July 10, 2010 (Chinavestor) China Housing & Land Development (NASDAQ:CHLN) - Unstable earnings, unfavourable cash position and a risky outlook. The report is available in pdf format: CV_CHLN_2010_Q1.pdf .
China Housing & Land Development (NASDAQ: CHLN) is a residential and commercial property developer based in Xian, and engages in the acquisition, development, management and sale of property in Northwest China. The company targets the middle income market which includes mainly first home buyers and first time up graders of self-owned properties. China Housing & Land Development (NASDAQ: CHLN) offers three fundamental types of real estate development including high-rise (between 12-28 stories high), mid-rise (7-11 stories high) and low-rise apartment buildings and villas (2-6 stories high).
We suggest a SELL rating on China Housing & Land Development (NASDAQ:CHLN). The company’s financial position may appear to be fairly positive given the rising end of period cash balance and a positive growth in total revenues. However, with a closer look at the sources of cash flows and revenues, the outlook no longer seems to be as bright.
Disappointing cash position:
Even though the end of period cash position appears to be favorable in the last 4 quarters, cash from operating activities has been rather stagnant. The company has been relying quite heavily on financing activities to retain its liquidity. The company has recently retired $10 million of its non convertible notes through an issuance of 1.73 million common shares to reduce its debt obligations, a move that will strengthen its balance sheet but with an impact on future earnings per share.
The company’s bottom line profit has been fluctuating significantly in recent quarters. A restructuring of a subsidiary was undertaken to obtain full ownership in Success Hill Investments and to gain more control over the Puhua Project. With the additional investment into the Puhua Project, CHLN’s future performance is dependent upon its success.
Uncertainty in real estate prices
The government’s measures to curb speculative buying in the real estate market may have a negative effect on the sales growth and profit margin of real estate companies. These measures raise the barriers to investing in this industry, resulting in demand uncertainty, price changes and a shift in investor behavior.
1: Disappointing cash position
China Housing & Land Development’s 2010 first quarter end of period cash balance was $66.3m, which is an increase of 80% from $36.9m in last quarter of 2009. However, despite the consistent increase in the end of period cash balance since second quarter of 2009, cash from operating activities has been fairly mediocre in the last four quarters, as represented by the blue line in chart 1. This implies that it has been sourced from other activities. In chart 2 below, cash from investing activities appears to be fairly constant over time, while in chart 3, the red line shows that cash from financing activities has followed a similar rising trend as the cash at end of period.
A comparison of Chart 1 and Chart 3 highlights some key characteristics between cash from operating activities and cash from financing activities. Throughout 2008, cash from operating activities has been in the negatives, yet in fourth quarter of 2008 there is a notable increase in cash at end of period. This can be reconciled by Chart 3, where the red line in December 08 shows that there is a significant increase in cash from financing activities, derived from investment and advances from non-controlling interest shareholders amounting to approximately $29m.
Likewise, in the most recent quarter, cash from operating activities plummeted from $12.9m to $0.16m, yet end of period cash increased by 80%. Chart 3 demonstrates that this rise is primarily a result of the $30m net cash provided by financing activities, comprising of bank loans. This may be a cause for concern because it suggests that the company is relying quite substantially on financing activities to maintain its liquidity.
2: Eight quarters of unstable earnings
China Housing reported first quarter 2010 total revenues of $33.6 m, an increase from $26.3m in the fourth quarter of last year. While the company has a net income from business operations of $2.98m, first quarter’s net loss attributable to the Company was $11.1m with an earnings per share of ($0.34), making it the second consecutive quarter of net losses. Net loss attributable to the Company in fourth quarter of 2009 was $1.05m. Gross margin increased by 38% to 6.48m, from 4.68m in the previous quarter.
As demonstrated by the Net Income graph above, China Housing’s net income attributable to the company in the last few quarters experienced quite significant fluctuations, and there have been substantial variances between the net income from business operations and net income attributable to CHLN. In the second quarter of 2009, the difference was primarily due to a periodic revaluation of derivatives and warrants amounting to non-cash losses of $8.7 million. Consequently, net loss attributable to CHLN was approximately $10 million in spite of a positive operating income of $4.37 million. This was followed by an upward revaluation of derivatives and warrants in the third quarter of 2009, which explains the higher net income attributable to China Housing & Land Development (NASDAQ:CHLN) of $12.8 million in comparison to the $3.23 million from business operations.
More notably, the large variance between the net income from business operations and net income attributable to CHLN in the first quarter of 2010 was caused by a once-off, non-cash charge incurred as a result of an acquisition to redeem 40% of Prax Capital’s interest in Success Hill Investments Limited. Success Hill Investments is a joint venture which was entered into by CHLN and Prax Capital to develop the 79 acres Puhua Project in Xian. By acquiring the remaining interest in Success Hill Investments, CHLN obtained Prax Capital’s 25% interest in the Puhua Project Company. The restructuring, announced on May 11, led to a $14.2 million one-time charge incurred in Q1 2010 and Prax Capital will be paid a total of $84 million over the next three years.
The company’s decision to extend its 60% interest to a full ownership in Success Hill Investments was driven by an intention to gain more control over the Puhua Project and to reap the additional income associated with the project. Under the initial agreement with Prax Capital, only 75% of the net income from Puhua Project was attributable to China Housing, but subsequent to the restructuring, 100% of this income will form part of the company’s earnings.
With this acquisition, it looks like China Housing is pushing on with an expansion strategy despite the Chinese government’s numerous policies to curb the rising prices in the real estate market. The company is banking on the Puhua Project contributing an additional $36.7 million to its net income through to 2014, which includes a projected tax saving (derived from interest payments to Prax Capital) of approximately $10.5 million. The pie chart above demonstrates a breakdown of the revenues recognised in the most recent quarter. JunJing II Phase One, JunJing II Phase Two, and Puhua Project are still under construction, while the completed projects include Tsining – 24G, and JunJing I. The Puhua Project contributed $11.5 million to China Housing’s 2010 first quarter’s revenues, accounting for approximately 34% of total first quarter revenues, hence, the company’s future earnings are quite considerably dependent upon the performance of Puhua Project, especially with the additional investment into the project.
Xian Tande is a major real estate developer in Xian, and a direct competitor of China Housing & Land Development (NASDAQ:CHLN) . It is listed on the Shanghai Exchange (SHA:600665), and is currently developing a project in Xian with GFA of 140,000 square meters. It operates its businesses primarily in Xi’an, Shaanxi province, Shenzhen, Guandong Province, and Suzhou, Jiansu province.
CHLN’s sales growth has outperformed its competitor Tande, as well as the industry rates. CHLN has achieved an impressive 5 year sales growth rate of 198.17 in comparison to its competitor, Tande, at 21.87, and the industry rate of 3.58. Yet, its profitability ratios indicate that profits are not as high as Tande. Operating margin for CHLN is 2.87 which is lower than Tande’s 12.55. CHLN’s EPS (MRQ ) vs QTR 1 Yr Ago of -910.05 is also far below Tande’s 131.12. Likewise, EPS (TTM) vs TTM 1 yr ago is -204.06 while Tande’s EPS (TTM) ratio is 26.87.
With a long term debt to equity ratio of 109.76, China Housing & Land Development (NASDAQ:CHLN) is more highly leveraged than Tande. The industry average is at 97.93 while Tande is lower at 67.19. However, the company has recently retired $10 million of its non convertible notes through an issuance of 1.73 million common shares to reduce its debt obligations. This will strengthen its financial position and reduce its long term debt to equity ratio.
4: Uncertainty in Real Estate Prices
In response to the rising real estate prices, the government has adopted tightening measures to curb speculative buying.
These measures include:
• Increasing the required down payment for a second housing mortgage from approximately 30% to the current 50%. (April 15)
• Increasing the borrowing rate on the second mortgage to 1.1 times the benchmark rates. (April 15)
• Local governments can restrict the number of units that can be bought. (April 17)
• Banks are to required to suspend lending to third home buyers, and to those who cannot provide tax returns or proof of social security contributions in the related city for at least one year. (April 17)
• Property developers who deliberately delay proposed sales dates to raise housing prices will be punished. (April 21)
• Developers are not allowed to take deposits for sales of uncompleted apartments without approval. (April 21)
• Developers must disclose to the public all apartments available for sale along with their prices, and commence sales within 10 days upon obtaining pre-sale approval. (April 21)
After the release of the new policies, new and second hand housing prices fell in various cities. Average prices of Beijing’s commercial residential properties for the week ended May 9 fell by 9.6% from the week before, and 31.43% from the week ended April 11. Prices of newly built houses in Beijing declined between 2,000 to 5,000 yuan. Likewise, the average house prices in Shenzhen fell by 25.44% and Shanghai by 12.2%. With these measures in place to curb the speculation of the real estate market, the property sales and price rises are expected to slow down.
Consequently, this may have a detrimental impact upon the ability of the company to generate greater sales in the near future. If the regulations prove to be effective in curbing speculative buying, and demand for residential and commercial property in Xian declines, China Housing may be faced with lower sales and lower prices.
Table 1: China Housing & Land Development Annual Income Statement
Table 2: China Housing & Land Development : Annual Balance Sheet
Table 3: China Housing & Land Development : Annual Cash Flow Statement
I, Linette Ng, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.
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