Downgrade to Sell as re-rating on farmland conversion is overdone
We downgrade Henderson to Sell （from Hold） following a 17% share price rallyin the past 2 months （it outperformed the sector average of 8% and HSI of 2%）。
In our view, the re-rating on the government’s potential acceleration offarmland conversion is overdone. Taking into account the split in land supplychannels, demand outlook, current land bank and farmland conversionprogress YTD, we believe it will take much longer to monetize its farmlandreserves. Specifically, we estimate NAV accretion from farmland conversion atjust 7.1% to 11.8%, and we believe the recent share price rally has more thanfully reflected this upside potential.
Supply of converted farmland can take 197 to 274 years to sell off
Henderson Land has the largest farmland reserves among Hong Kongdevelopers at 44mn sf in site area. Assuming plot ratios of 3.6x to 5x and anaverage unit size of 639sf, these farmland reserves can be potentiallyconverted to 161.6mn to 224.5mn sf of residential GFA, or 253,075 to 351,494units. Based on Henderson Land’s annual sales volume of 1,925 units andassuming two-thirds of land replenishment will come from farmlandconversion going forward, we estimate that it will take the market 197 to 274years to sell off the supply of converted farmland.
Corresponding potential NAV accretion ranges from 7.1% to 11.8%
We performed a sensitivity analysis of potential NAV accretion from farmlandconversion. Our analysis found that the plot ratios （3.6x, 4x and 5x） at whichfarmland is converted have an insignificant impact on NAV accretion over along conversion/take-up period. Assuming net profits of HK$3,000/sf,HK$4,000/sf and HK$5,000/sf （implying net profit margins of 20-25%），potential NAV accretion stands at 7.1%, 9.4% and 11.8%, respectively （roughlythe same at plot ratios of 3.6x, 4x and 5x）。
Target price of HK$47.9 based on sum-of-the-parts
Our target price is based on a sum-of-the-parts approach, which implies a2018 PE of 15x. We believe that applying a 5-7x PE to HK propertydevelopment and a 34% target discount to our estimated value of therespective investment property portfolios are appropriate in an ex-growthmarket. We have now adopted this methodology as our new valuation metricfor all HK developers under our coverage. Risks: government policy, salesmomentum and interest rate trend.
Outlook
We downgrade Henderson to Sell （from Hold） following the recent share pricerally, which outperformed the sector and HSI. In our view, the re-rating due tothe government’s potential acceleration of farmland conversion is overdone.
Taking into account the split in land supply channels, demand outlook, currentland bank and progress in farmland conversion YTD, we believe it willrealistically take 197 to 274 years （depending on the plot ratio） to monetizeHenderson Land’s entire farmland reserves. We estimate corresponding NAVaccretion at 7.1% to 11.8%, and we believe the recent share price rally hasmore than fully reflected this upside potential.
Valuation
Our target price is based on a sum-of-the-parts approach （previously targetdiscount on overall NAV）， which implies a 2018 PE of 15x. We believe thatapplying a 5-7x PE to HK property development and a 34% target discount toour estimated value of the respective investment property portfolios areappropriate in an ex-growth market. For China property development, webelieve that applying 7x PE （at the upper end of the 2019E PE range for Chinadevelopers and on par with industry leaders that have strong financialpositions, such as COLI and CR Land） is appropriate, considering the financialstrength and profitability profiles of Hong Kong developers. We have adoptedthis methodology as our new valuation metric across the HK developers underour coverage.
Risks
Macro risks: 1） external shocks and interest rate hikes if the low interest rateenvironment persists for longer, current high property prices could be wellsupported for longer; 2） sales volumes and property prices could be boosted ifthe government decides to loosen current administrative tightening measures;3） stronger-than-expected economic growth in the HK/Chinese economiescould have a positive impact on housing demand.
Company-specific risks: 1） if execution capability in China improves, this couldlead to a re-rating; 2） HLD could face less-than-expected competition for landbank following recent restrictions on China entities to invest in real estateprojects outside China, which could enable it to acquire land at morereasonable prices, leading to higher NAV growth.