Bruce Lee’s Underpants

From: Derek Hillen
Sent: Wednesday, October 12, 2011 11:29 AM

To: Derek Hillen
Subject: Bruce Lee’s underpants


“Notice that the stiffest tree is most easily cracked, while the bamboo or willow survives by bending with the wind.”  - Bruce Lee

Where are we on the downward spiral for the China property sector? Yes, it is cheap, trading at an average of 0.88 X P/B. In fact, a lot of these names are priced for bankruptcy but will they get any cheaper? My view is, yup, they will.

As has been well reported, mainlanders were busy piling into jewelry in Hong Kong during Golden Week rather than punting domestic real estate.

Anecdotally, living in Hong Kong for 6 years now I am getting tired, real tired, of all the coffee shops and other practical retail outlets being converted into another watch retailer or jeweler. This is the penalty residents here pay, aside from ridiculous property prices and rent, for allowing the full raw power of the Chinese consumer unfettered access to our tiny market. Rant over.

Golden Week saw property sales in China for 20 key cities fall 32% y-y and September saw the first aggregate fall in property prices in a year. Just for laughs, our property team ran the Chinese developers through the Altman Z Test for bankruptcy. Aside from COLI (688 HK, Buy), none passed! They’re all going under according to the strict teachings of Professor Altman yet, these tests penalize heavy capex and high liabilities which is pretty much the full business plan of the sector. More relevant is to look at the deterioration of their Z-scores since the financial crisis. Most of them have seen a deterioration of greater than 20% since then. This means things are now WORSE for the developers than during the depths of the financial crisis. Again, COLI fared better than the others.

Locked out of the corporate debt market since May, developers are facing greater cash flow pressure. Developers with the most cushioned cash flow are Longfor (960 HK), Shimao (813 HK), Agile 3383 HK) and R&F (2777 HK), according to analyst Stephanie Lau (see attached). The macro situation in China is arguably worse now than in 2008 as well, with money tight, banks taking for-ever to approve mortgages and the curb market charging annualized rates of 30-50% for short term loans.

Last night, the ancestral hometown of Bruce Lee, Foshan, which is the third largest city in Guangzhou province and now a center for the manufacturing of China’s underwear, suddenly announced they would ease their HPRs (home purchase restrictions). Local press reported Hainan Island was following. Was this a sign of a relaxation of policy at the edges from Beijing? Beijing apparently doesn’t think so. Foshan this morning issued a terse statement saying the relaxation had been “postponed.” The whole fiasco reminds me of the bogus “Through Train” kerfuffle in August 2007 when it was suddenly announced mainland punters would be allowed to invest directly in the HK stockmarket. This was as long as they opened up accounts at ONE bank branch in Tianjin and the whole country had to go through this one branch. That didn’t make sense to me then but our market rallied forty-odd percent on the “news.” Beijing quickly quashed the harebrained scheme and the whole thing was quietly “postponed” as well until SAFE (the State Admin. Of Foreign Exchange) played it safe, took out the Glock and put the final bullet in the plan January 2010.

Back to property, looking at P/B ratios, the trough for the sector was 0.66X vs. 0.88X now but times are harder for the sector now. Yes, local gov’ts get up to 40% of revenues from selling land and property so their interests are diametrically opposed to Beijing. But Beijing has nuclear weapons so I think they will listen. Until we see a signal, or a lack of response to a proclamation from an uppity city official, the time to buy the China property sector is still down the track.


US earnings season kicked off last night with Alcoa (AA US) reporting results. Their Q3 numbers missed by a country mile due to rising costs and slowing demand, which is a theme I think we will see repeated with other earnings announcements. Analysts have toned down earnings forecasts of 17% for Q3 down to 13% for US companies but I think they are high (the numbers and the analysts). The US economy is growing at what, 1.3%, and even if the global economy grows at twice that rate do we seriously expect corporate profits to grow 7X that amount?


You can get our research by typing MASR <Go> on Bloomberg.


Derek Hillen, CAIA

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