Logan Property: Key Beneficiary Of Positive Policies In Shenzhen And Greater Bay Area – Logan Property Holdings Company Limited (OTCMKTS:LPHHF)

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Elevator Pitch

I favor Hong Kong-listed Mainland China property developer Logan Property Holdings Company Limited (OTC:LPHHF) [3380:HK] for its exposure to Shenzhen and the Greater Bay Area, which are beneficiaries of favorable policies driving housing demand in these areas in the mid-to-long term. The company’s focus on urban renewal projects helps it to secure low-cost land bank and also provides an alternative source of earnings on top of its traditional property development business.

Logan Property trades at 5.5 times consensus forward FY2019 P/E at a premium to its historical five-year forward P/E of approximately 5.0 times, which is justified, considering the growth potential of Shenzhen and Greater Bay Area, and the new earnings growth driver in the form of urban renewal projects. It also offers a trailing dividend of 7.7%, or 7.0% excluding the special dividend of HK$0.07 per share paid on July 19, 2019.

Company Description

Started in 1996 and listed on the Hong Kong Stock Exchange in 2013, Logan Property is a Mainland China property developer focused on the Guangdong-Hong Kong-Macao Greater Bay Area, specifically Shenzhen which is a major city in Guangdong Province.

Logan Property has four key business segments: the property development segment; the property leasing segment; the construction and decoration contracts segment; and the primary land development segment. Logan Property’s property is involved in the development and sale of residential properties, while the property leasing segment earns rental income by renting out office units and retail shops. Its construction and decoration contracts segment builds residential buildings and office premises, and also provides decoration services. The primary land development segment is engaged in the sale of land held for development as part of urban renewal projects, which I will discuss in one of the sections below.

I will be focusing primarily on Logan Property’s property development segment for the purpose of this article, as it contributes the majority or 52% of the company’s 1H2019 revenue. Businesses complementary to the core property development business such as the construction and decoration contracts segment and the primary land development segment account for 32% and 16% of the company’s top line in 1H2019. Logan Property has limited recurring income contribution, with the property leasing segment contributing a marginal 0.3% of Logan Property’s 1H2019 revenue.

Shenzhen And Greater Bay Area Play

Logan Property is a play on Shenzhen and the Greater Bay Area. Approximately 81% of the company’s land bank as of end-June 2019, or RMB611.1 billion in salable resources was located in the Greater Bay Area; and Shenzhen accounted for 24% of Logan Property’s land bank or RMB180.3 billion in salable resources. Furthermore, Logan Property has been ranked first in Shenzhen in terms of contracted sales for 2017 and 2018 among all the Mainland China property developers, and the company derived 55% of its recognized sales in 1H2019 from Shenzhen.

Logan Property’s dominance in Shenzhen is further reflected in the 13 metro property projects it has currently under development in the area. Due to the company’s first-mover advantage in Shenzhen, it has managed to secure new metro property projects which will ride on the growing demand driven by the expansion of Shenzhen’s railway transit in the mid-to-long term.

Logan Property’s Metro Property Projects in Shenzhen

Source: Logan Property’s 1H2019 Results Presentation

In mid-August 2019, it was reported that China has drawn up a detailed reform plan to transform Shenzhen into a new special economic zone and a model or pilot city (for other Chinese cities). Potential reforms include changes to laws and regulations to make Shenzhen more business-friendly; privileges in yuan internationalization to increase Shenzhen’s attractiveness as a financial center; a reform of the registration system of Shenzhen’s ChiNext board to encourage new listings; building manufacturing innovation centers for specific high-tech sectors like medical instruments; supporting the research and development of artificial intelligence, bio-medical technology, mobile payments and 5G development in the city, among others.

More significantly, for the property sector in Shenzhen, people who currently live in Hong Kong or Macau but work in Shenzhen are planned to be treated as locals and given the same privileges as Shenzhen residents as part of these potential reforms. This is likely to encourage those from Hong Kong and Macau to buy homes in Shenzhen and be supportive of housing demand and home prices in the city. Logan Property is a key beneficiary of this, given its dominance presence in Shenzhen as highlighted above.

This follows on from the unveiling of the Greater Bay Area blueprint in February 2019, which aims to connect the two Special Administrative Regions of Hong Kong and Macao with nine cities in Guangdong (Guangzhou, Shenzhen, Zhuhai, Foshan, Zhongshan, Dongguan, Huizhou, Jiangmen and Zhaoqing) to create a leading world-class city cluster (to be comparable with bay areas in New York, San Francisco and Tokyo) in areas such as finance, trade, and innovation.

Notwithstanding recent ongoing protests in Hong Kong, the Greater Bay Area is a multi-year long-term initiative that should spur economic development and drive housing demand in the area in the years to come. Sell-side broker DBS expects the Greater Bay Area’s population to grow from 70 million now to over 100 million by 2030, and for GDP per capita to double to RMB265,000 in the same year. Logan Property is keen to capitalize on the growth potential of the Greater Bay Area, and it has set a goal of becoming the “market leader in GBA (Greater Bay Area) in next 3 to 5 years.”

Urban Renewal Projects Are An Alternative Source Of Land Banking And Earnings

Logan Property continued to maintain its exposure to Shenzhen and the Greater Bay Area in 1H2019, which contributed 31% and 64% of the company’s newly acquired land bank, respectively, in terms of attributable land cost. However, Logan Property is not the only property developer competing to acquire new land bank in the Greater Bay Area, which means potentially overpaying for land and depressing profit margins as a result.

Fortunately, Logan Property is not restricted to public land auctions for its land banking activities. Apart from existing salable resources of approximately RMB427 billion, the company has a pipeline of urban renewal projects (conversion of existing villages and factories into new mixed-use developments or homes) which could contribute approximately RMB325 billion in salable resources, of which 90% are located in the Greater Bay Area. Logan Property estimated that the average land cost for its urban renewal projects is less than a quarter of its estimated average selling prices, implying high profit margins.

The current ratio between conversion of existing factories and villages is 60:40. The conversion of existing factories has a shorter turnaround time compared to the conversion of existing villages, but initial capital investment is higher for the former compared with the latter.

Logan Property converted two urban renewal projects in Zhuhai and Foshan last year which contributed salable resources of approximately RMB18 billion. This year, the company plans to realize RMB70 billion in salable resources from three urban renewal projects in Shenzhen Free-Trade Zone, Huizhou Daya Bay & Shenzhen Qiaocheng East. Logan Property’s annual target is a minimum conversion of RMB30 billion in salable resources from urban renewal projects, which implies that its current pipeline of urban renewal projects will last for close to 10 years.

Urban renewal projects are also become an alternative source of earnings for Logan Property, in addition to its traditional property development business where it simply acquires land bank in public auctions and construct homes for sale. Urban renewal projects contributed 39% of Logan Property’s core profit for 1H2019, but the company expects this to normalize and targets to generate 10%-20% of its core earnings from urban renewal projects in future with an estimated net profit margin of 10%-15%.

Logan Property’s Urban Renewal Projects Converted In 2018

Source: Logan Property’s 1H2019 Results Presentation

Strong Contracted Sales Growth And Robust Financial Position Limit Downside Risks

Logan Property achieved contracted sales of RMB62.64 billion for the first eight months of 2019, representing a YoY increase of +27.5%. This is equivalent to 74% of the company’s full-year contracted sales target of RMB85 billion, which implies that it is on track to meet the target.

Logan Property also has unbooked sales (units sold that have yet to be recognized as revenue) of approximately RMB70 billion, which is more than two times the company’s annualized 1H2019 property development segment revenue. This should help to support and lock in the company’s revenue and earnings growth for the next two years.

The company’s strong contracted sales growth and significant unbooked sales help to limit the risk of an earnings disappointment.

Logan Property’s net gearing was 65.4% as of end-1H2019, and the company has historically maintained a manageable level of financial leverage, with net gearing not exceeding 72% in the past five years. The company’s funding cost is also in a comfortable range of 5.8%-6.1% for the past three and a half years since 2016, in line with industry averages. The stock’s cash-to-short term debt ratio is a healthy 2.2 times.

Valuation

Logan Property trades at 5.5 times consensus forward FY2019 P/E and 4.5 times consensus forward FY2020 P/E based on its share price of HK$11.08 as of September 27, 2019. The stock’s forward FY2019 P/E is at a premium to its historical five-year forward P/E of approximately 5.0 times.

The stock also trades at a P/B of 1.71 times, versus its five-year average P/B of approximately 1.4 times.

Logan Property offers a trailing dividend of 7.7%, or 7.0% excluding the special dividend of HK$0.07 per share paid on July 19, 2019. The company has committed to a dividend payout policy of distributing at least 40% of its core earnings.

Variant View

The key risk factors for Logan Property are a slower-than-expected pace of urban redevelopment projects, and weaker-than-expected economic growth and unfavorable policies relating to Shenzhen and the Greater Bay Area.

Also, Logan Property recently announced that the current CEO, Mr. Ji Jiande has stepped down as CEO with effect from September 10, 2019. The current Chief Financial Officer, Mr. Lai Zhuobin, will be appointed as the new CEO. It is necessary to watch if the change in leadership will affect Logan Property’s day-to-day operations and the company’s implementation of its long-term strategies such as Greater Bay Area exposure and the focus on urban renewal projects.

Asia Value & Moat Stocks is a research service for value investors seeking value stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like “Magic Formula” stocks, high-quality businesses, hidden champions and wide moat compounders).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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