Recent headlines from major publications such as Reuters, Bloomberg, CNA etc., have painted a bleak outlook for Country Garden. It seems to point that they would likely default on their debt which could potentially lead to a collapse of the whole company.
Country Garden was the largest real estate company in terms of sales in China last year. They generate 96% of their cashflows from real estate sales.
Headline numbers put them in debt of 196 billion US Dollars (1.4 trillion RMB). There have been also delays in the payment of interest on bonds and postponing the repayment of a key loan.
With the slowing of China’s economy coupled with inflationary pressure on construction costs, it has been a tough time for China developers. Country Garden is also not in the most ideal target segment, 60% of their property projects are located in 3rd to 4th-tier cities.
This is the segment where prices have fallen the most and the target buyers have low purchasing power.
We decided to have a look at their financials to have a better sense of the situation. Before we move into the numbers, let’s look at the background of Country Garden so we can paint a better narrative of their current predicament.
Background of Country Garden
Yang Guoqiang founded Country Garden in 1992 in Beijiao Town, Foshan City. He built the company from scratch, having previously worked as a farmer and on construction sites.
The company now has interests in property development, construction, fitting and decoration, property management, and hotel operations in a wide variety of global markets.
It was listed on the Stock Exchange of Hong Kong in 2007 with its annual sales exceeding RMB100 billion in 2013. The Company made it to the list of Fortune Global 500 for the first time in 2017.
In 2015, Chinese insurance giant Ping An became the second largest shareholder in Country Garden by acquiring 9.9% of the company for US$800 million.
Forest City Johor Bahru:
China made up the bulk of their business with 3125 developments as compared to 31 overseas developments. But what we could relate to when we talk about Country Garden, will be their grandiose Forest City Project that is just across the Causeway in Johor Bahru, Malaysia.
Forest City is meant to be a US$ 100 billion dollars development that was hyped up to be a paradise with turtles and white-sand beaches. To date, only US$ 4.3 billion has been invested and housing less than 10,000 residents. It is a far cry from their 700,000 projection.
Source: www.forestcitycountrygarden.com.my
The blueprint for Forest City was for 4 developments on 4 islands which are on reclaimed land. The largest island, Island 2, will be largely comprised of residential units. Island 1 will house Forest City’s central business district, shopping malls, the IT industrial park and others.
The remaining two islands will include a convention centre, additional hotels, a customs and border control clearance area, as well as duty-free shopping.
As to whether this mega development would eventually come to fruition would be dependent on many factors. The factors that come to mind would be
- Political Climate
- Singaporeans’ willingness to retire there (With the current sky-high cost, this could be a possibility)
- Transport link (The RTS to JB seems to be on track and operational in 2026)
- Crime rates etc.
Nonetheless, this is a sidetrack to our main focus, as this project would not have any material effect on Country Garden’s bottom line in the near to medium-term time frame.
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China Three Red Line Policy
We would like to just touch on the 3 Red Line Policy by China’s government which has anticipated the current debt issue surrounding property developers, as early as 2020 when they implemented this policy.
These are the 3 criteria:
- Asset to liability ratio must be greater than 70%
- Net debt to equity ratio must be less than 100%
- Cash to short-term borrowings ratio must be less than 1
The policy categorizes real estate developers by means of four colours, with each colour corresponding to the number of “red lines” that are overstepped. Each overstepped line is accompanied by annual growth restrictions on interest-bearing liabilities:
- Green indicates that a company meets all three requirements of the “three red lines”, and the liability growth rate cannot exceed 15%.
- Yellow indicates that one line has been crossed, and the liability growth rate cannot exceed 10%.
- Orange indicates that two lines have been crossed, and the liability growth rate cannot exceed 5%.
- Red indicates that all lines have been crossed, and the liability growth rate cannot increase at all.
In essence, this is how the policy works and the objective is to ensure that the property developers are overstretched. This is especially so with the low-interest rate environment for the past decade.
However, despite this policy, there have been high-profile bankruptcies by huge developers such as Sunac and Evergrande. We believe they are submerged too deep in debt that it is just not so easy to deleverage. This was further worsened by the lacklustre China’s economy.
Financials of Country Garden- Debt Load
| Stock | Country Garden | Evergrande |
| Price Earnings Ratio | Loss Making | Loss Making |
| Price to Book Ratio | 0.15 | Declared Bankruptcy |
| Price to Sales Ratio | 0.05 | 0.02 |
| Debt to Equity Ratio | 166% | Not available |
| Current Ratio | 1.2 | 0.69 |
| Cash and Equivalents | RMB 147 billion | RMB 8 Billion |
Source: Reuters
The headline numbers have been saying that they have racked up total debts of RMB 1.43 trillion which is not the case. The RMB 1.43 trillion dollars is the total liabilities which includes contract liabilities and trade payables.
Source: Financial Statements of Country Garden as of 30th June 2023
The actual interest-bearing component which consists of bonds and bank loans would amount to 257 billion. If we break it up, it will be 100 billion of bonds and 157 billion of bank loans. So the figure that the total debt of Country Garden of 1.4 trillion dollars would not be accurate.
We did a comparison with Evergrande which was the largest developer before they got into trouble. They have since declared bankrupt. There are no earnings to speak of as both registered losses.
Country Garden reported a loss of RMB $48.9 billion (US$ 6.7 billion) for the first half of 2023.
Their price-to-book ratio of 0.15 is an enticing proposition if we think that they are able to survive this ordeal with minimal further impairment to their asset base.
The current ratio of 1.2 is still healthy but they need to expedite and turn the tide over by doing more sales of their projects. Given the current climate, we will require China’s government to come in to revive interest in this ailing sector.
They have since June 2023 come up with property-related policies such as easing the mortgage restrictions. So they do know this would be detrimental if things come to a hard landing.
As the majority of the interest-bearing debt consists of bank loans, if the government is able to influence the banks to aid Country Garden to successfully refinance most of their bank loans, their liquidity situation would be more positive.
Their cash and equivalents of RMB 147 billion are more than enough to cover all their issued bonds and notes of RMB 100 billion.
So we guess the Trump Card lies in whether the China government’s stance is to save or not save Country Garden. Based on their financials, they are not in an extremely dire situation so we are sanguine about the current situation.
Factors to Take Note:
Difficulty in Repaying Interest on Bonds
We would just like to point out that Country Garden has not defaulted on any of its bonds and notes to date. They have managed to delay the payment of a maturing yuan-denominated bond.
They have also paid interest of US$ 22.5 million dollars on two US-denominated bonds after a grace period of 30 days.
Given they have cash of RMB 101 billion dollars, the mere fact they have issues in paying just US$ 22.5 million gives us a sense that their liquidity is under fire.
It could be having an issue trying to refinance the RMB 69.5 billion bank loan due soon.
China’s Property Market V Shape Recovery Unlikely
Source: Tradingeconomics.com
The fastest way to resolve the liquidity crunch is to sell off their inventory of apartments but given the latest price trend, it does not bode well. Property prices in China are now in decline as of the latest data point in July 2023.
The price decline is more prominent in the 3rd and 4th tier cities Country Garden has 60% exposure. The prices in Beijing and Shanghai are still holding well.
Though China’s unemployment rate is at 5.2% which is not a danger zone, their youth unemployment rate is at an unhealthy 21.3%. The growth rate of GDP has been 5.5% year-over-year for H1 2023, this is definitely not an indication of a booming economy.
Therefore, despite the government’s recent policies, a V-shaped recovery for the property market is unlikely in our opinion.
Valuation
Source: Financial Statements of Country Garden as of 30th June 2023
Given there are no earnings to speak of, we will approach the valuation from the price-to-book perspective. Given their greatest asset lies in their Properties under Development which are listed as Current Assets. The figure is RMB 818 billion.
To be realistic, we are of the view that a 20% discount would be necessary in order to clear the properties being built.
Currently, at a price of 0.93 HK, Country Garden is trading at a valuation of HKD 25.5 billion. This is at an attractive 0.15 Price to Book.
So if we take a 20% haircut on their development properties, it will give us a figure of RMB 655 billion. Adjusting for this, Country Garden will be trading at a Price to Book of 0.255.
If they survive this crisis and come up stronger, we are of the view that trading at 0.5 X Price to Book on the adjusted book value would be reasonable. This would put us at a possible target price of $1.8 HKD.
Summing Up
With the recent property crisis in China, it has led to the demise of some of the biggest names like Evergrande and Sunac. Would Country Garden be the next?
We have looked at their financials. Given their current standing, we are of the view that if the banks are supportive (with some direction from the government), they will be able to refinance their bank loans, Country Garden should survive this and see a better day.
The headline numbers of RMB 1.4 trillion are looking at their total liabilities, their actual interest-bearing debt is at RMB 257 billion. With cash and equivalents of RMB 147 billion (provided the numbers are accurate), Country Garden should be able to fend off this crisis.
However, we do not see a recovery of China’s property market in the near term and at best, it should stabilise.
In order to instil confidence, China’s government support in this situation is paramount. If they don’t act decisively, it could lead to a domino effect that will have a detrimental effect on an already precarious economic environment.
If Country Garden survive this crisis and comes up stronger, we are of the view that trading at 0.5 X Price to Book on the adjusted book value would be reasonable. This would put us at a possible target price of $1.8 HKD.
In spite of our view that Country Garden should survive this ordeal, it is way too risky for us to consider it as an investment.
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