• Overstretched balance sheet
• Potential of significant dilution risks
• Low valuations but not worth the risks

Strong Earnings Growth But at the Expense of Financial Prudence

Guangzhou R&F Properties Co., Ltd. (R&F) (Stock code: 2777 HK) is a property developer with a large presence in PRC. Although it had delivered strong core earnings growth in FY17 and 1H18, we believe this has come at the expense of financial prudence in its capital management. R&F’s net gearing ratio stood at 187.5%, as at 30 Jun 2018, and is one of the highest among the Chinese developers we track.

This would likely expose it to heightened risks relative to its peers in light of the slowdown or even decline in home price growth and tight credit conditions in China. We also believe there are potential refinancing risks for R&F, and this is compounded by the significant amount of bonds that can be puttable for early redemption in FY19.

Our Projections Are More Conservative Than Consensus

Looking ahead, we forecast FY18 and FY19 core net profit of RMB9.64b and RMB10.38b, which is 4.7% and 14.3% below Bloomberg consensus’ estimates, respectively. We see risks of its dividends being cut given its high net gearing position. Even if R&F decides to preserve its dividends, this could likely come at the expense of carrying out a large equity fund raising exercise (assuming shareholders approve the mandate at an EGM in Dec and approval is obtained by CSRC), which either way would be detrimental to its shareholders, in our opinion.

Trading at Low Valuation Multiples for a Reason; Initiate SELL

Although R&F is trading at a significant discount to the average forward P/E and P/B of its peers, we believe this may not be unwarranted given the risks highlighted above. We derive a fair value estimate of HK$9.63 after applying a conservative target P/E multiple of 2.6x (-2 standard deviations from 8-year mean).

Notwithstanding a prospective FY18F dividend yield of 10.1%, our potential total returns expectations are -8.9%. As such, we initiate coverage on R&F with a SELL rating (based on closing price of HK$11.90 on 6 Dec 2018).

While the possibility of a successful trade deal between China and the U.S. may improve investors’ sentiment, we would prefer investors to switch out of R&F given its risk profile and into Longfor (960 HK) [BUY; FV: HK$26.17] and KWG Holdings (1813 HK) [BUY; FV: HK$12.50] should they wish to gain exposure to the China property market.

Source: OCBC Research - 7 Dec 2018