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Morningstar | China Evergrande's Higher Profit for Interim Expected on Faster Completion, but Contract Sales Slows. See Updated Analyst Note from 07 Aug 2018

China Evergrande Group, or Evergrande, announced a positive profit alert for first-half 2018. The company expects its aftertax net profit and net profit from the core business to increase by 125% and 100% year on year, respectively. Further, the company expects its net gearing ratio to decline to 130% from 184%. The market reacted positively to the news by bidding the company's shares up more than 20%. Our reaction is more muted on the account of slowing contract sales momentum, despite the faster completion driving higher earnings in the near term. We adjusted our assumptions on sales and booking, resulting in our earnings estimate increasing by 12% and 10% for 2018 and 2019, respectively. We change our fair value estimate to HKD 21 from HKD 18 and maintain the company's no-moat rating.

Contract sales trend is slowing for the company. Year to July, contract sales were up 20% year on year, supported by 13% volume growth and 6% price growth. While still faster than the overall market, this growth rate is modest among its peers. Further, this is the slowest contract sales growth rate for the company over the past three years. As the period of strong sales growth was in 2016 and first-half 2017, revenue booking will likely decelerate after a robust first half in 2018. Further, given the inclusion of the third round of strategic investors in late 2017, minority interest now accounts for more than one third of the core earnings, up from the one quarter seen before, resulting in slower growth in attributable profit relative to core profit.

For full year 2018, the company guided a very modest contract sales growth of 10% to 15%. In contrast, strong sales growth averaged near 60% over the past three years. Year to date, the company recorded CNY 345 billion in contracted sales, or 55% to the full year target, assuming the lower range target.

The net gearing is expected to be below 130% at interim, we project a gearing of 160% at year-end, as some landbank replenishment is necessary to sustain the pace of presales and booking.