Company Reports

Amid prolonged property market downturn in China, Longfor Group Holdings, or Longfor, has renewed its strategic focus on developing residential projects and ramping up investment properties’ income in around 20 higher-tier cities. For property development, we expect Longfor to source over 90% of contracted sales and new landbank from wealthy regions, including the Yangtze River Delta and Chengdu-Chongqing Area. Moreover, ongoing homebuying policy tailwinds should drive a meaningful rebound in Longfor’s housing sales, in our view. That said, structural economic slowdown, coupled with population decline, will likely moderate Longfor’s sales growth over time. Under China’s property market consolidation, we believe Longfor should outperform most non-state-owned peers thanks to superior asset quality, quicker inventory turnover, and better financial health.

Longfor reported weak 2023 results, with core net profit down by around 50% year on year, but in line with its prior profit warning. Its CNY 173.4 billion in contracted sales for 2023 missed our forecast due to subdued buying activities in China in the second half. As we expect a slow recovery in home demand, we lower our 2023-27 revenue CAGR forecast to 2.8% from 5.8%. In addition, Longfor’s 2023 operating margin fell significantly by 530 basis points amid falling home prices, and we lower our midcycle margin forecast to 14.0% from 14.7%. We also raise our cost of debt assumption to 8.5% from 7.5%, given Longfor’s elevated funding cost, resulting in a higher weighted average cost of capital at 10.4%. Consequently, we cut our fair value estimate to HKD 14.50 per share from HKD 22.00. Positively, we think Longfor’s investment property operation and service businesses will likely see more resilient earnings growth, and the repayment of all offshore bonds due by end-2026 may ease investors’ concerns. Although Longfor’s shares remain undervalued, we prefer state-owned developers such as China Overseas Land & Investment, given their stronger brand recognition and healthier balance sheets.

We published our inaugural China real estate industry pulse for the first quarter of 2024 with the view that housing demand should gradually recover through 2026, supported by ongoing policy tailwinds. While new home sales in China remained sluggish in 2023, the nationwide average price was steadier due to a continuing mix shift to wealthier regions with more resilient prices. Moreover, we like the ramping-up of supportive measures since the second half of 2023 and expect further easing in buying restrictions and mortgage rate cuts in large cities. While share price performances could remain volatile in the near term, we see an improving risk/reward profile at the current valuation as the market may be missing key developers' improving sales outlooks. As such, we prefer top state-owned builders, China Overseas Land & Investment and China Resources Land, as both have seen better sales growth, higher asset quality, and healthier gearing ratios versus their peers.

Amid a prolonged property market downturn in China, Longfor Group Holdings has renewed its strategic focus on developing residential projects and ramping up investment properties’ income in around 20 higher-tier cities. For property development, we expect Longfor to source over 90% of contracted sales and new landbank from wealthy regions, including the Yangtze River Delta and the Chengdu-Chongqing Area. Moreover, ongoing homebuying policy tailwinds should drive a meaningful rebound in Longfor’s housing sales, in our view. That said, structural economic slowdown, coupled with population decline, will likely moderate Longfor’s sales growth over time. Under China’s property market consolidation, we believe Longfor should outperform most non-state-owned peers thanks to its superior asset quality, quicker inventory turnover, and better financial health.

We initiate Longfor Group Holdings with a no-moat rating and fair value estimate of HKD 22 per share, which lands in Morningstar 4-star territory and implies a 0.5 times price/book ratio. Despite being a privately owned China real estate developer, Longfor should survive the current market downturn by developing quality residential projects in wealthy cities, in our view. While we expect Longfor to outperform most privately owned peers on the top line and operating cash flow for the long term, its short-run earnings may lag state-owned developers like China Overseas Land & Investment, which have better-positioned residential projects. Nonetheless, we believe Longfor’s flagship commercial complex Paradise Walk, coupled with rental apartments, should fuel recurring income growth to offset property market swings. We also foresee Longfor’s gross margin to improve to 22.1% in 2027 from 21.2% in 2022, thanks to a housing demand rebound and a favorable mix shift to investment property and service businesses. Our valuation implies a modest underpricing for Longfor, as we believe that its recurring revenue growth and profitability pickup have not been fully priced in.