March 25,China: Real Estate Developers Gao Hua Securities Investment Research 1 March 25, China: Real Estate Developers Eyeing potential industry consolidators Strong execution and balance sheet – well positioned China’s two largest listed developers, Vanke (000002.SZ/200002.SZ, Neutral) and COLI (0688.HK, Buy), reported theirannual results last week, which were broadly in line with our and market expectations. In our view, both companies demonstrated strong execution and skillful cash flow management during their aggressive geographic and volume expansion in . Near-term headwinds – opportunity for industry leaders Both companies indicated the recent property market weakness has had a limited impact on their project sales as shown by their ytd sales; in addition, both companies said that their funding needs are still well supported by banks. They remain optimistic about long-term property price trends in China and believe the present correction is rational and healthy. They further believe government credit tightening will force out some overly leveraged developers from the industry that have poor execution, which could help them increase market share and solidify their leading positions. In addition, both developers are positive about the central government’s plan to accelerate the establishment of an economic housing system in China and expect less policy intervention in the private sector once the system is fully in place. Positive implications for the sector We expect similarly positive news flow when remaining listed developers announce their results, including: (1) significant yoy ASP increase and margin expansion; (2) higherrevenue lock-in ratio as of 1Q08 yoy (for both Vanke and COLI: 40% this year vs. 30%-35% in 1Q07); and (3) current sales progress of listed names less affected by weak sentiment compared with the industry avg given their brand equity and product quality. We think this will provide a cushion to developers’ E earnings growth delivery. Undemanding valuations, particularly for potential consolidators We think the sector (excl. A-shares and Singapore-listed stocks) is trading at a very attractive level, with average discounts of 58% and 34% to our estimated base-case and ex-growth endE NAVs, respectively. We think valuations are particularly undemanding for those companies with strong balance sheets and solid execution capabilities, whose earnings and NAV growth should be less affected and which we view as likely industry consolidators, namely, our Buy-rated names: Sino-Ocean (3377.HK, on Conviction List), COLI, KWG (1813.HK), Agile (3383.HK) and SOHO (0410.HK). Upcoming events March 26: KWG annual results announcement March 27: Sino-Ocean annual results announcement March 28: China Resource land annual results announcement April 18: Agile annual results announcement April 20: Greentown annual results announcement April 21: Shimao Property annual results announcement Related research Feb 25: Demand headwinds to persist; be selective – ratings and TP changes Sector share price discount to existing land bank ‘08E NAV -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% 120% 140% Dec-05Feb-06Apr-06Jun-06Aug-06Oct-06Dec-06Feb-07Apr-07Jun-07Aug-07Oct-07Dec-07Feb-08 The sector (HK listed)market cap weighted averagepremium to NAVis 22% Note: Our calculation doesn’t include two A-share listed companies (Vanke, CMP) under our coverage as both companies are trading at a significant premium to NAV vs. their Hong Kong-listed peers. Source: Bloomberg, Gao Hua Securities Research. Yi Wang, CFA +86(10)6627-3022 | yi.wang@ghsl Beijing Gao Hua Securities Company Limited Yunting Luo +86(21) 2401-8921 | yunting.luo@ghsl Beijing Gao Hua Securities Company Limited Beijing Gao Hua Securities Company Limited and its affiliates do and seek to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For analyst certification, see the text preceding the disclosures. For other important disclosures, contact your investment representative. Beijing Gao Hua Securities Company Limited Investment Research March 25,China: Real Estate Developers Gao Hua Securities Investment Research 2 Analyst briefing takeaways: Cautious near-term, positive long-term Key takeaways from the analyst briefing of China Vanke and COLI affirmed our near-term cautious but long-term positive view on the sector. Near-term outlook remains cautious; expecting more price cuts Management for both companies stated that though they believe transaction volumes in the property market will recover in 2Q as a result of: (1) more projects to be put for presale in 2Q; and (2) as a result of recent price cuts from some developers, they believe volume recovery might not be strong enough to ease developers’ near-term cash flow pressures, which could trigger further price cuts in the near-term. Long-term outlook remains promising Management for both companies believes the current correction in the property market is rational and healthy. They remain positive on the longer-term price trend in the China property market. Based on its own analysis, China Vanke’s management concluded that the development of China’s property market is at a similar stage as Japan was in the 1970s, which experienced over 15 years of steady growth after a mild correction in the mid 1970s. Government could ease some policies and remove some restrictions to stabilize the market in the near-term Though we are cautious, we believe early relaxation of some government policies could help stabilize the property market. We have seen some signs of such relaxation recently: 1. Second-home mortgage policy We note the recent easing of second-home mortgage policies in Beijing and Shanghai. Second-home purchasers can still enjoy first-home mortgage terms (30% down payment, mortgage rate equaling 85% of prevailing commercial loan rate) as long as their previous mortgage is fully paid off. Previously, only homebuyers with no record of mortgage borrowing could enjoy preferential terms for their first-home mortgage. 2. Reopen capital market financing channel for property companies In addition, the CSRC stated that it will not stop or suspend IPOs or back-door listings of property companies provided the proceeds will not be used for land bank replenishment. This is the first time that the CSRC has been positively disposed towards property companies’ capital market financing since October . Economic housing system—a potential threat to the private sector We believe the recent renaming of the Ministry of Construction as the Ministry of Housing and Urban-Rural Construction underscores the government’s strong commitment to addressing the increasing housing needs of China’s low-income population, but this has also raised market concerns on whether supply from low-end properties will become a potential threat to the private sector. March 25,China: Real Estate Developers Gao Hua Securities Investment Research 3 Both companies believe the establishment of a low-end housing system in China needs to be accelerated and that it will have a very limited negative impact on the private sector given the different target buyers (COLI and Vanke target the mid- to high-income population in China, not the low-income population) plus the very small percentage of low- end property supply that would be added to the total supply. But, China Vanke’s manage