Mainland Chinese stocks rose on Wednesday, driven by a rally in financials and the beleaguered real estate sector. The broad market CSI 300 closed up 2.9%, by far the biggest gains in Asia on a generally positive day for markets across the continent.
Country Garden Holdings (HK: 2007), the biggest developer in China by sales for 2021, saw its shares jump 6.3% in Hong Kong. Its property management spin-off Country Garden Services Holdings (HK:6098) was the top gainer in Hong Kong’s benchmark Hang Seng index, climbing 9.7%.
At least for today, investors appeared to get past the “red flags” raised by nearly a dozen mainland developers struggling to prepare their annual results. Most have a deadline which is tomorrow, or which has already expired. Many also saw listeners quitting, alluding to the chaos behind the scenes to make sense of the numbers. Although most companies cite Covid staff shortages as one of the reasons, they have generally also encountered huge cash flow problems and slowed sales sharply.
Many of China’s biggest developers are listed in Hong Kong, where the CSI Hong Kong-Listed Tradable Mainland Real Estate Index climbed 6.5% on Wednesday, avenging its 2.1% drop the previous day, and more . The broad Hang Seng index in Hong Kong rose 1.4%.
But the stock market movements of the past two days have been prosaic by recent standards, with volatility in Chinese stocks in general and real estate stocks in particular being exceptionally high. This CSI index of mainland developers listed in Hong Kong fell 25.0% between March 10 and 15, then peaked at 34.2% on March 17. After this week’s moves, it is closing in on where it started in March, down “just” 8.1% since the start of the month.
Still, times are dire for Chinese property developers. The sector is grappling with forced deleveraging from the Chinese government which has challenged the business model of many homebuilders: selling off-plan apartments before they are built, rushing into development using this financing, finishing the project as quickly as possible, and moving forward. Chinese property prices have reversed in many Chinese cities, sapping homebuyer enthusiasm.
The slowdown in sales has led to financial difficulties for many developers, which causes doubts among apartment buyers, leading to a slowdown in sales…it becomes a vicious cycle involving a loss of confidence.
One of the biggest stock price moves today could come from the company that sparked speculation about the financial health of developers. China Evergrande Group (HK:3333) and (EGRNF), which lost its title as China’s largest developer to Country Garden when it failed, announced today that it will raise C¥3.66 billion (576 million USD) by selling a real estate project in the city of Hangzhou, near Shanghai. But Evergrande shares have been suspended since March 18.
So far, nine developers have said they can’t file their annual accounts on time, including Evergrande. The others are: Agile Group Holdings (HK:3383) and (AGPYF); Fantasia Holdings Group (HK:1777); Kaisa Group Holdings (HK:1638); Logan Group (HK: 3380); Ronshine China Holdings (HK:3301); Shimao Group Holdings (HK:0813) and (SIOPF); Sinic Holdings (HK:2103); and Sunac China Holdings (HK:1918).
Ronshine, for example, saw PricewaterhouseCoopers resign as auditor on March 21, just 10 days before the company was due to release its financial statements tomorrow.
There’s more than a little trouble compiling taxi receipts. Auditors normally only quit when they do not want their name associated with creative/questionable number calculations. The results are sure to be low; even accountants who stay on board can offer “qualified opinions” that they base their approval only on what they have been told.
Nomura China property analysts Jizhou Dong and Stella Guo note that “when developers change auditors ahead of the annual earnings season, it generally raises red flags about potential audit issues and should raise concerns. serious market concerns about the reliability of their financial figures.
Evergrande was also supposed to file its annual report by tomorrow and will miss that deadline. Instead, he tells us today about a deal he just made – after dropping a bombshell on a US$2 billion financial hole he is investigating accounts of.
Evergrande is selling the Crystal City project, a mixed commercial and residential development currently under construction in Hangzhou, a city known for its entrepreneurs and headquartered to Alibaba Group Holding (HK:9988) and (BABA). Evergrande says it does not have the cash to complete the construction, which has been delayed by its cash flow problems, and is handing over the project to the public company working on its construction, as well as the local public developer.
The contractor, Zhejiang Construction Engineering Group, is an operating arm of Zhejiang Construction Investment Group (SZ: 002761), which is state-owned but listed on the Shenzhen Stock Exchange. The developer is Zhejiang Zhejian Real Estate Group, which is ultimately owned by the Zhejiang provincial government. Hangzhou is the provincial capital.
The Evergrande Group will only make a net profit of 216 million yen ($34 million) which it will use for working capital, as much of the money will be used to reimburse the contractor for the construction he has already done.
This type of divestiture is increasingly common in China, where developers who lack working capital must sell projects, or even sell them entirely, usually to government-controlled entities. It is a form of government bailout without being a government bailout. Interestingly, while the Beijing government can be tough on getting developers into shape, real estate companies often have very warm relationships with local governments. The sale of land to developers is one of the main sources of revenue for municipal and provincial governments.
Evergrande remains deeply troubled. It also announced this week that it was setting up an independent investigation committee made up of its independent directors to look into how well its property management spin-off, Evergrande Property Services (HK:6666), has achieved 13.4 billion yen ($2.1 billion hole) in its balance sheet. Its shares have also been halted since the March 18 close.
It was only when preparing its financial figures for last year that Evergrande Property Services realized that the banks had seized the billions in cash because it was being used as collateral on pledges by an unidentified third party. Both Evergrande companies called for their shares to be suspended early last week so they could try to find out what happened.
The missing US$2.1 billion represents most of the cash the property management company had. The company says preliminary findings show it was used as collateral when the company ran into financial difficulties.
Rival developer Hopson Development Holdings (HK:0754) will feel like they’ve dodged a bullet. Hopson agreed to buy 50.1% of Evergrande Property Services for HK$20.0 billion (US$2.6 billion), part of what I explained is a rescue effort for his company mother. But the deal fell through, as I also pointed out, due to doubts about the accounts.
Hopson, who insisted he still wanted to move on, said he was supposed to pay the money into Evergrande Property Services’ bank account, so the property services unit could settle its accounts payable and receivable with its parent company. But Hopson said China Evergrande Group tried to change the terms so he would be paid in cash instead. Hopson declined to do so, saying she would not know if the target subsidiary would get what the parent company owed it.
This is a case-specific story depicting many behind-the-scenes races to get developer finances in shape. There is no way for investors to hit the Chinese real estate sector with any short-term security. Daring speculators could make massive gains in a day or suffer heavy losses.
The Chinese government, in a committee meeting led by Vice Premier Liu He, promised to provide some stability to the sector, as I explained mid-month. But Beijing has been reluctant to help individual developers who have run into trouble. As a result, paper today wins out of this struggling sector remains just that, paper, and far from anything as safe as houses.
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