Country Garden: All Eyes On Lower-Tier Cities Exposure And Robotics Business

Summary

• Country Garden's relatively higher exposure to lower-tier cities could mean weaker contracted sales growth in FY2020, as compared to its peers which are focused on Tier-1 and Tier-2 cities.
• Country Garden could potentially spin-off its robotics business in the future, and this is not necessarily positive.
• Country Garden trades at 4.1 times consensus forward next twelve months' P/E and 1.19 times P/B, and it also offers a consensus forward FY2020 dividend yield of 7.6%.
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Elevator Pitch

I maintain my "Neutral" rating on Hong Kong-listed Mainland China property developer Country Garden Holdings Company Limited (OTCPK:CTRYF) (OTCPK:CTRYY) [2007:HK].

Country Garden's relatively higher exposure to lower-tier cities could mean weaker contracted sales growth in FY2020, as compared to its peers which are focused on Tier-1 and Tier-2 cities. Country Garden could potentially spin-off its robotics business in the future, which could help to monetize the value of this new business eventually. However, this also means that Country Garden has an intention to continue investing in the robotics business to build it up to a certain scale.

On the other hand, Country Garden's valuations are undemanding and the company has a strong financial position, which justifies a "Neutral" rating.

This is an update of my initiation article on Country Garden published on September 30, 2019. Country Garden's share price has declined by -5.7% from HK$9.95 as of September 26, 2019 to HK$9.38 as of May 4, 2020 since my initiation. Country Garden trades at 4.1 times consensus forward next twelve months' P/E, versus its historical five-year and 10-year average consensus forward next twelve months' P/E multiples of 6.7 times and 7.1 times respectively. The stock is also valued by the market at 1.19 times P/B, and it offers a consensus forward FY2020 dividend yield of 7.6%.

Readers are advised to trade in Country Garden shares listed on the Hong Kong Stock Exchange with the ticker 2007:HK, where average daily trading value for the past three months exceeds $35 million and market capitalization is above $26 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

Weaker-Than-Expected Contracted Sales Likely Due To Lower-Tier Cities Exposure

Country Garden's contracted sales grew +10% YoY from RMB501.9 billion in FY2018 to RMB552.2 billion in FY2019. In contrast, the company's contracted sales growth rates were +63% and +31% for FY2017 and FY2018 respectively. In other words, Country Garden's contracted sales growth has slowed considerably last year.

A number of Country Garden's peers among the 10 largest property developers in Mainland delivered relatively faster contracted sales growth last year, as compared to Country Garden. China Overseas Land & Investment Limited (OTCPK:CAOVY) (OTCPK:CAOVF) [688:HK], Shimao Property Holdings Limited (OTCPK:SIOPF) (OTCPK:SHMAY) [813:HK] and Longfor Group Holdings Limited (OTCPK:LGFRY) (OTCPK:LNGPF) [960:HK] saw contracted sales growth of +25%, +48% and +21% respectively in 2019.

In the first three months of FY2020, Country Garden's contracted sales decreased by -16% YoY, compared with the average -11% YoY decline in contracted sales for eight large-cap Mainland China property developers. Specifically, China Overseas Land & Investment, Shimao Property and Longfor Group achieved comparatively narrower contracted sales declines of -12%, -9% and -14% respectively in 3M2020.

Country Garden disclosed at the company's FY2019 earnings call (audio recording and transcript not publicly available) on March 27, 2020, that it expects to have salable resources of RMB906.6 billion and achieve a sell-through rate of 67% for FY2020. In other words, Country Garden is targeting approximately RMB607.4 billion in contracted sales this year, which implies a YoY growth rate of +10%.

With the company's contracted sales down -16% YoY in 3M2020, Country Garden will have to do some serious "catch-up" for the remainder of the year. However, Country Garden's targeted sell-through rate of 67% for FY2020 is lower than FY2019's actual sell-through rate of 72%, which is conservative.

Country Garden's weaker-than-expected contracted sales for FY2019 and 3M2020 is possibly a result of the company's significant exposure to lower-tier cities in Mainland China. While most large-cap Mainland China property developers tend to focus on Tier-1 and Tier-2 Chinese cities, Country Garden has taken a different approach, choosing to keep faith with the more exciting growth potential in lower-tier Chinese cities. Country Garden generated 56% of the company's contracted sales from Tier-3 and Tier-4 Chinese cities. Tier-3 and Tier-4 Chinese cities also contribute 54% of the company's RMB906.6 billion in salable resources for FY2020.

In the company's FY2019 results presentation, Country Garden provided details regarding the ROI (Return On Investment) for its property projects located in Tier-3 and Tier 4 cities and the demand-supply dynamics in these lower-tier cities, which are reproduced below.

Country Garden's ROI For Property Projects In Tier-3 And Tier-4 Cities

Source: Country Garden's FY2019 Results Presentation Slides

Demand-Supply Dynamics Of Tier-3 And Tier-4 Cities Where Country Garden Has A Presence In

Source: Country Garden's FY2019 Results Presentation Slides

As per the charts above, Country Garden claims that its property projects located in Tier-3 and Tier-4 Chinese cities have delivered higher ROI compared with its projects in Tier-1 and Tier-2 cities. The company also highlights that there is no over-supply in 88% of the Tier-3 and Tier-4 cities where it has a presence in.

Nevertheless, property demand in Tier-3 and Tier-4 cities should be relatively less resilient than Tier-1 and Tier-2 cities in an economic downturn. This implies that Country Garden's relatively high exposure to Tier-3 and Tier-4 Chinese cities could mean weaker contracted sales growth for the company, compared to its peers which are more focused on Tier-1 and Tier-2 cities.

Potential Spin-off Of Robotics Business In The Future

A sell-side research report authored by CGS-CIMB Securities (Hong Kong) Limited published on March 30, 2020 suggested that Country Garden is "still looking at spin-off of robotics unit in future" when the robotics unit grows "becomes sufficiently large in scale for a spin-off."

On one hand, this means that Country Garden has plans in place to monetize the value of the company's robotics business eventually. On the other hand, this also implies that Country Garden plans to continue investing in the robotics business so that it can grow to a certain scale.

At the company's FY2019 earnings call on March 27, 2020, Country Garden referred to its core property business as "a tiger" and new businesses like robotics and modern agriculture as "wings". The company believes that "the new business can bring greater value to the core business" just like "a tiger with wings."

Country Garden spent approximately RMB1.97 billion on research & development expenses relating to new non-core businesses such as robotics and modern agriculture last year, which represented a +61% YoY increase from RMB1.22 billion in research & development expenses for FY2018. Higher-than-expected research & development relating to new businesses going forward could potentially be a drag on the company's earnings in the future.

Details Of And Plans For Country Garden's Robotics And Modern Agriculture Businesses

Source: Country Garden's FY2019 Results Presentation Slides

Relatively Strong Financial Position To Limit Downside Risks

Given the current challenging economic environment brought about by the coronavirus pandemic, companies with stronger balance sheets are better positioned to weather the storm ahead, and Country Garden stands out in that respect.

Country Garden has a net gearing of 46.3% as of end-FY2019, while a list of 25 Hong Kong-listed Mainland China property developers which I tracked has higher average net gearing ratios of 90%-100%. In addition, the company's cash to short-term debt ratio and EBITDA-to-interest coverage ratio are relatively healthy at 2.3 times and 4.0 times respectively.

Valuation And Dividends

Country Garden trades at 4.7 times trailing twelve months' P/E and 4.1 times consensus forward next twelve months' P/E based on its share price of HK$9.38 as of May 4, 2020. As a comparison, the stock's historical five-year and 10-year average consensus forward next twelve months' P/E multiples were 6.7 times and 7.1 times respectively.

Country Garden is also valued by the market at 1.19 times P/B, versus its historical five-year and 10-year mean P/B multiples of 1.74 times and 1.63 times respectively.

Country Garden offers a historical FY2019 dividend yield of 6.7% and a consensus forward FY2020 dividend yield of 7.6%. The company proposed a final dividend of RMB0.3425 per share for 2H2019, which brought full-year FY2019 dividends per share to RMB0.5712. This implies a +17% YoY increase in absolute terms from FY2018 dividends per share of RMB0.4884, and a dividend payout ratio of 30%. Market consensus expects Country Garden to increase its dividends per share by +13.5% YoY from RMB0.5712 in FY2019 to RMB0.6485 in FY2020, in line with a similar level of expected earnings growth this year.

Risk Factors

The key risk factors for Country Garden include weaker-than-expected contracted sales due to its significant exposure to lower-tier Chinese cities, higher-than-expected research & development relating to new businesses going forward, and lower-than-expected dividends in the future.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.