Fundamental themes of the reform:
A sweeping reform agenda for China’s next decade has caused heady discussion and speculation within and outside the country. While the 60 specific policies sound ground-breaking and well articulated, we believe that the exact impact of the reform depends completely on how thoroughly these policies are implemented and executed.
We find it interesting that many compared this year’s 3rd Plenum to that of 1978, in which Deng Xiaoping, the then de-facto party head, opened up China to the outside world. Since then, 36 years have passed, and vested interests still command roughly 30% of issued shares in the Chinese economy. Our scepticism is driven by the belief that these groups may create major obstacles in any reform that would, in effect, reduce their power and wealth-generating capability. In our view, this is probably one of the primary reasons for the demise of plans implemented to reform the notoriously inefficient SOEs. Therefore, we prefer not to be elated prematurely about the effectiveness of the reform agenda, absent any fundamental change in the structure of various institutions.
In our opinion, two of announced policies are most relevant to the direction of the Chinese property market: [i] the proposed relaxation of “Hukou”, and [ii] the proposed gradual liberalisation of interest rates and private capital markets. The former is likely to accelerate the urbanisation process, with more migrants moving to the 300 prefecture-level cities in the country. Improved infrastructure and increased housing demand may ensue. The latter may increase competition among banks, driving lending rates down and providing developers with lower-cost funding. We list below a number of developers that may be better positioned to benefit from the reform, if successfully implemented.
Developers to move to smaller cities:
Developers are moving to smaller cities in China, either by choice or by force. Bullish on the country’s urbanisation progress, major developers have increased land banking in T2/T3 cities since 2010. Small- to medium-sized developers have transitioned to smaller cities, as they lack adequate capital resources to acquire expansive land sites in T1 cities.
In 2013, T1 and key T2 cities regained their popularity, and attracted many cash-rich major developers. Meanwhile, land markets in T2/T3 cities have also been competitive, given the increasing entry of small- to medium-sized developers that were forced out of T1 cities. In addition, some large developers such as China Vanke, Evergrande and Country Garden are poised to benefit from increasing urbanisation. In 2012, both Vanke and Evergrande acquired more than 90% of their new land parcels in T2/T3 cities.
We identify below three companies that are best positioned to take advantage of the would-be accelerated urbanisation.
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Evergrande: After years of expansion in low-tier cities, Evergrande has amassed the largest land bank at presumably the lowest cost among its peers. However, we believe that the developer will continue to penetrate T3/T4 cities, as a combination of cheap land cost and fast asset movement in low-tier cities is key to sustaining Evergrande’s aggressive growth.
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Country Garden: The company has executed a strategy of occupying peripheral areas of regional hub cities, both from cost and regulatory perspectives. The developer’s excellent performance in 2013 is partially attributable to its forward-looking land acquisitions in low- to mid-tier T2/T3 cities in 2011 and 2012. With the pronounced urbanisation plan, the company is now very likely to continue executing this tested strategy.
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Central China RE: CENCHI has acquired expertise in developing properties in low-tier cities in Henan, which is one of the most populous provinces in China. We believe its strategy to target the mass market aligns well with the central government’s goal of developing the province into a regional economic hub in central China.
In our opinion, potential movers that may selectively enter into peripheral capital cities and affluent T2/T3 cities include China Vanke, Poly Property Group, Greenland Holdings, Longfor, Guangzhou R&F, Gemdale Corp, Sino-Ocean Land Holdings, Shimao, Franshion, Yuexiu Property and Kaisa.
Smaller developers that may be forced to seek second chances in T3/T4 cities may include KWG Property, Yuzhou, Future Land, Road King, Fantasia and Powerlong Real Estate.