Initiating with a Buy rating and 17% upside potential
We initiate coverage of China SCE with a Buy rating and a target price ofHKD3.47. We like the company for its: 1) decent land bank with increasingexposure to T1/T2 cities (64% of GAV); 2) strong earnings growth (26% CAGRover FY16-19F) driven by strong contracted sales (41% CAGR since 2013) andpotential gross margin expansion; 3) inexpensive valuation at 5.4x FY17F P/Eand 1.1x FY16 P/B and a 53% discount to NAV; and 4) a potential decentdividend yield of 6-9% in the next three years.
Improving land bank with higher T1/T2 cities exposureChina SCE has been actively replenishing land bank in T1/T2 cities anddestocking in low-tier cities over the past few years. By end-2016, it had a totalland bank of 9.1mn sqm (including 49%/15% in T1/T2 cities by GAV), which webelieve will provide total saleable resources of about RMB100bn to support28% sales growth to RMB30.2bn in FY17F, and maintain flattish growth in2018F (even without further land acquisitions). We believe contributions fromT1/T2 cities will continue to increase to c.70% in 2017/18F from 66% in 2016and 51% in 2015.
Strong ASP rally to boost gross margin expansion and core profit growth
Thanks to higher exposure to T1/T2 cities, China SCE has achieved strong salesgrowth (41% CAGR) since 2013. Coupled with an ASP rally last year, weexpect the company to deliver strong core earnings growth (26% CAGR overFY16-19F) to RMB1.7bn/2.4bn/2.7bn in the next three years and gross marginexpanding to 27-29% (vs. 25% in FY16) in the period.
Decent dividend yield, but gearing may remain high
Management is keen to maintain a payout ratio of more than 30%, andcoupled with strong earnings growth, we expect the company to offer a 6-9%dividend yield in FY17-19F. However, we expect net gearing to remain highdue to its active land acquisitions.
Valuation and risks
Our target price of HKD3.47 is based on a 45% discount to end-FY17F DCFbasedNAV of HKD6.32. The stock trades at 5.4x FY17F P/E (EPS: RMB0.49),1.1x FY16 P/B and at a 53% discount to NAV. Key risks to our target priceinclude weaker-than-expected sales growth, slower margin recovery, andhigher net gearing due to unwise land acquisitions.