Recently, Citi said that after a three-year deleveraging cycle, China's real estate industry is improving, and credit risk can be further reduced to an acceptable level. Other Wall Street analysts also pointed out in the report that investors' exposure to Chinese real estate stocks is currently relatively low, and the upward momentum is poised to begin, so investors are advised to take a neutral or even bullish stance.

The same is true. By the close of trading on March 22, China Domestic Housing (CESCPD) had rebounded rapidly from its lowest point, with a maximum increase of 34.6%, while the Hang Seng Index rebounded from its lowest point to a maximum increase of only 16.36% during the same period. After three years of hard work, the Hong Kong stock market seems to have entered a technical bull market. Amidst this wave of rising domestic housing stocks, the author noticed an impressive increase in Shangshi City Development (00563.HK). Its rebound even surpassed that of the Hong Kong stock market. As of March 22, since February this year, Shangshi City's opening price had risen 27.94%.

1. Withstanding industry pressure, net profit increased dramatically, and gross margin was not inferior to industry leaders

(Data source: choice)

According to the 2023 financial report, Shangshicheng's operating revenue was HK$7.954 billion, and the company owner should account for profit of HK$495 million, an increase of 21.6% over the previous year.

After excluding non-controlling interests, the company achieved net profit of HK$491 million in 2023, an increase of 60.9% over the previous year, which indicates that the company achieved better results in reducing internal operating costs. Notably, profit attributable to shareholders also increased 21.6% year over year to HK$494.57 million. Basic earnings per share were HK10.32 cents, a significant increase from the previous year's HK8.47 cents. These data reflect the increase in profitability and shareholder return achieved by the company in 2023.

The overall real estate industry will be extremely difficult in 2023, and it will be difficult for companies to make profits. Under these difficult circumstances, Shangshi Chengkai still achieved a net profit growth rate of more than 20%, which is not easy. The reason is that Shangshi Chengkai actively adapts to changes in the market environment, overcomes the impact of the macro environment with a forward-looking layout, keen market insight and excellent execution, and seizes market opportunities to complete the delivery of more high-end projects in the second half of the year, achieving resilient growth in profits throughout the year.

In terms of dividend payments, the company still maintains impressive dividends. Shangshi City Development paid a final cash dividend of HK2.1 cents per share and a special cash dividend of HK 0.8 cents in 2023. The company continued to pay dividends to shareholders during the year. Although there was no increase, the total amount was still considerable. This move may help maintain shareholders' interests and increase the company's shareholder return.

According to data, Shangshi Chengkai is a local real estate company in Shanghai with a deep background. In 2010, Shanghai Industrial Holdings acquired Shangshi City Development and became its parent company after holding it, and the Shanghai State-owned Assets Administration Commission stood behind Shanghai Industrial Holdings. Simply put, Shangshi Chengkai is an overseas listed state-owned real estate enterprise under the Shanghai State-owned Assets Administration Commission.

Shangshi Chengkai (0563.HK) is listed on the Hong Kong Main Board and is positioned as a core urban integrated developer. The industry is based in Shanghai, spanning Tier 1 and 2 cities such as Beijing-Tianjin-Hebei, Pearl River Delta, and Xi'an. It mainly includes various business formats such as high-end residences, office buildings, shopping centers, star hotels, and apartments.

With the advent of the downturn in real estate, the net revenue and profit of real estate developers, large and small, are under great pressure. Operating income has plummeted in a cliff-style manner, and industry rumors of overdue debts have erupted from time to time. In this environment, while withstanding the downward pressure on the industry, Shangshicheng Kai maintained positive revenue growth, and seized the period of declining interest rates to optimize debt and reduce debt ratios and financing costs. Among similar enterprises, Shangshicheng Kai's ability to generate revenue and reduce debt is much superior to other peers.

In terms of scale and business, Shangshicheng Kai is a “small but beautiful” company, but although it is backed by the Shanghai State-owned Assets Administration Commission and has a good background, it is still quite low-key. The author checked past data and found that the company's shares have been successively held by foreign investors such as Bank of Switzerland, Bank of Norway, Vanguard, BlackRock, and the American Teachers Pension Fund, etc., and the value of its shares has been dug up by foreign institutions, and the inside of the wall is blooming.

As a representative of small but beautiful real estate companies, Shangshi Chengkai has maintained an excellent record of outperforming the industry's gross margin for many years. The company's gross margin was 41.8% in 2023, up 14.9 percentage points from the company's gross profit margin of 26.9% in 2022. This indicates that the company achieved higher gross profit during the year and achieved significant improvements in operating efficiency and profitability. The increase in gross margin mainly benefits from the relatively large share of commercial housing projects delivered by the company and the high gross margin, which reflects the company's good performance and efficient operation ability in the field of real estate development. The increase in gross margin not only helps the company improve its level of profit, but also helps enhance the company's competitiveness and financial soundness.

The average gross margin of the company exceeded 30% during the period 2014-2023, and the average gross margin of the industry was about 25% during this period. Even when the real estate industry cycle peaked and the overall gross margin of the industry declined, the company's gross margin maintained a profit advantage of 5-10% higher than the average gross profit margin of the industry.

The figure below: The gross margin trend of Shangshi Chengkai over the years 2016 to 2023.

(Data source: choice)

As a comparison, the picture below is the “chart of the overall gross margin of listed real estate companies over the years” found by the author. As can be seen from the chart, the overall gross margin of listed real estate companies in China was around 25% in 2015-2021. Combining the above two pictures, it can be seen that in the past 11 years, apart from a gross profit margin of 15.5% in 2012 and a gross profit margin of 15.5% lower than the industry in 2013, the gross profit margin of Shangshi Chengkai has not been lower than 25% of the industry center in a year.

(Photo Credit: Cushman & Wakefield)

Why has Kamishijikai been able to maintain such a high gross profit margin for so many years? The author believes that since the company's main business focuses on high-end commercial housing development in first-tier cities, especially in Shanghai, housing prices in Shanghai have remained strong during this round of adjustments, thus contributing to a high gross profit margin.

The second reason is that Shangshi City is very focused in terms of development and management. Only by focusing can we work slowly and meticulously, and maintain competitive barriers in a martial arts field full of experts. Compared to other large real estate companies, Shangshi Chengkai's gross profit quality is higher, the business is more focused, and the service is more efficient, and it is truly “small but beautiful.” This is also the reason why it is favored by well-known overseas investment institutions.

In terms of revenue scale, although the company does not have an advantage in the industry, there is quite a bit of room to release the value and profit of the company's individual projects. The small, beautiful, and compact projects built by the company in the industry ensure that profit levels not inferior to industry leaders can be released without too much cost pressure or operating pressure. The overall sales scale of the company is stable and stable, while the profit side continues to release growth momentum, showing a fairly steady development side and setting a small but beautiful benchmark for domestic housing stocks.

2. Policies warm up the wind to promote loose financing, and the development prospects of Shangshi Chengkai are clear

In terms of policy, this year's two conferences have a lot of focus on the real estate industry. Addressing both the symptoms and the root causes and mitigating real estate risks will be one of the key tasks of this year's real estate policy. As can be seen from the reports of the two sessions, the construction of a new real estate development model is more clear in terms of this year's policy, and reforms may be deepened in the future in terms of housing security systems, land management systems, industry development models, and financial, fiscal and taxation support systems.

The author anticipates that the policy will focus on stabilizing expectations, stabilizing housing prices, and stabilizing real estate in the short term. In the medium to long term, it will promote the transformation of real estate to a new development model in terms of building a multi-level housing supply system, advancing land management system reform, and improving the housing finance system.

Since the introduction of the “16 Financial Rules”, financial supervisory authorities have required financial institutions to treat all financial institutions equally to meet the reasonable financing needs of housing enterprises with different forms of ownership, mitigate liquidity risks, and establish a real estate financing white list project.

Under the influence of various policy tools, the decline in real estate is gradually narrowing, and this year's financing environment will be more friendly compared to the past three years.

According to data from the National Bureau of Statistics, the cumulative year-on-year decline in development capital for housing enterprises in 2023 was 13.6%. The decline has remained stable since September, and the year-on-year decline in domestic loans (-9.9%) and self-financing (-19.1%) narrowed to varying degrees compared to the previous value. Up to now, more than 6,000 projects have entered the housing enterprise financing white list, with loan amounts exceeding 200 billion yuan. The overall positive impact on the market is expected to be further evident.

Kamishijo Kaikai made good use of this relaxed financing environment. In 2023, Shangshi City Development adopted various financing methods, which greatly enriched the company's cash flow.

In terms of bond issuance, Shanghai Chengkai, a subsidiary of Shangshi City Development, completed the issuance of the second domestic corporate bond issue on September 7, 2023, with a total principal amount of RMB 1.8 billion, a coupon interest rate of 3.5%, and a period of 3 years. Proceeds from this bond issuance will be used to repay Shanghai Chengkai's old debts. This not only saves financial costs, but also shows the capital market's confidence in Shangshi City Development and its subsidiaries.

Finally, in terms of loan financing, Shangshi City Development signed a supplementary loan agreement with the lender on November 30, 2023, amending certain terms and conditions relating to the HK$500 million revolving loan facility and extending the maturity date of the revolving loan facility to October 31, 2024 or another extended maturity date. This indicates that Shangshi City Development is receiving additional financial support through loan financing to meet possible capital requirements and operational challenges.

In summary, Shangshi City Development will finance in 2023 through various methods such as issuing notes, bonds, and loan financing to support its operation and development. These financing activities not only provided financial support, but also demonstrated the capital market's confidence in the development of Shangshi City.

Financial reports show that the cost of financing in 2023 was HK$688 million, compared with HK$683 million in 2022, which is little change.

In the current market environment, the future development prospects of Shangshi Chengkai are mainly reflected in the following aspects:

1) Urban Village Remodeling

In April 2023, the State Council reviewed and approved the “Guiding Opinions on Actively and Steadily Promoting Urban Village Renovation in Megacities” (hereinafter referred to as the “Guiding Opinions”) to promote the active and steady implementation of urban village renovation in 21 megacities. As the base for the development of Shangshi City, in the past 3 years, Shanghai has completed the renovation of 1.857,000 square meters of the central city, benefiting 92,000 households. According to the “Guiding Opinions”, Shanghai plans to launch 30 new urban village renovation projects from 2023 to 2025, 10 each year, with an area of not less than 4 million square meters, which provides a wide range of market opportunities for the development of Shangshi City.

2) Urban renewal projects

In terms of market layout, the company actively expands the urban renewal market and continues to take advantage of the trend in this field. In July 2021, the company's TODTOWN Tianhui Project won the “Best Landmark Complex Award” and the RICS “Annual Urban Renewal Project Excellence Award” at the 2021 Surge Urban Renewal Conference. In addition, in 2020, Shangshi Chengkai's Shangtou Xinhong Investment Company undertook the “Urban Village Renovation Project” in Hongxing Village, Xinhong Street, Minhang District, Shanghai. The renovation included the construction of the relocation and resettlement housing project and the development of the supporting commercial project “Chengkai Preference+ Xinhong Hui” to vigorously develop a new climate of urban renewal. The commercial project covered various business formats such as fresh supermarkets, popular restaurants, and family places to provide more complete commercial services for surrounding residents.

3) Broadening the advantages of localization

As a local state-owned enterprise in Shanghai, relying on the parent company Shangshi Holdings, Shangshi Chengkai has a strong territorial advantage. Parent company Shangshi Holdings revealed in a March 2023 press release that in 2022, Shangshi Chengkai and a joint bidder successfully won the land use rights for six plots located in the Lingang New Area of the Shanghai Pilot Free Trade Zone, which can be developed as a residential development project of about 271,081 square meters and a commercial development project of 9,892 square meters. The plot is extremely valuable, further consolidating Shangshichengkai's leading position in the Shanghai market.

4) The advantages of project experience are obvious

In terms of project experience, the company has accumulated rich real estate development experience. It has 28 real estate projects in 10 major cities in China, distributed in Shanghai, Beijing, Tianjin, Wuxi, Shenyang, Xi'an, Chongqing, Yantai, Wuhan and Shenzhen. Most of them are medium- and high-end residential properties, and construction projects are being carried out at full speed. As disclosed in the 2023 financial report, these projects have provided the company with a total of about 3.482 million square meters of future saleable area, and rich industry experience has laid a good foundation for the company's long-term development.

3. The valuation is far below the industry average PB, and the rebound potential is strong

(Image source: Futu)

By the close of trading on March 22, 2024, the net opening rate of Shangshi City was 0.148 times, far lower than the average net market ratio of 0.65 times the industry average (average PB of Shenwan's second-level real estate development industry). The company's valuation was only 23% of the industry. At the same time, the company's dividends were quite generous, compounded by ultra-low stock prices. The signs of underestimation of the company's value are very obvious.

In terms of cash flow, according to the 2023 financial report released by the company, the bank balance and cash for Shangshi City Development in 2023 was HK$5.986 billion, an increase of HK$1,508 billion over the same period last year, demonstrating the company's good financial performance and fund management capabilities during the year.

In 2023, the company's balance and liability situation improved dramatically. The ratio of the company's net debt to total equity (that is, net borrowing/total equity) was 58.4%. Compared with 63.0% in 2022, the debt ratio decreased by 4.6 percentage points, and the company's debt situation was continuously optimized. At the same time, the company's operating efficiency is also improving steadily. In 2023, the company's liquidity ratio was 1.4 times, compared with 1.1 times in 2022, an increase of 27.3%.

In the past, Shangshicheng's stock opening price was suppressed for a long time. In addition to well-known industry factors, the industry believes that the reason affecting its stock price was that the company's assets were highly concentrated in Shanghai, and before the industry was adjusted, the local real estate regulation policy in Shanghai was one of the most stringent cities. However, with the gradual liberalization of purchase restriction policies in important cities such as Guangzhou and Hangzhou, the market's expectations for the loosening of Shanghai real estate are rising. In the future, Shanghai will have a connector effect with Jiangsu, Zhejiang, etc., and diversification of the company's cash flow from Yangtze River Delta project sales is not ruled out.

The company is small but beautiful, and the quality is excellent. In a situation where the overall Hong Kong stock market is weak, management frequently buys back shares and is optimistic about the company's future prospects. During the reporting period, the company purchased a total of 2.894 million shares of common stock in 2023, with a total purchase price of HK$1,322 million. After completing the repurchase of the above shares, the company completed the cancellation of shares, which greatly benefits existing shareholders and boosts investor confidence.

(Image source: CICC)

According to CICC's research, as of September 12, 2023, the average PB hub for mainstream Hong Kong developers since 2010 was 0.6 times, such as Changshi Group 0.51 times, Henderson Land, 0.57 times, and Kowloon. Hang Lung Properties, Sun Hung Kai Properties and Swire Properties were slightly higher, 1.03 times, 0.76 times, and 0.70 times, respectively. However, the current PB of Shangshi Chengkai (0563.HK), a domestic housing stock, is only 0.15 times that. It is extremely cheap in terms of valuation. It is in a value depression, far below the central value of the Hong Kong real estate stock industry. In contrast, I believe its bottoming back will be stronger than that of Hong Kong real estate stocks.