Shorting Chinese property
Evergrande isn’t the only Chinese real estate group facing an uncertain future
One key structural feature of the Chinese economy over the past 15 years has been the booming property market. Thanks to a combination of rapid economic growth, loose monetary policy and Beijing’s decision to put housebuilding and construction at the forefront of a series of fiscal stimulus packages, the Chinese real estate sector is the largest in the world. Indeed, China’s property market is now worth twice as much as the US property market, even though the US economy is still 50% larger in dollar terms
(and only slightly smaller when differences in purchasing power are accounted for). However, this boom seems about to come to a messy end.
Beijing has slammed on the brakes, restricting access to credit and tightening regulations, in a (belated) attempt to deflate the bubble. In the past, attempts to rein in the sector have ended without much impact, partly because the Chinese government feared that a slowdown in the sector would have too much of an impact on growth. However, the current crackdown seems more serious. Not only has the number of new building projects collapsed, but many Chinese property groups are now in trouble, most notably Evergrande, which technically defaulted last month, and is undergoing an official “restructuring”.
China’s property woes
While not quite on the scale of Evergrande, another company which stands to lose from the fallout is KE Holdings (NYSE: BEKE). It claims to be China’s largest real estate broker in terms of transaction numbers – according to its figures, its sales more than doubled between 2017 and 2020. As a result, its share price also doubled only a few months after it listed in the US in August 2020. However, its share price has since fallen by more than two-thirds, as doubts about Chinese property continue to grow. To add insult to injury, Muddy Waters Capital, run by noted short-seller Carson Block, published a report in December querying some of the figures KE has produced regarding sales and transactions.
Yet even if its figures are accurate, KE Holdings seems overvalued, trading at 35.4 times 2022 earnings. Assuming the Chinese real estate market doesn’t collapse (a big assumption, as things stand), KE’s growth is set to fall to a more modest 10% a year. Meanwhile it faces intense competition from other national brands, as well as local brokers, who are willing to charge a fraction of its 2% fee on every sale. Another concern is the fact that it is struggling to use its capital productively, producing a measly return on capital employed (ROCE) of around 2% a year. Unless it is able to increase this, its growth will effectively be destroying value.
Overall, with the share price still drifting lower I’d suggest shorting KE Holdings at the current price of $21.74 at £90 per $1. I’d cover your position if it rises above $32.74. This gives you a possible downside of £990.
“Even if its sales figures are accurate, KE Holdings looks overvalued”