ANCHOR REPORT China property: Stick to quality beta; keep an eye on alpha A ripe patch for the best large caps, while some small caps can share the pie too We expand our coverage to 16 developers, where we identify high dividend-yield plays, four high-growth small caps with potential to re-rate, and potential results beats/misses. We suggest investors accumulate quality big names (COLI, Shimao, Sunac) and those with potential to exceed results expectations (Kaisa, Guangzhou R 2) attractive valuations at 3-4x FY14F P/E; 3) declining borrowing costs; and 4) potential high return at re-rating. China property EQUITY: PROPERTY Stick to quality beta; keep an eye on alpha A ripe patch for the best large caps, while some small caps can share the pie too We expand our coverage to 16 property developers from nine, with initiations for CIFI, Franshion, Greentown, Guangzhou R big names with strong execution should rally first The China property sector trades at 6.1x FY14F P/E (historical average: 9.8x) and at a 45% discount to NAV (historical average: 32%). Considering the overhang of credit tightening, we suggest investors focus on big-scale developers in the following three categories: 1) big SOEs with cheap financing like COLI; 2) those with good track records and strong execution like Shimao; and 3) small caps that are scaling up and show re-rating potential like Sunac. Short-term catalysts: strong results and February property sales We expect major developers to deliver strong results, with earnings up on average by 28% y-y (ex Shui On Land, which we have downgraded to Reduce). While the declining gross margin trend is well known among investors, managements upbeat guidance may help to boost investor confidence in the China property sector. Also, while we expect weak sector sales for January, we look for the February numbers to rebound strongly on seasonality (note that Feb 2014 will see less of an impact from the Lunar New Year given that the holiday was in end-Jan this year, vs mid-Feb in 2013). Results beats: Kaisa, Guangzhou R results misses: Poly, Shui On We expect positive surprises at Kaisa and Guangzhou R Guangzhou R how to resolve the dilemma between high gearing and landbanking needs Shimao Bought abundant amount of land in 2013. How much in saleable resources does this represent? When will they start to contribute to sales? What is the average margin. Progress of investment properties, such as Mini Mall Shui On Progress of XinTianDi IPO. Any en bloc sales in 2014 and 2015 SOHO China Progress of the three land sales in Shanghai Progress of transition from property sales to property investment. Sunac Plans on financing, especially offshore financing. Launch plans for the “land king” projects acquired in 2013. What ASP do you plan to sell at? Yanlord Management targets to achieve CNY30bn sales in five years time. How much land acquisitions are needed in order to provide sufficient saleable resources, regional focus? Source: Nomura research 7 Stock selections We value the companies on eight key measures: profitability, financing advantage, scale, product quality, landbank quality, leverage, growth prospects and execution. Two SOEs, COLI and CR Land, rank the highest with more than 70 points of a possible total of 80. Shimao and Franshion achieved 66 and 63 points, respectively. Longfor and Sunac are scored at 61 each, followed by Guangzhou R this implies an around 3.5% dividend yield. Sunac (1918 HK, Buy, TP: HKD8.72) (1) Best candidate to re-rate into a mid-cap developer among small caps on the back of its strong contracted sales (CNY50bn) achieved in FY13, potential for core earnings to reach CNY4.0bn in FY14F, and quality landbank in T1 and T2 cities. (2) We expect Sunac to grow 36% y-y to reach CNY68bn in contracted sales in FY14F on the back of abundant saleable resources of CNY125bn. (3) Sunac has a quality landbank in T1/T2 cities including 10.3% in Shanghai, 8.8% in Beijing, 5.5% in Hangzhou, and 31.2% in Tianjin (headquarter). This makes Sunac well positioned for potential market downside, if any. COLICR LandShimaoLonforSunacCOGOSOHOShui On LandYanlordGreentownPolyKaisaGuangzhou R we expect SOHO China, KWG, and Poly Property to deliver 4-5% dividend yield. Guangzhou R KWG also targets CNY30bn sales, while we expect Kaisas sales to reach CNY40bn by 2015F and Sunacs to reach about CNY80bn. Their growing scale should re-rate these companies into mid-cap developers, thus enabling them to enjoy the fruits of scale - lower borrowing costs. Currently, average borrowing costs are 8-10% for small-cap developers, vs 5-8% for mid-cap developers. If we assume the borrowing costs for the small-cap developers decline by 20% due to increased scale, their net margins should rise significantly, we estimate. And if we simply assume 25% earnings growth over the next two years for the small caps, and we apply a 40% potential P/E re-rating