the low level of land acquisitions in 1H15. Meanwhile, while we have already seen three companies (Franshion, Joy City and Beijing Capital Land) issue profit warnings, we believe these are exceptional cases on uneven revenue bookings. In our view, while the soft results could dampen market sentiment, this provides a good entry opportunity for state-owned developers like COLI, CR Land, Greentown, Joy City and Franshion. Gross margin expected to see further compression in 1H15 While gross margin has already seen a marked compression of 2 percentage points in FY14 to 31%, we believe gross margins are likely to be further compressed in 1H15. In particular, the decline in profitability will be driven by: 1) bookings of sales achieved during the market downturn in the first three quarters of 2014 at low ASPs carrying lower margins; 2) bookings of projects acquired at the land market peak in 2013; and 3) stepped-up effort to clear inventory via marked price cuts in 1H15. Net gearing is likely to rise further by mid-15 on tighter collateral requirements While most developers have slowed down their pace of acquisitions in 1H15, net gearing for many developers is likely to rise by end-2015 on the back of the tighter collateral requirements. Specifically, developers could previously deploy project loans pledged by later phases of a project for other purposes (like buying another piece of new land). However, starting this year, the entire loan from project financing for all the phases has to stay inside the project and cannot be used outside of the project. As project financings normally last for one year and have to be rolled over every year, developers that have deployed the project financing from a project to other projects would likely need to top up the cash shortfall, and hence, this would result in higher net gearing. Uneven revenue bookings leading to fluctuation in earnings Revenue recognition for Chinese developers is based upon on delivery of the units. Hence, the timing of the construction completion is influential on the underlying earnings being reported. Nevertheless, there is no consistency in construction completion, which leads to wide fluctuations in earnings (i.e. % of revenue recognition/net profit in 1H fluctuates without a consistent pattern/trend). Specifically, revenue recognized/net profit in 1H made up 37-47%/37-40% of total revenue/net profit, respectively. Be selective; we prefer state-owned developers over private developers While the falling Chinese stock market presents new risks to the Chinese economy and property market, we now see a rising likelihood of additional policy support for the property markets in Tier-2/3/4 citi