Downsizing cannot be the best of both worlds. While maintaining credit, companies must resolutely remove inventory, deleveraging, and risk, and must also endure the costs of not being able to acquire land, declining profitability, and falling sales rankings. So, is a smaller country garden with poor profitability still interesting for equity investors? We think there are. The company has retained a cohesive and effective team, a good credit record for dealing with huge challenges, a good product line and delivery reputation, and a healthier balance sheet than its history.

The company announced its 2022 results, achieving annual operating revenue of 43.4 billion yuan, -18% year-on-year, and gross profit of 32.9 billion yuan, or -65% year-on-year. The company reported a net loss of 6.1 billion yuan. If exchange gains and losses and changes in investment property valuations are excluded, the parent's core net profit is 2.6 billion yuan.

Strong payback and delivery capabilities help the company get through difficult times. In 2022, the company achieved contract sales of 357.5 billion yuan, a year-on-year ratio of -36%, with a sales removal rate of 65%. The equity repayment amount was 332.5 billion yuan, and the equity sales repayment rate was 93%. Although the company's sales have clearly outperformed the industry, the company has done its best to promote sales in weak markets.

The company's sales in 66 cities entered the top three in the region, with 14 cities accounting for more than 20% of the market. The company delivered nearly 700,000 housing units during the year. By the first two months of 2023, the company achieved sales of 46.9 billion yuan, a year-on-year decrease of 32%, and narrower than the decline in sales for the full year of 2022.

Saleable resources are still abundant, and sales and profits are still resilient to recovery. The total sales value of the company's equity at the end of 2022 was 955.5 billion yuan, of which Tier 1 and 2 accounted for 39%. Since the company's current pricing is close to the cost line, the company's performance is very flexible compared to pricing (which of course also means that the risk is not small). Compared to other real estate companies, the company's settlement revenue and profit fluctuate within a relatively wide range. Although the company acquired little land in 2022, there is quite a bit of value the company can supply. At the end of 2022, the company's forensic ready-to-sell area was 23.8 million square meters, an increase of 12.8% over the end of 2021.

Through many efforts, the balance sheet was gradually repaired. The company is the representative of private industrial enterprises that have persisted and stabilized their credit until now. In 2022, the company opened up resources and saved money, and achieved remarkable results. At the end of 2022, the company's balance ratio fell below 70% to 69.4% for the first time, the short-term cash debt ratio fell 1.6 times, the net loan ratio fell to 40%, and the size of interest-bearing debt fell from 317.9 billion yuan at the end of 2021 to 271.3 billion yuan in 2022. The company is generally close to the requirements of the three red lines. Optimizing cash flow requires not only promotional sales, but also an appropriate reduction in investment. In addition to reducing land acquisition, the company has also reduced unnecessary construction and investment, putting pressure on the monthly rigid outflow of operating capital.

Land payments made by companies in 2022 fell 91% to 12.1 billion yuan; project payments fell 15% to 237.3 billion yuan; and tax payments fell 58%. This shows that the company is consciously optimizing the pace of the project and reducing development costs. It also shows that the government has strongly supported the company and made every effort to help the company guarantee credit and delivery.

Deleveraging and inventory removal are still mid-term tasks. Companies' weighted average borrowing costs are still rising slightly, and financing channels have yet to fully recover. We expect that 2023 will still be a year of net decline in corporate borrowing, that is, companies still need to continue to pay close attention to sales and reduce leverage. Overall, we believe that the most difficult time for the company is over, and the confidence of the company's customers, partners, and creditors is gradually recovering. Of course, it will take time for the company to repair its balance sheet. In the process, the company's overall operating scale and profitability may still hover at a low level, and the company's industry ranking may decline in trend.

Risk factors: The risk that the recovery in the region where the company is located falls short of the national average, and sales will drop sharply year over year.

There is a risk that the company has fewer and fewer projects to develop, and the overall level of profitability is low.

Profit forecasting, valuation, and ratings: Downsizing cannot be the best of both worlds. While maintaining credit, companies must resolutely eliminate inventory, deleveraging, and risk, and must also endure the costs of not being able to acquire land, declining profitability, and falling sales rankings. So, is there anything interesting about a smaller, less profitable Country Garden for equity investors? We think there are. The company has retained a cohesive and effective team, a good credit record for dealing with huge challenges, a good product line and delivery reputation, and a healthier balance sheet than its history. We adjusted the company's 2023/2024/2025 EPS forecast to 0.31/0.31/0.39 yuan/share (the original forecast 2023/2024 was 0.47/0.40 yuan). Referring to the PE valuation of private development enterprises including Binjiang Group, Longhu Group and other companies in 2023 (forecast by CITIC Securities Research Department), we gave the company 6.5 times the target market value of PE in 2023, corresponding to the target price of HK$2.33, maintaining the company's “increased” investment rating.