Poly Property’s (PP) 1H14 revenue met our estimate by growing 8.2% YoY. Core net income decreased 59.8% YoY to HK$497m, and core net margin deteriorated to 4.4% from 2013’s 5.8%, due to the surge in finance cost on lower interest capitalisation and higher minority interests.
Owing to the thinner-than-expected margin, we trim our 2014E EPS by 3% to HK$0.59, and downgrade the stock to HOLD.
Key Factors for Rating
PP’s 7M14 contracted sales amounted to RMB13.4bn, equal to 47.9% of its full- year target. According to management, its full-year target can be attained if the 2H14 sell-through ratio reaches 46%, vs. 43% in 1H14. We reckon that with the fierce competition expected in 2H14 due to developers’ massive project launches, PP’s sell-through rate is likely to deteriorate in 2H14. Hence, it is still facing considerable risk of failing to meet its sales target.
Net gearing jumped to 105.7% from 2013’s 82.1%, due to higher-than- expected cash outflow for land premium payments. PP acquired a total of 2.25m sqm of landbank in 1H14. Together with payments for land-banking in previous years, PP is expected to pay RMB11bn in land premiums in 2014, above previous guidance of RMB9.1m. Thus, we project a further rise in net gearing to 106% at end-2014. Good news is that this did not result from a lower cash collection ratio, as the ratio improved to 74% from 2013’s 71%.
Finance cost surged 57.6% YoY, contributing to further core net margin squeeze to only 4.4% from 2013’s 5.8%, largely due to less interest capitalisation. We estimate similar finance cost in 2H14 to 1H14, with higher net gearing offsetting the larger portion of interest capitalisation. On a positive note, effective interest rate decreased to 6.98% from 2013’s 7.57%; interest rate on trust loans also declined to 8.8% from 2013’s 9.86%.
Gross margin stood at 25.1% in 1H14, below 1H13’s 31.2% but above 2013’s 23.4%. PP is adjusting its geographical focus to shift towards Yangtze River and Pearl River Deltas. We expect the effect of this change on margins to take time to be reflected on the P&L statement. We project gross margin to stay at around 24-25% in 2014-15.
Key Risks to Rating
Net gearing may exceed expectations if its contracted sales target is missed.
Valuation
We lower our 2014E NAV by 18% to HK$9.23/share, due to the higher net gearing and lower net margin, and derive our target price of HK$3.69 by applying a 60% discount to our NAV. The stock is currently trading at a relatively deep NAV discount of 62% which we consider fair given its high gearing. We downgrade our rating to HOLD.