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Morningstar | Poly Developments Is in a Balancing Act Between Earnings Growth and Balance Sheet Strength

As the Chinese property market enters a consolidation phase, large developers will be the main beneficiaries as smaller players and nonspecialist firms are pushed out of a market characterized by greater pricing pressure and less funding liquidity. Changing demographics will lead to slower urbanization and lower fixed-asset investments, and the capital market will see tighter liquidity as the central government seeks to deleverage gradually. In our view, the buoyant property market and the accommodative policy environment are mostly in the past.Given Poly Developments' well-known name brand affiliation with a prominent SOE and its large operational scale, it is expected to be a beneficiary of consolidation. Over the past five years, its top-line growth has kept apace relative to its peers, such as COLI and Vanke, at roughly a 25% CAGR. However, earnings growth has been below par, at a 13% CAGR. In particular, earnings growth for 2015 and 2016 was 2% and 0%, respectively, owing to the extensive use of private-equity financing at the project level. The group’s slower asset turnover has led to a stretched balance sheet and higher financing costs, despite its SOE affiliation.In order to achieve the company’s ambitious contract sales target of CNY 500 billion during the 13th Five-Year Plan (ending 2020), it will likely continue to make large portfolio acquisitions via its parent company. To fund this growth, the company will need to continue leveraging private-equity financing and using the joint-venture structure for more of its projects. Poly Developments also has an ambitious expansion plan in the commercial property sector, targeting 10 million square meters of commercial properties by the end of 2020, up 10 times from the current portfolio. The expansion plan is billed as an asset-light play, with other private-equity funds (Poly Capital, JV with China Life) acquiring and holding the physical assets. Earnings from commercial property sector account for 5% of the earnings currently. Given the asset-light approach, we do not expect the business to contribute to the top line or earnings significantly during the projection period.