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Morningstar | China Evergrande's Interim Results a Beat, but Growth Slowing

China Evergrande Group's, or Evergrande's, interim 2018 results were above our estimate, driven by faster booking, stronger margin and lower expenses. The company reported net profit of CNY 53 billion and core business profit of CNY 55 billion, up 129% and 102% year on year. Accounting the strategic investors' injection of capital into the company's onshore entity, the minority shareholders are entitled to approximately 42% of earnings during the period. Excluding the impact of gain on disposals, we estimate the core profit attributable of CNY 29 billion, or 66% of our full-year projection. The company declared no interim dividend, same as previous years. But, the company will pay a special dividend to make up for the lack of final dividend in 2016 and 2017. While the earnings for the period were stronger than expected, but, given the slowing sales trend and lower growth prospect, we maintain our fair value estimate of HKD 21, along with the company's no-moat rating.

The booked revenue and gross profit totaled CNY 300 billion and CNY 109 billion, up 60% and 62% year on year. The top line and gross profit account for 52% and 57% of our full-year projection. The gross margin was steady at 36%, roughly the same as a year ago. Earnings were also boosted by lower than expected SG&A and other operating expenses, totaling 6.4% of the contract sales during the period, compared with 7% and 7.6% for full-year 2017 and 2016. We expect this expense ratio to climb higher as contract sales growth to taper off.

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. 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.

The company continues to take steps to improve its capital structure. Net gearing fell to 159%, down significantly from 240% at year-end. The lower gearing was partially attributed to a slower land bank expansion, relative to the contract sales pace. During the period, the company acquired land reserve of 31 million square meters, compared with 126 million and 102 million during 2017 and 2016. The land bank totaled 305 million square meters at the period end, compared with 312 million and 229 million at year-end 2017 and 2016.

As the gearing continues to decline over the next few years, the company will likely benefit from a stronger balance sheet and lower financing cost. During the period, the effective interest rate was 8.3% down slightly from year-end 2017, and lower than plus 9% average in the years past. We project gearing to fall below 150% by 2019 and borrowing cost to fall below 8%. However, even at the current level, the company's gearing is still very high relative to its peers, given the asset intensity of the sector.

Further deleveraging will be at the expense of future growth. In addition, the equity injection from strategic investors will cap the growth in attributable earnings. While the on-shore listing is still pending, strategic investors have some protection through preferential provisions such as performance undertaking, preferential dividend distribution and repurchase obligation. Considering the uncertainty of the on-shore listing and the preferential terms available to strategic investors, we believe the firm is currently overvalued.