China’s Overseas Development: lack of profit

A few days ago, China Overseas Development announced an option plan to grant nearly 300 million shares in the second phase to more than 1000 employees. Can this save the company’s current depressed share price? < / P > < p > China’s overseas development always has the title of profit king, but because the sales scale gradually lags behind the competitors, the net profit and core net profit of China’s overseas development have lost the title of No.1 in the industry, and can only stick to the principle of No.1 in the net profit of the parent company, which is partly derived from the substantial increase in fair value and interest capitalization, and this may be possible to a certain extent It explains the phenomenon that the net profit margin of the company can be basically stable when the gross profit margin of the company drops or even reaches a new low in recent years. < / P > < p > in the past two years, China’s overseas development contracting scale has begun to speed up. In the first 11 months of 2020, China’s land acquisition nearly equaled the number one leading enterprise. Under the three red lines, China’s overseas development competitors with higher leverage have a lot of room to maneuver, but real estate enterprises are gradually moving away from relying on borrowing to drive scale growth. < / P > < p > this is the second option plan of China’s overseas development. In 2018, the company granted 107 million shares to 404 people at HK $25.85 per share, with a total value of HK $2774 million. < / P > < p > but it is not known whether the down option plan can be fully realized. After the launch of the first stock option, China overseas development did not perform well in the secondary market, and the company’s share price rarely exceeded the expiration price. In 2018 and 2019, 2.28 million and 2.73 million options were invalid respectively. < / P > < p > in the first half of 2020, 4.03 million options will lapse, but 32.75 million options will be exercised, obviously at HK $25.85 per share. Compared with the company’s current low stock price, the relevant holders will have a significant loss. Therefore, the second option plan launched this time is not only the continuation of the first option plan, but also can help some employees who have exercised their rights to “fill their positions” and reduce the cost of ownership. < p > < p > CICC believes that this move is expected to boost short-term market sentiment. The company pointed out that in addition to the larger number of options granted, it will also give more options to senior executives (more than three times of the first issue), which is expected to boost market sentiment. CICC also believes that China’s overseas development is expected to exceed its 2020 sales target. < / P > < p > as of the end of November 2020, among the large-scale real estate stocks listed in Hong Kong, China Overseas Development Co., Ltd. is one of the companies with the most sluggish performance. The stock price of the company has fallen all the way and rarely rebounded, with a decline of more than 30% in the year. Even if the company publishes the semi annual report and the third quarterly report, it has not reversed this decline. < / P > < p > according to the semi annual report of China’s overseas development, in the first half of 2020, the company achieved revenue of 88.625 billion yuan, a year-on-year increase of about 11%; the profit attributable to shareholders of the company was 20.527 billion yuan, a year-on-year decrease of nearly 4%. Although the profit declined slightly, only one overseas development company in China with net profit of more than 20 billion yuan in the first half of the year still deserves to be the profit king. The third quarter report of China overseas development shows that in the first three quarters of 2020, the company achieved a revenue of 118.3 billion yuan and a net profit of 38.82 billion yuan. China overseas development did not disclose the profit attributable to shareholders of the company. In the third quarter, the revenue of China’s overseas development was only over 100 billion yuan, and in the half year report, the revenue of several peers was far more than 100 billion yuan or even more than 250 billion yuan. China’s overseas development can obtain more attributable net profit. In addition to the low proportion of minority shareholders’ equity, one of the main reasons is that the net profit margin is higher than that of ordinary competitors. Among them, the fair value of China’s overseas development’s net profit has increased a lot. < / P > < p > in the first half of 2020, the change of fair value of the company’s investment properties was 5.198 billion yuan. According to wind, the operating profit of China overseas development was 31.262 billion yuan, that is, the profit and loss of fair value change accounted for 16.63% of the operating profit. < / P > < p > in fact, in the profit structure of China’s overseas development in recent years, fair value accounts for a large proportion. According to the data adjusted by wind, during 2017-2019, the changes in fair value of overseas development investment properties in China were RMB 4.97 billion, RMB 9.123 billion and RMB 10.002 billion, respectively, and the operating profits were RMB 52.557 billion, RMB 61.975 billion and RMB 62.344 billion, accounting for 9.46%, 14.72% and 16.04% of the fair value, respectively. < / P > < p > the proportion of changes in fair value of China’s overseas development in operating profit has been rising, nearly doubling in the past three years. In fact, in the first half of 2020, the fair value change of China’s overseas development has been the first in the industry, far exceeding all competitors. Even in 2017-2019, it is rare for real estate stocks to double the scale of changes in fair value, and few of them can break 10 billion. < / P > < p > different from the general real estate enterprises, which mainly invest in shopping malls, the overseas investment properties in China are mainly office buildings. In 2017, the company put into operation Zhonghai grade A office building with a total area of 2.29 million square meters, which has reached 2.87 million square meters by the end of 2019. Correspondingly, at the end of 2017, China Overseas Development held more than 3.66 million square meters of commercial properties, and increased to 4.38 million square meters by the end of 2019. If the construction in progress and the part to be developed are included, the line area is 10000 square meters. < / P > < p > the fair value increased significantly, but the rental income of investment properties did not keep up with the pace of fair value. In 2017, the total income of commercial property held by China overseas development reached HK $2.94 billion, of which the rental income was HK $2.45 billion, a year-on-year increase of 14.5%. < / P > < p > in 2018 and 2019, the total income of commercial properties held by the company was about 3.245 billion yuan and 4.16 billion yuan respectively, of which the rental income of investment properties was 2.97 billion yuan and 3.75 billion yuan. Due to the impact of the epidemic, in the first half of 2020, China’s rental income from overseas development was 1.92 billion yuan, an increase of only 6.2%. < p > < p > the fair value measurement of investment property is fully in line with the accounting rules. However, if the fair value of investment real estate is significantly reduced due to the fall of house prices in the future, it will be a disaster for related companies, which need to bear more risks than most of their peers. At this time, the assets that used to be profits will eat the income statement, and the fair value will show the other side of the double-edged sword. < / P > < p > there are many ways for real estate enterprises to adjust their profits, and the interest treatment of interest bearing liabilities is also one of them. With the rapid change of fair value, the proportion of interest capitalization of overseas development in China has increased significantly, which will undoubtedly directly enhance the company’s current net profit. < / P > < p > because the operation of the real estate industry has a certain special attribute, corporate loans are mainly used for real estate development, and the development projects generally have the characteristics of long cycle. Therefore, the interest expenditure in the construction process is generally partially capitalized. It is this characteristic that the amount of interest capitalization of developers directly affects the company’s net profit. < / P > < p > China’s overseas development has always been a model of steady development. The company’s debt control is reasonable, and the three red lines frequently mentioned in the real estate industry are all passed: the debt ratio after excluding the advance payment does not reach 70%, the net debt ratio is far less than 100%, and the cash to debt ratio is far higher than the minimum requirement of 1. At the end of the first half of 2020, the interest bearing liabilities of China’s overseas development exceeded 200 billion yuan, reaching 208.61 billion yuan. The last time the company broke through the threshold of integer was in 2015 when the interest bearing liabilities exceeded 100 billion Hong Kong dollars. At the end of 2017 and 2018, the company’s interest bearing liabilities were HK $178.24 billion and HK $195.95 billion. After changing to RMB in 2019, the company’s interest bearing liabilities at the end of the year were RMB 189.96 billion. < / P > < p > the interest bearing liabilities are well controlled, and the loan interest rate remains low, so the total interest of China’s overseas development has not expanded. Under the control of the total amount, the interest capitalization rate of China’s overseas development has gradually increased to the limit ratio. In 2017, the company’s total financial expenses were HK $7.495 billion, and the capitalization amount was RMB 6.101 billion, with a capitalization rate of 81.4%. However, the capitalization rate of the previous year was far less than 80%. < / P > < p > in 2018 and 2019, the total financial cost of China’s overseas development was 7.859 billion yuan and 8.97 billion yuan, the capitalization amount was 6.527 billion yuan and 8.211 billion yuan respectively, and the capitalization rate was 83.05% and 91.54%. In 2019, the company’s interest capitalization rate will break through 90% for the first time, and then step into a new stage. < / P > < p > in the first half of 2020, the total amount of financial expenses for China’s overseas development is 4.452 billion yuan, and the capitalization amount is 4.021 billion yuan. The capitalization rate is still more than 90%, reaching 90.32%. < / P > < p > the increase of interest will erode profits, and capitalization can relieve the pressure of current net profit growth. If we still maintain the previous capitalization ratio, it will directly affect hundreds of millions of yuan of profits of China’s overseas development, and the already stressed profit growth will be even more precarious. < / P > < p > the rapid changes in fair value, the increasing interest capitalization rate and less minority shareholders’ equity can certainly make China’s overseas development remain the first place in the net profit of the parent company. However, the core net profit of the company has long lagged behind its competitors. In the case that the company’s size is also obviously lagging behind, it seems that it is only a matter of time before it loses the first place in the net profit of the parent company Question. < / P > < p > the reason why China overseas development can obtain the title of profit king is that the company’s higher net profit attributable to the parent company. In terms of net profit, as early as 2017, China’s overseas development lost the title of “profit king”. In this year, the company’s net profit was 35.227 billion yuan, directly falling to the third place of neifang stock. < / P > < p > compared with net profit and net profit attributable to the parent company, institutional investors in Hong Kong pay more attention to the core net profit of the enterprise, that is, the net profit after deducting the gains and losses from the fair value of investment property, exchange gains and losses, the gains and losses from the fair value of financial instruments, the gains and losses from the disposal of financial instruments, donations and some other non real estate development businesses. < / P > < p > the book profit brought by the change of fair value will not produce real cash flow. Therefore, in the Hong Kong market dominated by institutional investors, more attention is paid to the company’s core net profit, especially the parent core net profit, rather than just the net profit. < / P > < p > compared with the growth rate of net profit of parent company, the growth rate of core net profit of China’s overseas development is not so stable. In 2017, the company’s net profit after deducting changes in fair value was HK $34.26 billion, an increase of 9.27%. < / P > < p > in 2018, the core net profit of China overseas development after deducting changes in fair value was HK $37.09 billion, an increase of 8.3% year on year. In 2019, the company’s core net profit was 34.3 billion yuan, with a year-on-year growth of 10.1%. This is the first time that the core net profit of China’s overseas development has reached a double-digit increase after 2016. < / P > < p > in 2019, two of the listed neifang stocks in Hong Kong have a core net profit of more than 40 billion yuan, which has left China’s overseas development far behind. In the first half of 2020, the core net profit of China’s overseas development was 17.94 billion yuan, a slight increase of 0.3% over the same period last year, and the increase rate dropped significantly. < / P > < p > how long can China’s overseas development last, even if it is the proud king of net profit? In 2016, the net profit of the company’s parent company exceeded 33 billion yuan, and the gap between the second place and the company was more than 10 billion yuan at that time; in 2017 and 2018, it narrowed to about 6 billion yuan, and the gap between the net profit of China’s overseas development and the second place was less than 3 billion yuan in 2019. After the disclosure of the 2020 annual report, will the only remaining “fig leaf” of China’s overseas development be torn off? < / P > < p > even if we have a net profit margin that far exceeds the average profit level of our peers, we will not be able to make profits when the sales scale is far behind