Is China Recovery on the Bubble?

Source: Wall Street Journal by Rick Carew

The global economic recovery has drawn support from a swift rebound in China. Now, investors and economists wonder whether a bursting Chinese property bubble could put China's economy in a bind.

Over the past week, China's cabinet has announced measures aimed at cracking down on property speculators, including tougher down-payment requirements for second and third homes. This comes after China reported an 11.7% rise in urban home prices last month from a year earlier, its fastest gain in five years.

"This is the critical policy point that finally cracks the Chinese property market," declared Morgan Stanley China strategist Jerry Lou.

All this could be seen as bolstering the case for short-seller James Chanos. The name of Mr. Chanos's $6 billion hedge fund, Kynikos Associates LP, means "cynic" in Greek—appropriate since the New York-based money manager earlier this year made himself the world's best-known cynic when it comes to China's growth story.

"What we're talking about is a world-class, if not the, world-class property bubble," Mr. Chanos said in an interview with Charlie Rose, comparing conditions in Chinese cities to Dubai and Miami. He predicts the bubble will begin to unravel later this year.

Mr. Chanos argues that China's lending spree during the financial crisis has pumped too much money into real estate, and that housing prices have surpassed affordability.

Among the counter-arguments: China's growing wealth feeds a long-term demand to upgrade the country's housing stock, and regulators put a tight cap on loan-to-value ratios, limiting the downside of any bubble. Some note that China's government, using measures such as those announced in the last week, has long avoided a crash in housing prices.

Those inclined to favor Mr. Chanos's analysis—or who at least believe that some kind of correction is likely—could try to emulate his strategy. He is betting on a decline in the price of Hong Kong-listed Chinese property developers and other companies linked to China's property market, such as those exporting cement and copper to China.

However, he hasn't specified company names and didn't reply to a request for information on his positions.

Below are three companies that reflect exposure to the China property story. All three trade in Hong Kong, making them accessible to international investors. There's no evidence that Mr. Chanos has a position in any of them. But those who believe China's property market is heading for further trouble might consider shunning them from their portfolios, or taking a short position on them—that is, selling borrowed shares with a view to buying them back at a lower price. (Of course, those who take the opposite view might look for opportunities to pick them up on the cheap.)

Evergrande Real Estate Group Ltd. is a highly indebted company with broad market exposure and aggressive, expansion-minded management, qualities that make it vulnerable to an earnings shortfall.

Evergrande continued its rapid expansion last year, growing its land bank by 30%. It had a difficult time bringing its Nov. 2009 initial public offering to market, and since listing, its shares have dropped by about a third. It's also gone back to the capital markets quickly for more cash, paying a hefty 13% interest rate on $1.35 billion of U.S. dollar bonds issued in January and April this year that come due in 2015. Its shares trade at 40.4 times 2009 earnings and 5.9 times 2010 expected earnings, a wide gap indicating the volatility of its earnings stream.

Agile Property Holdings Ltd. is a play on Hainan, a free-wheeling, tropical island off China's southern coast that is in many ways China's Miami.

A lush environment and nice beaches make it a playground for new-money Chinese and a prime target for speculators betting on luxury properties. In March's property price data, two cities in Hainan, Sanya and Haikou, set the fastest pace, rising 53.9% and 52.1% respectively. The Chinese government helped spark the speculative fever by laying out plans in January to build Hainan into an international tourist destination.

Agile has close to 30% of its landbank and 2010 contracted sale tied up in a single project, Hainan Clearwater Bay, according to Royal Bank of Scotland analysts, tying Agile's fortunes closely to Hainan's fate. Its shares are trading at 15.1 times 2009 actual earnings and 9.8 times 2010 expected earnings.

Fueling much of the boom in property prices has been easy money from Chinese state lenders. China's government pushed banks to lend record volumes of credit during the global financial crisis to keep the economy moving, some of which could go bad in a property crisis.

China Construction Bank Corp. is the country's top mortgage lender and a major lender to infrastructure projects. Its residential mortgage book grew 41.4% last year.

Of the 1.54 trillion yuan ($225.61 billion) in infrastructure loans on its books, 351 billion yuan were made in 2009. Both loan categories could come under stress if there is weakness in the property sector and borrowers have trouble repaying. Many local governments and their investment arms depend heavily on land sales for revenue and could default on loans if that income stream dries up. A deteriorating balance sheet could be enough to offset the earnings boost that CCB and other Chinese banks enjoy from a central bank-mandated spread between lending and deposit rates. Its shares trade at 11.1 times 2009 earnings and 8.1 times 2010 expected earnings, roughly in line with peers.

Source article: http://online.wsj.com/article/SB10001424052748703763904575195744190802772.html