The outlook is grim for China Housing & Land Development (CHLN.NASDAQ) despite strong second-quarter earnings this week. SinoSage took a look behind the door – so to speak – and the outlook for shareholders is not good.
The company’s revenue in second-quarter rose US$37 million, up 9% on the first three months. Operating income almost doubled to US$5.7 million from US$3 million over the same period. However, contract sales decreased 15% to US$38 million compared to US$45 million in the first quarter.
China Housing’s revenue comes from two projects: JunJing II Phase Two (US$21.9 million) and Puhua (US$8.9 million). JunJing II revenues increased 44% in the second quarter, but the Puhua project declined by 23%. What makes this even more remarkable is that Puhua only commenced sales last October while JunJing II is close to completion. Puhua’s lower base point should make it easier to show growth. The significant revenue decline on a small number is therefore cause for concern.
CHLN recognizes revenue according to the percentage of construction completion sold rather than contract sales in the corresponding period, which means current revenues only reflect past contract sales volume. Puhua sold 195 (US$15 million) units in the fourth quarter of 2009, 198 (US$16.7 million) in the first quarter of 2010 and 138 in the second quarter of 2010 (US$14.6 million).
Even though unit sales were stable in the final quarter of 2009 and the first of 2010, recognized revenues came to just US$20.4 million for the six-month period. This is the result of low construction activity, which SinoSage reported during the trip to Xi’an in early June.
Commenting on the decline in contract sales, Feng Xiaohong, CEO of China Housing, blamed “national policies implemented to curb speculation in the real estate market.”
These tightening policies might explain Puhua’s sales drop, but it’s not the only story. The JunJing II project still managed to post a 44% increase in revenues in the second quarter, while residential sales in Xi’an as a whole rose 26% compared with the first quarter. SinoSage believes Puhua’s problems are as much to do with the project failing to live up to its massive hype and sizeable price tags (which we have noted before) as any macroeconomic factors.
JunJing II has only 10% of its unit left and is due to end in the third quarter, leaving only Puhua outstanding. The project is expected to sell 5,000 units for US$700 million over five years ending in the third quarter of 2014, or 1,000 units per year for a total US$140 million. Based on the contract sales figures for the last three quarters – 531 units sold for US$46.3 million – Puhua must make more sales in the final three months than it has in the first nine in order to meet its target.
With sales already sliding in the second quarter, SinoSage expects the company to fare even worse in final six months of 2010. And it’s not like Puhua can rely on policy support from Beijing, the government having given no indication that it will loosen existing curbs on the real estate market.
Finally, Sinosage is concerned about cash. Does China Housing have enough money in reserve to begin new projects in the second half of the year? It has US$68 million cash in hand plus the limited income flows from Puhua – but the company must make an annual payment of US$29.5 million to Prax Capital, a former investor in the project.
China Housing has two fundraising options: a secondary share offering and a private equity deal. Investors wouldn’t welcome the former while the experience with Prax is a disincentive to engage in the latter. SinoSage believes China Housing is in for a difficult six months and sticks by its earlier advice that investors should steer clear.