China’s property developers have a habit of countering bad news with good. Bears expect a slowdown, given high net debt and government plans to rein in excessive borrowing. But core profits at big developers grew about 50 per cent on average in the most recent earnings reporting season. The sector cannot defy the bears for ever.
The business has already become tougher in two respects. First, the government has restricted land supply in an effort to forestall price drops, so it is harder for developers to increase land banks. Recent mergers in the sector have achieved this at lower cost than auctions.
Second, regulators are expected to limit residential property sales volumes by restricting consumers’ access to credit. As a result, Moody’s thinks sales growth will slow in the second half this year, after an 18 per cent jump in the first half.
There has been no margin squeeze so far. Sales price growth has outpaced the rate of increase in land costs, with the result that finished property still costs around twice what the land did. That is a ratio as high as it has been since 2013. But it is now likely to decline.
If sales growth does slow, the largest groups will probably gain more market share. The share of the top 10 groups has already quadrupled in the past decade to a fifth. Buying land is a means of gaining scale in a consolidating industry.
But it has come at a cost. In a heavily leveraged industry, Evergrande and Sunac stand out with net debt of more than twice shareholder’s equity, even after counting perpetual securities. The sector average is 70 per cent. Both groups have indicated that reducing debt is a priority. In the meantime, they will be helped by lower debt costs — these fell to a record low of 5.4 per cent in the first half. Agreed sales will help with cash flow once they are completed.
Growth in the value of newly acquired land has outpaced the growth in acreage. If that is because of savvier deals, fine. If it is because groups have loaded up on debt to buy speculative land in less mainstream locations, shareholders should be worried.