Action
　　Country Garden issued a profit warning on August 18, expecting 1H22 core net profit to drop 67-70% YoY to Rmb4.5-5.0bn and attributable net profit to fall 93-99% YoY to Rmb0.2-1.0bn. We downgrade Country Garden from OUTPERFORM to NEUTRAL. We think that short-term factors such as the debt problems of other real estate firms and regional COVID-19 resurgence are likely to disrupt supply and demand in the new-home market. This may weigh on investor expectations for the firm’s fundamentals and risk appetites, in our view.
　　What’s changed?
　　Recovery of new-home market disrupted since July. High frequency data shows that GFA-sold of new homes in 50 cities fell 29% YoY in July and 34% YoY in the first two weeks of August, deteriorating again following the improvement in June (-30%). In addition to low volume of newly-launched projects, falling sell-through ratio in monitored cities and leading indicators of existing homes all point to a wait-and-see approach among homebuyers. Apart from watching strengthening city-specific sector support policies, we also suggest paying attention to the implementation and impacts of measures to ensure the delivery of property projects going forward. Amid macro pressure, we see uncertainty in the firm’s full-year sales. Corporate filings show the firm’s January-July attributable sales value fell 40% YoY to Rmb215.2bn.
　　Sector pressure resulting in slowing project delivery and falling profit margin in 1H22. We estimate the firm’s 1H22 revenue fell about 30% YoY to Rmb164.4bn. We estimate gross margin at 12-13%, or slightly over 15% after excluding provisions for inventory impairment. This marked a gradual bottoming in gross margin compared with the 19.7% in 1H21 and 16.1% in 2H21, in our view. The firm is addressing sector pressure and balancing asset value as well as cash-flow-positive profit through resolutely reducing inventory of low-quality assets and actively launching projects with relative ease in funding collection.
　　Numerous measures to support financial conditions. We estimate operating cash flow at about Rmb5.0bn in 1H22, given the relatively high ratio of sales proceeds collection at about 92% and strict control over opex. In addition, we think the balance of interest-bearing liabilities fell by about Rmb25bn (end-2021 balance at Rmb317.9bn). We thus estimate end-1H22 net gearing ratio at about 50% (vs. 45% in end-2021) and cash on hand at about Rmb150bn (vs. Rmb181.3bn in end-2021), compared with scheduled repurchase of Rmb4.0bn of domestic bonds in 2H22.
　　How do we differ from the market? The recovery of the firm’s growth potential may be slower than market expectation.
　　Potential catalysts: 2022 sales and earnings missing market expectation.
　　Financials and valuation
　　Given adjustment in sales schedule and gross margin, we lower 2022-2023 earnings forecasts 27% and 35% to Rmb18.65bn and Rmb16.69bn with YoY decline at 30.8% and 10.5%. The stock is trading at 2.7x and 3.0x 2022-2023e P/E. We cut TP 60% to HK$2.86 (3.2x and 3.6x 2022-2023e P/E with 20% upside).
　　Risks
　　Better-than-expected recovery in sector fundamentals; debt resolution of real estate firms markedly faster than market expectation; the firm’s full-year sales and earnings significantly beating market expectation.