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Country Garden (2007.HK) Sales in difficulty, expected to be 20 billion in 2008

Wednesday, November 12, 2008

5351

Country Garden(2007)

Recommendation on 12 November 2008
Recommendation	Buy
Price on Recommendation Date	$1.390
Target Price	$1.600

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Summary

Country Garden’s sales for the first 9 months in 2008 have amounted to RMB 12.6 billion. As there’s no remarkable performance recent months, we forecast the company’s total sales for 2008 will be RMB 20 billion around. In first half year, the Equity Swap has resulted in loss amounting to RMB 440 million in fair value. In second half year, as the company’s share price plunged seriously, the fair value loss caused by Equity Swap will be further enlarged, thus the company will need to further accrue provisions. On performance side, we cut down 2008 and 2009 EPS to RMB 0.303 and RMB 0.318 respectively, 12-month target price down to HK$ 1.6, 15.1% higher than current close. For the time being, the share price has over plunged and is not able to show its fundamental aspects, we give Country Garden “Buy” rating.

2008 revenue to reach 20 billion by forecast

As of September end, the sales of Country Garden have reached RMB 12.6 billion. According to its announcement, the company totally generated RMB 1.34 billion in contract sales during the national holidays, among which the major projects are located in Shenyang, Guangzhou, Foshan and Jiangmen. Galaxy Palace, the company’s fourth project in Shenyang recorded contract sales of RMB 240 million. The recognition of Country Garden’s projects in north region is beyond our expectation.

In mid-October, large scale of accommodative property policies are launched by the government, varying from lowering down-payment ratio, cutting mortgage loan rate and deed tax rate, raising housing accumulation fund limit etc. According to our estimation, Country Garden’s sales performance will benefited from these new measures, the sales will achieve a 10% promotion. In Q4, the company’s average monthly sales are expected to reach RMB 2.5 billion. The company’s total sales in 2008 will reach RMB 20 billion, only representing 62.5% of its whole year sales target (RMB 32 billion.)

In general, the sales pressure still remains heavy. This year its salable GFA increased from 9.73 million sq.m. to 17.05 million sq.m. in the fist nine months, showing straight line up trend. Large projects under construction and new launched projects lead to rapid increase in salable GFA. Besides, see figure1, GFA available for construction are showing a down trend since the beginning of the year. The re-investment and scale of newly start turn down remarkably.

Performance dragged by Equity Swap

Impacted by the huge loss in derivatives of several HK listed companies, Country Garden released recently that the company’s investment in derivatives would generate loss of no more than USD 250 million.

The company’s 2008 Interim Report shows the Equity Swap agreement with Merrill Lynch & Co. caused RMB 440 million loss in fair value to the company in the first half year. We think Country Garden is not at the initiative position in this transaction, the fundamental reason being Country Garden’s will to ensure convertible bonds to be successfully issued in order to pay back the short-term loans in due. This motivation is different from other listed companies in investing derivatives.

In view of macro economy and market cycles, this fair value loss caused by derivatives will have impacts on the Country Garden’s performance in the coming years. In 2008 and 2009, the impact will be relatively large. We believe this will have substantial influence on investors’ confidence and the company’s share price may therefore be pressed in a long time.

However, although fair value loss caused by derivatives has largely impacted the company’s performance, the derivatives will be paid off until 2013. Before that, the Equity Swap will not impact substantially the company’s operating and financial situations.

Large fluctuation in share, negative impact

Since October the share of Country Garden went through large fluctuations and company’s management frequently reduced and increased shares. Three executive board members reduced share holdings for several times in October, totally decreased by 790 million, cash out HK$ 1.16 billion. Meanwhile substantial shareholder Yang Hui Yan and CEO Cui Jianbo spent HK& 340 million increasing 210 million shares. We think the company’s management team has different view on share holding, this may imply that the management structure has some changes. This also will impact investors’ confidence to some extent and weigh on the share price.

Besides, HKEx released in mid-October that 9.52 billion shares hold by Yang Hui Yan, substantial shareholder of Country Garden, were taken over by Goldman Sachs, which accounted for 58.2% of the company’s total issued shares. In late October, Country Garden announced that these shares have been held by substantial shareholder self, only 150 million shares by mortgage, which accounts for about 0.92% of the company’s total issued shares. We think currently Country Garden has tight cash flow. Shares taken over by third party is an important signal of seeking outside capital. According to current market situation, it will be rather difficult for the company to raise funds again. Capital shortage situation will continue.

Risk

Currently the company is facing main risk from the external environment, the systematic risk. The deteriorating global economy and slowdown of local economy both have negative impact on the company’s business in mainland, HK and Macau. Recently although the global wide market saving measures help to ease severe economic situation, down trend of cycle industries is difficult to turn around. The systematic risk will exist in a rather long time.

Evaluation

We low down again Country Garden’s 2008 sales forecast to 20 billion, slightly over 60% of its annual sales target. Therefore we further cut down profit forecast in 2008 and 2009. According to our estimation, Country Garden’s EPS in 2008 and 2009 will be lowered to RMB 0.303 and RMB 0.318 respectively, book value per share down to RMB 1.33 and RMB 1.55 respectively.

According to current global economic situation and by reference to the below table2, P/E of property indexes in global main markets, we think P/E at 4.5-5 times is relatively in a safe range. Considering the market risk, We estimate Country Garden’s P/E in 2009 to be 4.5 times, 12-month target price at RMB 1.43, equal to HK$ 1.6, 15.1% higher than current close, and recommend “Buy” rating.

Financial data

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