Kate Lin: Welcome to Morningstar. It's been a very busy few weeks for Country Garden Holdings (02007) as the developer announced its latest earnings report while being embroiled in a liquidity crisis. To help with the latter, the company announced that it will plan an equity issuance to help avoid default and negotiate payment extension for its outstanding onshore debts. But will it be able to raise as much as it needs? We're talking to Jeff Zhang, our equity analyst at Morningstar.
Hi, Jeff. The numbers around sluggish home sales were as expected. What else was of note for investors in the latest earnings report?
Jeff Zhang: We do know that, for the developers that we cover, they post very subdued gross margins for property developments in their earnings for the first quarter as well, which we think is mainly due to lower selling prices and elevated land costs. Besides, we also note the elevated inventory level in lower-tier cities for most developers as the homebuying sentiment in those areas remains weak in the first half.
Lin: So Country Garden announced an equity issuance, will it be able to raise as much as it requires, and what would be the impact for Country Garden going forward?
Zhang: We think that Country Garden engaged in equity issuance to a certain creditor just to avoid a default on its previous debt. And so with that already in place. We do expect Country Garden to engage in more of the equity issuance and to the creditors for a debt-equity swap. With that being said, we view that high uncertainty still remains over whether Country Garden could be able to raise an adequate amount of funds for debt servicing as right now as accessibility to funding remains very subdued.
Lin: So after this earning season, have you adjusted our assumptions and estimates for Country Garden and its property service subsidiary, Country Garden Services (06098)?
We maintain our fair value estimate for Country Garden this time as we have previously addressed this high likelihood of default through raising our assumption on the weighted average cost of capital, while lowering our gross margin estimate. Our fair value estimate for Country Garden stayed at HK$ 1.2.
With that being said, we did lower our top-line growth estimate for Country Garden Services given a more competitive market for the Chinese property management [companies]. With that being said, we still view the shares undervalued as Country Garden Services is separately managed from Country Garden with more resilient margins from its asset-light property management services. So that's our findings.
Lin: Lastly, what is your base case scenario for Country Garden and the sector as a whole as we enter the last month of 2023?
Zhang: We think that Country Garden will likely see net losses for 2023 and 2024, mainly given more subdued profit margins and and higher impairment they provided on the unsold items. And so Country Garden will likely see weaknesses on both the top line and bottom line through the next two years.
However, for the sector as a whole, we do feel that the housing demand will likely rebound through the second half following more policy tailwinds, particularly in higher-tier cities, where we will see more resilient demand. That being said, we maintain our view for only a gradual sector recovery through at least 2025.
Lin: Right. Thank you so much, Jeff. For Morningstar, I'm Kate Lin.
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