E-House China: Regulations Raise Opportunity for Chinese Real Estate 19 comments
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E-House China (EJ) is one of the premier agencies which contracts with real estate developers in China. The company has exhibited tremendous growth in both sales and earnings over the last five quarters while at the same time seeing its stock drop to levels not seen since its IPO in August of 2007.
Much of the stock weakness appears to be due to investors' concerns over regulations in China aimed at easing inflationary pressure in housing. As more citizens use their newfound wealth to purchase living space, builders are struggling to keep up with demand in many cities. This causes price levels to rise sharply and raises concerns of long-term problems similar to what the US is currently experiencing.
Despite the negative macro headlines, the overall picture still appears very healthy for the selling agency. Similar to the US counterparts RE/MAX or Keller Williams, E-House advertises and sells homes to individuals and collects a selling commission on each transaction. Currently the company generates the majority of its revenue from its primary real estate agency services. The primary services essentially denote that this is the first time the property in question has been sold on the open market.
Developers rely on EJ to sell these new homes, and, in a tightening market, they will be even more likely to retain a professional agency instead of trying to sell the properties themselves. Furthermore, EJ has begun “pre-selling” arrangements with developers, where the company essentially pays for a portion of the developers' inventory and then collects that capital back once the sales are complete.
A healthy balance sheet and access to capital markets allows EJ to participate in these capital intensive transactions and essentially creates barriers to entry for agencies who do not have hundreds of millions to put on the line in a selling arrangement.
In addition to the primary real estate services, the company also is active in secondary real estate transactions. This represents transactions between existing homeowners who are selling to new buyers. While this only represented about 10% of revenue for the fourth quarter, it looks to be a growing part of the business as the company consolidates and strengthens its 160 regional locations across five Chinese cities. Strengthening this portion of its business provides diversification from the primary market and gives the company additional choices to offer its purchasing customers.
Finally, E-House has a consulting and information services arm that is expanding quite rapidly. A new database product dubbed CRIC has been built and is now in the process of being rolled out to paying subscribers. One key relationship has been cemented with Sina.com (SINA) which should give the platform strong visibility among those searching for houses.
The most recent earnings announcement showed that the company pulled in $121m in revenue for 2007 which translated to earnings of $0.56 per share. Management is guiding expectations for 2008 of $210-240m in revenue which would essentially double last year's at the high end. Analysts believe that this guidance is extremely conservative when looking at the selling agreements signed with certain development projects as well as the added benefit of the database subscriptions. The consensus earnings numbers for 2008 and 2009 are $0.87 and $1.18 which appear to be realistic given EJ’s strength in the market.
At those earnings levels, the stock appears to be very attractively priced. The company issued its IPO at $13.80 which could add some resistance short-term, but the fundamental backdrop should support much higher prices once investors become confident that the company will be able to grow earnings despite what is construed as headwinds for the sector. A break above $14 on high volume might be just the event necessary to break EJ out of its slump and signal to investors that the time is right to capitalize on this growing company’s bright future.
Disclosure: Author does not have a position in EJ.
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This article has 19 comments:
Nervous markets are often incredible buying opportunities. Certainly there is no guarantee that earnings will continue to grow according to estimates, but the evidence points to a really exciting scenario. I believe patience will pay off as the Chinese real estate market outpaces its critics and other initiatives such as the database project pay large dividends.
Thanks for the comments guys!
Zach
zachstocks.com
I am long with EJ. (Let me declare my interest first).
Always enjoy a thoughtful piece on stock that I own.
Just a couple of information to supplement / spark some good discussions:
(a) any concern that mainland Chinese are more incline to buy brand new units than 2nd hand?
(b) PRC gov't is tightening the real estate developers credit line - is this a good thing (i.e. trying to rein in the construction boom overhang to allow for an orderly real estate development) or a bad thing (i.e. dropping real estate price & people adopt a wait-n-see approach) for EJ?
(c) Would you go long with this stock? If so, at what price?
(d) I am curious at the source of your information - (PS: I am not challenging you one way or the other. Just that these days, we are flooded with lots of information.)
(e) What are the competiting real estate agencies in China with EJ?
My underlying theme for this stock is that as mainland Chinese become more affluent, they want to upgrade their life. One thing that Chinese always want is to own real estate.
Having said the above, I must confess that I was very much against this stock when it was trading in mid 20s last year. I found that its valuation was way too high to justify a real estate agency business in China. In the low teens, I think it is more justifiable.
Is this over-sold? I don't know. EJ has to prove itself that it can deliver growing profit - which is the "confidence" that investors look for afterall (and not just a theme or a China play).
My 2 cents worth. Hope this is a money doubler for me :)
Patrick
a) Actually EJ primarily operates in the new house market so this would be a positive for the company. Secondary purchases and sales have not taken off yet as a major source of revenue.
b)tightening credit lines for the developers is actually opening some doors for EJ which has partnered with some developers and put up its own capital to help the developers. Obviously this adds a degree of risk, but also gives the company a competitive edge in negotiating with developers for exclusive rights.
c) Since writing the article, I have started a long position around the $13.50 area. I still have the potential of getting stopped out, but believe this is a good spot to own.
d) If you go to zachstocks.com and search for EJ or E-House China, you will find the original copy of my article. At the bottom of each post, I have a link to my notes on the stock. That should give you a good idea as to my research sources.
e) I have not been able to find much information on competitors. I believe they are not publicly traded (or at least not on US exchanges).
Hope this is helpful and again, thanks for the comment!
Zach
zachstocks.com
Also if the Chairman (Mr. Zhou) was not sure they were going to beat earnings estimates or at least be at the high end (even more likely given the steep dollar devaluation) he would not have bought back US $7million worth of stock right now.
Lets hope your right. The earnings report comes out on May 15. I believe it will beat the estimates and take this stock to above the $20 range. Its been at $17-19 the whole last and this week. I think once the earnings comes out it will ignite the rockets.
In terms of the CEO buying some shares. Your right intuition tell me that, revenue for this years quarters were probably higher and beat the estimates hence the buying of millions of stocks. He obviously knows somethings we dont. Additionally with the summer olympics approaching in few months, I expect this real estate boom to be at its summit.
Let all cross our fingers and await the earnings report.
I believ people had unattainable expectations for the earnings report. Although it was higher than expected, i think people were wanting and expecting the earning to blow the estimates away. Before the market opened it was at $18.30 but then it sharpely dropped after earnings release.
I listened to the whole earnings report and thier guidance is strong, however with the number of shares outstanding and sooner or later the housing market in china is going to reach a threshold. I dont see this stock going to $30+ anytime soon, as analyst predict.