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Guangzhou R&F Properties Co., Ltd.（2777.HK）Proposed to issue 6 billion bonds, 2008 sales expected to reach RMB 18 billion

Wednesday, November 26, 2008

6718

Guangzhou R&F Properties Co., Ltd.(2777)

Recommendation on 26 November 2008
Recommendation	Hold
Price on Recommendation Date	$3.340
Target Price	$3.790

Weekly Special - 1318 MAO GEPING

Summary

R&F Properties proposed to issue domestic corporate bonds in the PRC with an aggregate amount of no more than RMB 6 billion, maturity for 5 to 10 years. If approved, it will help to improve the company`s financial situation. For the first ten months this year, the company`s contract sales has reached RMB 14.5 billion. We estimate the company will be able to achieve its annual sales target which is RMB 18 billion (adjusted). We give R&F Properties “Hold” rating and estimate its 12-month target price at HKD 3.79, 13.5% higher than current close.

Proposed to issue RMB 6 billion domestic corporate bonds

R&F Properties announced recently that it proposed to issue no more than RMB 6 billion domestic corporate bonds in PRC with maturity of 5-10 years. All proceeds raised from issuing bonds will be used to repay part of its existing bank loans and supplement the working capital of the company. If the proposal is successfully approved, the company is expected to issue bonds in Q2 2009.

See figure 1, among domestic property companies listed in HK market, R&F Properties has the highest liability ratio: its net debt to equity ratio is as high as 142%. After its proposal of issuing A shares failed, issuing corporate bonds has become the pragmatic choice for the company. This proposal will have the company`s liability change from short term to medium and long term, and will help to ease the company`s capital pressure in the short term.

Financial cost is what R&F Properties needs to be faced with. Due to current deflation risk in the currency market, the company needs to pay more interests to investors to compensate their risk. By reference to the situation of domestic listed companies issuing bonds and current interest rate, we estimate the coupon rate of secured bonds will be 5-6%, coupon rate of debenture bonds will be 8%. The financial cost will exceed RMB 300 million every year. The company`s dividend payout and investment plan in recent years will be affected.

Besides, borrowing from bank will be a realistic choice for property companies. The semi-annual report shows the company`s short-term and long-term bank loans for the period has amounted to RMB 8 billion, and in addition, the company needs to pay RMB 5 billion land expense and RMB 2 billion construction expenses before end of 2008. Currently the company has delayed RMB 7 billion loans in due and this largely eased the company`s tight cash flow in the short term. We think the situation of company`s tight capital chain will remain and its financial risk still high. See above Figure, the company`s long-term and short-term loans both show up trend, among which the long-term loans has remarkable growth.

Sales expected to reach RMB 18 billion in 2008

See figure 4, R&F Properties, Sino-ocean Land and COLI are the leading companies in the sector, which achieved good sales target completion. For the first ten months, the turnover of R&F Properties has totaled RMB 14.5 billion, among which sales for October alone exceeded RMB 2 billion. We think the management team is pragmatic by adjusting the sales target from RMB 24 billion to RMB 18 billion. This will also reduce the investors` anxiety. In 2008 R&F Properties will be able to achieve this new sales target, RMB 18 billion, representing a 12% growth compared to that of 2007. However, the inventory turnover ratio of R&F Properties is at the low level (per figure 4). As of June end, the inventory of the company exceeded RMB 18.3 billion. The company needs to carry out more pragmatic measures to ease the sales pressure.

Pricing strategy is worthwhile to try. According to our perspective, R&F Properties has cut sales price continuously in Beijing and Guangzhou since August, price down by 10-20%. In 2008 first half year the average contract unit sales price is RMB 11275 per sq.m., and we estimate in second half year the unit sales price will be 15% around down, about RMB 9500 per sq.m..

Commercial property step into payback period, rest on the launch of REITs

The company`s investment properties are mainly located in Guangzhou, Beijing and Tianjin. Since 2007 second half year, with construction of several investment properties completed one by one, the investment property has stepped into payback period, the net asset value increased robustly (See above figure).Currently, the properties operated by the company includes four integrated large commercial properties (office building and retail building) and four five-star hotels. It has another four hotels and two commercial projects under construction. As of 2008 mid, the total GFA of investment properties by the company was 0.6 million sq.m. around, total net asset value was RMB 7.36 billion, accounting for 29% of non-current assets.

We think over large scale of investment property has frozen large amount of capital and self operated property can only generate limited cash flow, which are the major reasons resulting in cash shortage. See below table, the rental income is very limited in the short term, and is not able to cover the company`s normal capital expenditure.

In our view, selling parts of investment properties and issuing REITs shall be a good choice for R&F Properties to solve its capital problem. Currently the company has realized the importance of having investment properties change from renting to selling. The recent company announcement shows the company will sell parts of its investment properties to someone of the board in order to ease the capital pressure. We guess selling investment properties is a short-term financial activity by the company, and there may be premium buy-back article in the sales agreement.

In addition, issuing REITs will effectively solve the company`s capital problem. Recently, the state council has approved issuing REITs. In first half year of 2009, detailed implement rules of REITs in China will be officially released. Property companies such as R&F Properties which has higher proportion of investment properties will benefited from it in the long term. However, In short term, the benefit is very limited.

Risk

Currently the company is mainly facing systematic risks from external environment and industry cycle adjustment. The deteriorating global economic situation and slowdown of domestic economy have negative impact on the company`s business. Recently the central and local government launched large scale of market saving policies which help to ease the current tight economic situation, but it is difficult to turn round the down trend of cycle tight economic situation. The systematic risk will remain in a rather long time.

Valuation

The performance of R&F Properties in recent years will be largely affected by fair value gains of investment properties. In 2008 and 2009, R&F Properties` EPS will reach RMB 1.82 and 2.16; the impact of fair value gains of investment properties to EPS exceeded 50%. According to our calculation, core EPS of R&F Properties in 2008 and 2009 will be 0.99 and 1.08 respectively, book value per share to be 5.02 and 5.88.

Currently P/E and P/B of R&F Properties both fell to the historic lowest level, NAV discount over 80%. The whole property industry is at the down trend, only has occasional trading opportunities. In 2008 the whole real estate market encountered large fall, averagely 80% down. As the performance of real estate companies normally lag behind, the situation of “performance down while share price up” may probably occur. Anyway, the overall investment risk is high. We think 3 times of core P/E ratio and 0.6 times of P/B ratio can be regarded as trading central price of the company in the coming one year. Its 12-month target price is HKD3.79, 13.5% higher than current close. We give it “hold” rating.

Financial data

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