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Morningstar | 02007 Updated Forecasts and Estimates from 21 Sep 2018

As the Chinese property market enters a consolidation phase, large developers are expected to be the main beneficiaries as smaller players are pushed out of a market characterized by greater pricing pressure and less funding availability. The change in demographics will lead to slower urbanization and lower fixed-asset investments. The capital market will see tighter liquidity as the central government seeks to gradually deleverage. The buoyant property market and the accommodating policy environment are mostly in the past.Country Garden is unique among large developers in its focus on lower-tier cities. This is reflected in the company’s average selling price, as well as the accommodation value of its land acquisitions. As the peak of the Chinese property market has passed in terms of sales and construction, only certain metropolitan areas will see continued growth in the coming decade, while the overall sector will shrink gradually. Country Garden has a high level of exposure outside of these core metropolitan areas, accounting for roughly three fourths of the land bank. The majority of large developers have just half of their land banks outside of these core metropolitan areas.While the company’s strategy bears significant risk, given industry trends, the company has a good track record of selecting and building in areas with good spillover demand, as well as creating greenfield projects for second-homebuyers. While these lower-tier cities are more prone to faltering demand and inventory buildup, the firm faces much weaker competition, allowing it to capture most of the value from the industry roll-up process.Further, land cost is usually less than 15% of revenue, compared with more than 30% for its peers. As construction costs are similar across projects, a low land cost, especially one below construction cost, allows a developer to achieve higher return on total invested capital. Hence, the company has historically achieved ROICs 100 basis points above its cost of capital. The decline in the past three years is due to a step-up in area under construction to support contract sales growth. We expect ROIC to rebound, reaching 50-100 basis points above WACC.