PB valuation is applied to the construction industry, reflects the realisation value of an enterprise's immediate liquidation, and is a static and conservative valuation method. PB is an important indicator of the relative valuation method. It is mainly applied to mature asset-heavy industries, that is, revenue and profits are more dependent on capital, such as banking, steel, chemicals, etc. From the perspective of capital dependency, PB valuation is also reasonable for the construction industry: in the financial statements of construction companies, the asset side is mainly cash, accounts receivable, completed and unsettled receivables, etc., and the debt side is mainly bank loans, bonds, payables (supplier arrears), etc. From this, it can be seen that the assets held by construction companies are basically financial or liquid assets, and there are few fixed assets such as equipment and plant. This is because although the construction industry is essentially a service industry, construction companies assume a large part of the financing function due to intense competition in the industry, so construction companies assume a large part of the financing function. Financial strength is an important test criterion for whether enterprises can obtain projects, and capital is also one of the factors driving the continuous expansion of scale. Construction enterprise PB has a clear economic meaning — that is, a multiple of the immediate liquidation value of the enterprise. It is a static and conservative valuation method:
The net book assets of a construction company can be seen as the net cash obtained by the enterprise after recovering all of the project accounts receivable (including accounts receivable and contract assets) and then paying off accounts payable and other debts, that is, the realized value of the immediate liquidation of the construction enterprise. It theoretically forms a certain bottom line value, so PB=1 has a clear economic meaning. However, construction companies generally still have the ability to continuously obtain orders. Ongoing orders are several times their revenue, and they still have the ability to continue operating in the future. PB does not take into account the increase in net assets, which is a static and conservative valuation.
Adjusted PB valuations are constructed to serve as a more conservative valuation base for the company by adding deductions and deductions for some potentially overvalued assets. The traditional PB valuation method may be overestimated when estimating the book value of some assets of construction companies: for example, the market is concerned that in some cases, construction companies' accounts receivable may be partially unrecoverable, there are potential losses, and some receivables are collected on a regular basis, and accounts receivable need to be discounted. In addition, assets such as inventory and contract assets all have risks of not being realized/preserved, and additional deductions are also required. We can think of the adjusted net assets of the company as a relatively conservative value after deducting the impairment. Therefore, the adjusted static PB = 1 times can be regarded as the “bottom of the valuation” of the company. Based on the above ideas, we have calculated that the additional impairment amount to be deducted from China's construction book assets is 191.6 billion yuan. The detailed adjustment analysis is as follows (the data is as of the end of 2023):
Accounts receivable: The total book value is 257.7 billion yuan, the cumulative impairment reserve is 45.3 billion yuan, and the impairment reserve ratio is 14.9%. Theoretically, the accrual ratio is already high, and the company's one-year accounts receivable in 2023 accounted for 66.7%, up from 2022. However, since the company has accounts receivable from some private real estate companies, assuming that the extreme circumstances of risk are taken into account, an additional amount of impairment will be required.
According to the 2023 annual report, the amount of the company's individual accrued impairment accounts receivable was 112.2 billion yuan (including high-risk accounts receivable such as private real estate companies), and the impairment provision was 25.8 billion yuan, accounting for 23%. The proportion of bad debts raised by the hypothetical design reached 70%, requiring an additional deduction of 52.8 billion yuan, for a total of 78.6 billion yuan. It is expected to basically cover the risk exposure of this group of private real estate companies.
Inventory: Total book inventory of 796.3 billion yuan, with depreciation reserves of 8.24 billion yuan. The company's inventory is mainly real estate business development costs (land and unfinished products), accounting for 71%, followed by real estate development products (finished products for sale), accounting for 26%. We believe that as a leading real estate central enterprise, the company's overall business strategy is relatively conservative, and the risk of additional large inventory depreciation is low: 1) The company's layout is mainly in Tier 1 and 2 core cities, and the land storage structure is relatively healthy. 35% of the inventory is located in the four major first-tier core cities. The four first-tier cities that added land acquisition reserves in 2023 together accounted for 46%, and the top ten cities, including second-tier key cities such as Suzhou, Chengdu, and Nanjing, accounted for 76% in total.
2) The overall profitability of the company's real estate business is high. In the past two years, the average sales price of the company was 23,809 yuan/square meter, and the average cost of land acquisition was 14,322 yuan/square meter, which has a high margin of safety. However, in order to fully reflect the possible risk of inventory impairment, we assume that the inventory calculation is prepared for impairment of 5%, and an additional 32 billion yuan of impairment is required.
Contract assets: The book value of the current portion of contract assets is 335 billion yuan, and the impairment reserve is 9.85 billion yuan, accounting for 2.9%. Contract assets can be viewed as future accounts receivable. Refer to the average data for several years in the company's history. Generally, depreciation preparations account for about 10% of accounts receivable. Assuming that the contract asset supplement is depreciated at a rate of 10%, an additional impairment value of 24.6 billion yuan is expected.
Long-term accounts receivable: book value of $111.3 billion, depreciated value of $2.51 billion has been accrued, with an accrual ratio of 2.2%. This portion of receivables mainly comes from government receivables generated by PPP and other projects, so the risk of impairment is lower than the overall risk of receivables (10% impairment ratio). Therefore, assuming an additional 5% impairment ratio, an additional deduction of 3.2 billion yuan of impairment would be required.
Other non-current assets: Among them, the original book value formed from contract assets was 322.1 billion yuan, of which the vast majority came from government receivables from PPP and other projects, accounting for 71%. The hypothetical design raised the 5% ratio, and an additional deduction of 12.1 billion yuan would be required.
Equity investment/investment real estate/fixed assets: Total 325.2 billion yuan. Of these, investment real estate and fixed assets are all recorded using the cost method, and the fair value of some assets is already significantly higher than the book. Assuming conservative considerations for monetizing these non-current assets at a 10% discount, an additional deduction of $32.5 billion would be required.
Goodwill: The premise of goodwill is that the acquired company can continue to operate its business, so all deductions are required when calculating book monetization. The cumulative goodwill of 2.4 billion yuan was accumulated at the end of 2023.
Deferred income tax assets: Deferred income tax assets can be understood as assets that can be expected to be used to deduct taxes in the future. The premise of existence is also the future continuous operation of the enterprise, so they should also be deducted from the book value when the enterprise is liquidated and realized. The company's year-end 2023 deferred tax assets were $22.9 billion.
Perpetual bonds: The valuation of common shares of listed companies does not include preferred shares and perpetual bonds. Common shareholders cannot obtain this portion of value when the company is liquidated, so other equity instruments such as preferred shares and perpetual bonds need to be deducted when calculating book value. The company's perpetual debt at the end of 2023 was $9.1 billion.
Based on the above assumptions, the additional impairment amount to be deducted from the company's book assets was 191.6 billion yuan. The net assets returned to the mother at the end of 2023 were 427.6 billion yuan, and the adjusted net asset value after deducting additional impairment was 236 billion yuan. The valuation did not take into account the increase in the book value of net assets due to the company's future performance operations, and can be viewed as a relatively conservative valuation of the company. The current market value of the company is 225.2 billion yuan, lower than the adjusted net assets of 10.8 billion yuan. The adjusted static PB is 0.95 times (PB = 1 times the valuation base), which has a strong margin of safety.
The valuation is at an all-time low, and the dividend rate of 5% is attractive. As of the latest closing date (2024/7/12), the company's PE/PB was 4.1/0.53 times, respectively, and is still in the lowest range in history. In 2024, the company's dividend was 11.3 billion yuan, an increase of 6.6%. The dividend rate was 20.82%, an increase of 0.02 pcts over the previous year. The current dividend rate is 5.0%.
Investment advice: The company's construction business orders continue to grow steadily (13.7% increase in the first half of this year), the business structure continues to be optimized, the share of residential orders is declining, the share of municipal infrastructure is rising, and the infrastructure attributes of the construction business are constantly increasing. The risk of repayment is expected to decline in the future, and the quality of operations will steadily improve. In the real estate business, the company's advantage as a leading central enterprise has expanded, and the logic of increasing market share continues to be strengthened. Real estate sales in the first half of this year were 191.5 billion yuan, down 20.6% year on year. The performance was significantly better than that of the industry as a whole and leading companies as a whole (according to Kerry statistics, the trading volume of top 100 real estate companies fell 39.5% in January-June). At the industry level, real estate policies have changed and are expected to continue to be strengthened, which is expected to catalyze the repair of leading real estate chain valuations.
Currently, the company's valuation is in the lowest range in history, and the dividend rate of 5% is highly attractive, continuing the core recommendation.
Risk warning: risk of falling macro demand, risk of impairment of accounts receivable, risk of continuing decline in real estate prices, risk of errors in calculation assumptions, etc.