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2019-10-18 19:24:17

Elevator Pitch

I like Hong Kong-listed Mainland China property developer Longfor Group Holdings Limited (OTCPK:LGFRY) (OTCPK:LNGPF) [960:HK] for its strong contracted sales and earnings growth, growing revenue contribution from recurring income businesses and relatively low funding cost comparable to state-owned property developers.

But the positives have been priced in, with Longfor Group trading at 10.2 times consensus forward FY2019 P/E, which represents a significant premium to its historical five-year forward P/E of approximately 7 times. Most Mainland China property developers also trade at much lower mid single-digit P/E multiples. Longfor also offers a trailing dividend yield of 3.5% and a consensus forward FY2019 dividend yield of 4.1%. I suggest a lower entry price of HK$27.40 pegged to 7 times FY2020 P/E.

Company Description

Started in Chongqing, China in 1993 and listed on the Hong Kong Stock Exchange in 2009, Longfor Group is among the top 10 largest Mainland China property developers based on its contracted sales of RMB105.62 billion for 1H2019. Longfor Group derived approximately 88.3%, 6.7%, and 5.0% of its 1H2019 revenue from the property development, property investment (shopping malls and long-term rental apartments), and property management services segments, respectively.

Strong Contracted Sales, Supported By Prudent Land Banking, Translate To Future Earnings Growth

Longfor Group is targeting a 20% CAGR for contracted sales and earnings for the next three years, which is achievable based on its track record and land banking strategy.

The company achieved a +17% YoY growth in contracted sales from RMB149.08 billion in 9M2018 to RMB174.62 billion in 9M2019. It is already ahead of its full-year target of RMB220 billion in contracted sales for FY2019, with 9M2019 contracted sales already accounting for 79.3% of the FY2019 target. Longfor's future contracted sales are well-supported by the company's prudent land banking approach.

Longfor Group has a total land bank of 70.93 million sq m or 49.11 million sq m on an attributable basis located in Pan Bohai Rim, Western China, Yangtze River Delta, Central China, Southern China and Hong Kong as of end-June 2019. Notably, the company's average land cost for its land bank was RMB5,632 per sq m or approximately 34.7% of its current average selling price or ASP for property sales. This implies that Longfor has been prudent in acquiring new land bank at a reasonable cost so as to secure a high profit margin for its property development sales.

As an illustration of this prudent approach towards land banking, Longfor did not acquire significant land bank in 1Q2019 when the property market was heating up due to expectations of possible policy loosening, which led to high land bank acquisition prices. Instead, Longfor chose to acquire most of its land bank for 1H2019 in the months of May and June, when the property market has cooled significantly and land prices were more attractive. In 1H2019, Longfor added new land bank equivalent to a GFA of 9.24 million sq m or 6.71 million sq m on an attributable basis. Also, approximately two-third of Longfor's land bank in terms of GFA is located in Tier-1 and Tier-2 cities which boast relatively stronger economic growth and housing demand compared with lower-tier cities in China.

Longfor's 1H2019 core net profit, excluding revaluation gains, was up +26.0% YoY to RMB4.70 billion. Its target of a net profit CAGR of 20% for the next three years is achievable on the back of strong contracted sales growth of +77%, +29% and +17% YoY in FY2017, FY2018 and 9M2019, respectively, and increased recurring income contribution (discussed in the next section of the article). More importantly, Longfor had sold but unrecognized contracted sales of RMB247.0 billion, equivalent to more than three years of revenue based on the company's annualized 1H2019 revenue, of which 30-40% will be recognized in 2H2019, and the remaining 60-70% to be recognized in FY2020 and FY2021.

Growing Revenue Contribution From Recurring Income Businesses

The property investment (shopping malls and long-term rental apartments) and property management services segments accounted for 6.7% and 5.0% of Longfor's top line for 1H2019, respectively, but they contributed a larger proportion of the company's bottom line. For 1H2019, Longfor generated 18.0% and 3.9% of its operating profit from the property investment and property management services business, respectively. In other words, more than a fifth of Longfor's earnings for 1H2019 was derived from recurring income sources.

Longfor's property investment business generated RMB2.6 billion in revenue for 1H2019 or RMB5.2 billion on an annualized basis, and the company targets to achieve approximately RMB9 billion in revenue for the property investment business by FY2020. Similarly, Longfor aims to grow the revenue contribution for the property management services business from RMB4 billion (annualized based on 1H2019 segment revenue) to RMB6 billion in FY2020. In summary, revenue from recurring income sources is expected to roughly double from RMB8 billion (annualized based on 1H2019 numbers) now to RMB15 billion next year. It re-invests approximately 10% of the cash proceeds from contracted sales every year in investment properties.

Longfor is one of the first few property companies in China to develop shopping malls, and it has 29 shopping malls and a GFA of approximately 2.96 million sq m as of end-June 2019 operated under the Paradise Walk (one-stop experience shopping malls), Starry Street (community shopping malls) and MOCO (mid- to high-end household and lifestyle shopping centers) brands. Retail sales for the shopping malls grew +23% YoY to RMB12.3 billion in 1H2019, while shopper footfall increased +16% YoY to 220 million over the same period, and the shopping malls have an average occupancy rate of 98% as of end-June 2019. The company targets to open 9 and 16 new shopping malls in 2H2019 and FY2020, respectively.

In terms of unlocking the value of its shopping malls, Longfor has no immediate plans to spin off the shopping mall assets, but it will consider divesting partial non-controlling stakes in certain mature shopping malls to private equity funds to realize value.

Longfor rents out more than 60,000 apartment units in Tier-1 and Tier-2 cities such as Beijing, Shanghai, Shenzhen, Hangzhou, Nanjing, Chongqing and Chengdu on a long-term basis in first- and second-tier cities under the Goyoo brand. Apartment rental income increased +210% YoY to RMB430 million for 1H2019, and Longfor aims to increase the number of apartment units available for rental from 60,000 now to 80,000 by the end of the year. Longfor has achieved an occupancy rate in excess of 90% for rental apartments in service for at least six months. The company was ranked among the top three rental apartment operators in China in terms of brand awareness by Chinese Real Estate Industry Association.

Longfor has a property management services arm managing 4.4 million sq m in Gross Floor Area or GFA of properties serving 2.4 million homeowners in 73 cities across China. Income from property management and related services grew +48% YoY to RMB1.8 billion in 1H2019.

Low Funding Cost Comparable With SOEs

Longfor Group's cost of funding was 4.56% for 1H2019, and it managed to issue new domestic corporate bonds in July 2019 with coupon rates as low as 3.9%. This is very impressive considering that the China property sector's average financing cost is higher at approximately 6.5% based on 30 Chinese property developers I track, and most of those with lower funding costs are state-owned enterprises or SOEs. One such example is property developer China Resources Land Limited (OTC:CRBJY) (OTCPK:CRBJF) [1109:HK], the real estate arm of state-owned conglomerate China Resources Group, which had a funding cost of 4.45% in 1H2019. I wrote about China Resources Land in an earlier article published on September 3, 2019.

Access to financing at a reasonable cost is a key competitive advantage for property developers, and Longfor clearly has an edge over most non-SOE property developers in that respect. Longfor also does well on other credit metrics.

Longfor has investment grade credit ratings from rating agencies such as BBB- by S&P, Baa3 by Moody’s, and BBB by Fitch. The company's net gearing was relatively low at 53% for 1H2019, versus an average net gearing of approximately 90% for a list of about 30 Mainland China property developers which I track. Foreign currency debt exposure is limited at only 21% of the company's total debt. Average debt maturity period was 5.69 years, implying limited refinancing risks. Longfor also has low short-term liquidity risks with cash to short-term debt ratio at 4.22 times for 1H2019.

Valuation

Longfor Group trades at 10.2 times consensus forward FY2019 P/E and 8.3 times consensus forward FY2020 P/E based on its share price of HK$32.70 as of October 17, 2019. This represents a significant premium to its historical five-year forward P/E of approximately 7 times.

The stock is valued by the market at 2.1 times P/B versus its historical five-year average P/B of approximately 1.2 times.

Longfor Group offers a trailing dividend yield of 3.5% and a consensus forward FY2019 dividend yield of 4.1%, supported by a 45% dividend payout ratio.

Variant View

The key risk factors for Longfor Group include weaker-than-expected contracted sales growth, lower-than-expected earnings contribution from recurring income sources and regulatory policies with a negative impact on the Chinese property market.

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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.


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