China Real Estate-2017Outlook:Gloom but not doom

Stay with quality. Confusion and gloom about the health of China’s property marketand concerns about the formation of a property bubble are likely to linger. Despite this,we see selective opportunities emerging. Demand-side measures in the form of homepurchase restrictions (HPR) are now old news, while the government has recentlyfocused more on mortgage credit risks. Growth in contracted sales is likely to moderatein 2017 after an exceptionally strong 2016, but we think the fall in share prices since4Q16 has incorporated much of the market uncertainty. In our view, investors are toobearish, and this creates an opportunity to buy quality names with a proven executiontrack record. We stay with our bottom-up stock selection approach and highlight COLI(688 HK), CRL (1109 HK) and Longfor (960 HK) as our conviction Buy ideas.
More conservative pricing assumptions. Growth in home prices will likely continueto diverge, based on geographical location and city tier, due to different supply-demanddynamics. Controlling the pace of home price growth is the government’s top priority,and this will likely limit developers’ pricing power. In this report we introduce our 2017home price forecasts – we expect residential property prices in tier-1 cities to be flat,with prices falling 5% in tier-2 cities and 7% in tier-3 cities.
ROIC analysis assesses risk/reward profile. Our differentiated analysis of ROIC vsWACC reveals a positive economic spread for five stocks, including COLI, CRL andLongfor. A positive spread reflects long-term value creation that can be attributed tooperational and capital efficiency. This analysis justifies our positive views on thesestocks, all of which are our conviction Buy ideas for 2017.
Valuation and risks. We adjust NAVs, target discounts and target prices based onour lower home price assumption, partially offset by revisions in contracted salesforecasts and a lower WACC assumption. We adjust the target NAV discounts ofseven stocks by widening the target discounts by 0.5 standard deviation to reflect alower risk appetite in the current environment. As a result, we downgrade Agile (3383HK) and SOL (272 HK) to Hold from Buy and Country Garden (2007 HK) to Reducefrom Hold. We reduce the target prices of the 14 stocks we cover by an average of15%. Key downside: unexpected changes in monetary conditions, which haveremained relatively accommodative.
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