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How can LVGEM (China) as a small private-owned real estate enterprise always lagging behind survive the cold winter of industry? Author: CHINA LVGEM


  1. During the darkest time of real estate industry, a small private-owned real estate enterprise always lagging behind has unexpectedly survived so far


In the past year, the real estate industry experienced the darkest moment with obstacle in both the sales side and the financing side, which brought huge pressure on the asset chain of real estate enterprises in the industry, especially the small and medium-sized real estate enterprises with relatively weak funding. Real estate enterprises were plagued by default storm and bankruptcy. According to relevant data, 396 real estate enterprises went bankrupt in only one year in 2021, which means that one real estate enterprise collapsed every day on average. Even in 2022, this momentum has not diminished. In the first seven months, the cumulative number of bankrupt real estate enterprises has also reached 214.


Under such a severe industry situation, the author noticed that LVGEM (China), as a small real estate enterprise that had always lagged behind in the industry with a scale of only RMB3-4 billion, has survived this crisis of real estate enterprises. The reason behind this is intriguing.


Being in the interim financial reporting season of Hong Kong stock market, many real estate enterprises cannot escape the fate of a sharp decline in profits. Due to the factors such as delayed delivery of projects or falling sales and prices, real estate enterprises delivered dismal interim results, a few of them recorded profits being cut in half, and many real estate enterprises’ profits have even shrunk by 8-10 times, which is jaw-dropping. On the other hand, the report delivered by LVGEM (China) shows that the company’s interim results and profit remain positive, becoming a “legacy” within the industry.


In my opinion, the fact that LVGEM (China) survived the crisis and achieved steady performance may be related to the business advantages of the following two aspects.


First, the company focuses on the urban renewal field, which is relatively stable, and does not blindly pursue big scale.


We know that urban renewal projects often have a long cycle attribute, and the profit rate is relatively high, which belongs to the business model of “long line to catch big fish”. This kind of model with a long period of early investment makes real estate enterprises more inclined not to blindly pursue big scale, but to carry out business layout around the idea of making a single project bigger and better.


Therefore, we can see that although LVGEM (China) has long regarded itself as “small and beautiful”, the company’s actual profitability has always been good, and the gross profit margin has always been 40% at the industry high level. In particular, the gross profit margin of the projects located in Shenzhen has even reached 60%, and the net profit can reach 30%. Compared with the median gross profit margin of 19% of typical real estate enterprises in 2021, LVGEM (China)’s urban renewal projects are quite profitable. This kind of profitability strengthens the safety pad for real estate enterprises in the current environment and helps them pass through the cycle.


At the same time, due to the small scale, the project development is carried out steadily according to the plan that the next project will begin after the previous project achieves good payment collection, so its cash flow also forms a virtuous circle, and is relatively less affected and interfered by the external environment. Hence during the industry reshuffle, we can see that LVGEM (China), which has been dormant for many years, finally survived because it did not expand too much.


On the other hand, for real estate enterprises with high turnover, heavy loan and leverage, slight influence on the industry would put their capital chain under pressure. In particular, in the face of the unprecedented dramatic changes in policy and market environment in the past two years, these real estate enterprises showed their true colors, responding to the saying “when the tide recedes, we will see who is swimming naked”.


Second, the project is located in the core area, with high asset quality and high selling rate.


From the perspective of the industry crisis faced by real estate industry, the tightening capital brought by the policy on the debt side is one aspect, and the sales side is also another important aspect. Residents are faced with a “crisis of trust” in the default of real estate enterprises. Especially in the first half of 2022, the large-scale “default of mortgage” broke out, and the real estate sales showed a serious lack of confidence. Due to this, buyers will pay more attention on the quality and appreciation potential of assets, rather than blindly making moves, which also gives opportunities to real estate enterprises with project layout in core regions. From the perspective of its layout, the urban renewal projects of LVGEM (China) are often located in the urban core area with guaranteed selling rate and strong turnover capacity.


For example, the Baishizhou project is located in Shahe Street, the east of Nanshan District, Shenzhen, and is only a river away from the “Cosmic Center” Yuehai Street. Nanshan District has gathered Tencent, Lenovo and many other enterprise headquarters, and is indisputable the leading engine of the economy of Guangdong-Hong Kong-Macao Greater Bay Area. This also determines that the Baishizhou project is a core asset in the core area of the first-tier city, Shenzhen.


In combination with the real estate market, the overall transaction performance of new housing in Shenzhen in the first half of the year was not satisfactory, with the turnover of new housing falling by nearly 38% year on year. However, against this background, the number of new housing transactions in Nanshan District rose by nearly 39%, demonstrating the strong anti-risk ability of this region.


The author also noticed that the transaction area of Nanshan District in the first half of the year reached 308,500 square meters, an increase of 36.8% year on year, with strong market digestion capacity, and the transaction of housing with price more than RMB10 million accounted for the half. At the interim results meeting, LVGEM (China) pointed out that next year Baishizhou Phase I would launch the project of 135,000 square meters for the first time. Given that in the first half of this year Nanshan District digested about 150,000 square meters of luxury houses with transaction prices above RMB10 million although the real estate market was in depression, in next year when Baishizhou Phase I launches the project of 135,000 square meters, the selling rate may be guaranteed to some extent.


Back to the industry level, the author believes that the real estate industry has come to the second half, and the investment logic of the market will no longer focus on scale, but on two directions. First is resources: focus on the high-quality asset layout and anti risk ability of real estate enterprises. Second is profitability: focus on the performance of real estate enterprises in the profit side and their ability to operate sustainably.


From this perspective, LVGEM (China) has performed commendably in these two aspects, so how should we view its long-term opportunities?


  1. Can the “atypical real estate enterprise” LVGEM (China) leapfrog the cycle in the storm of the industry?


As we have seen above, LVGEM (China) is an “atypical real estate enterprise” in the industry, and the business model of focusing on the urban renewal makes it unique. However, under the environment of industry storm, although the urban renewal business model itself has some advantages in risk resistance, LVGEM (China) is still of small scale. It is difficult not to worry about whether it will be eliminated by the market or eaten by other “big fish”? After all, at the beginning of 2022, LVGEM (China)’s short-term debt within one year was as high as RMB9.8 billion as disclosed, and its own capital lying on its account was only RMB7 billion.


With its high-quality assets of urban renewal as “protection”, is LVGEM (China) really safe?


At the beginning of the year, the market saw that LVGEM (China)’s short-term debt within one year was RMB9.8 billion as disclosed, which is twice as its own scale. This has also led to doubts about the company’s liquidity risk.


Here comes to the middle of 2022. According to the information disclosed by LVGEM (China)’s interim results, as of August 2022, the company had completed the rescheduling of RMB8.28 billion of short-term debt at the beginning of the year. For the small public offerings of RMB1.4 billion due in August, RMB900 million has been renewed and RMB500 million has been paid; RMB300 million of the HK$600 million of Hong Kong dollar bonds due in August has been renewed, and the remaining RMB300 million will be due in December, which the company expected to renew in the same way by the end of December. The company’s debt pressure has been greatly eased.


This is mainly due to the debt structure of LVGEM (China) in breakdown. The debt is mainly bank and other loans, accounting for more than 80% of the total debt. This part of debt has high-quality assets as collateral, with relatively low difficulty in renewal; In this way, although the amount of debt on LVGEM (China)’s account is high, the actual debt to be repaid is far lower than the book figure. The capability of LVGEM (China) to complete the rescheduling of 84% of its debt in the first half of the year also shows the safety of this debt structure. At the same time, LVGEM (China) claimed that it did not have any off-balance liabilities or trusts, which made many real estate companies collapse. Given LVGEM (China) does not have this kind of liabilities, its debt structure is relatively clean and reliable.


However, it is only the first step to get through this year smoothly, and LVGEM (China)’s US dollar bonds due in March next year are the big challenge that stands in the way. According to Bloomberg data, the size of the US dollar debt is US$470 million. LVGEM (China) indicated at the interim results meeting that the company had now taken active actions to make “three preparations” for the US dollar debt next year: 1) With RMB7.9 billion of saleable value, the company can make extra efforts in marketing to enrich its own funds; 2) The company is arranging refinancing of operating property loans for domestic properties, and the financing scale is expected to increase by RMB1.5-2.0 billion; 3) Make refinancing of estimated US$300-500 million based on Baishizhou’s overseas equity.


The company disclosed its current saleable value, most of which is from LVGEM Royal Bay in Zhuhai, with a value of nearly RMB6 billion. According to the company, the value of RMB6 billion is all existing buildings that meet the pre-sale conditions, and the northern district has been fully capped in August. The capital expenditure for this part of the construction can be greatly reduced, which will relatively relief the company’s liquidity pressure.


For Baishizhou project or other urban renewal projects, investment properties can refinance around RMB2-3 billion. Facing the mountain of US dollar debt, LVGEM (China) seems to have found a ladder.


In the first half of the year, the market financing environment was still unspeakably loose. Under the premise of balance shrinking in the market, many real estate companies encountered bank withdrawal crises. LVGEM (China) disclosed in its interim results meeting that with the support of high-quality urban renewal projects, the company’s bank withdrawals amounted to RMB3.41 billion in the first half of the year, which also reflects the recognition of financial institutions for its high-quality assets and anti-risk capabilities.


For LVGEM (China), holding of the “Big Mac” urban renewal project – Baishizhou urban renewal project is like holding the “joker bomb” in the turbulent real estate industry. Once the Baishizhou Phase I project is pre-sold next year, the entire company will be fully “revitalized”, so the question is, will LVGEM (China) be able to make it to that time?


  1. Can an ant swallow an elephant? It all depends on the pre-sale of Baishizhou Phase I next year


There is no doubt that the Baishizhou project is a milestone project that determines the future development of LVGEM (China), so it has drawn quite high market attention. Of course, the market is constantly questioning whether such a small company is able to develop such a large project?


In the first half of the year, LVGEM (China) announced that Vanke would take an 8% stake in the Baishizhou project at a consideration of RMB2.3 billion. According to the estimates of the transaction, the overall valuation of Baishizhou urban renewal project is around RMB33 billion. Vanke’s entry into Baishizhou project has alleviated this doubt to a certain extent. With the blessing of a leading real estate company with a state-owned background and always being known for its stability, LVGEM (China) will obviously have more confidence in operating Baishizhou. In particular, Vanke itself is also a cornerstone investor of LVGEM (China). As a strategic shareholder, it will help small private real estate company like LVGEM (China) further secure, and it is expected to help LVGEM (China) in both financing and sales in the future.


At the same time, it can be seen from the details of the investment cooperation that Vanke does not pursue short-term profits and does not participate in the profit distribution of the first and second phases of the Baishizhou urban renewal project, which also gives LVGEM (China) more room for maneuver and lays a solid foundation for further development.


In addition to the support of Vanke, the Baishizhou project is also supported by a syndicated loan of RMB20.7 billion, which can meet the capital needs for the demolition and development of the Baishizhou project. Judging from the latest situation, the construction of the project is progressing smoothly, the construction of plus or minus zero is currently underway, and it is expected to be in pre-sale in 2023.


Let’s calculate in combination with the Baishizhou project Phase I.


According to estimates, the construction and installation cost of the Baishizhou project Phase I is RMB8,000 per square meter, while the surrounding real estate is priced at RMB120,000-140,000. The Phase I has 330,000 square meters, and the value of the goods will reach about RMB40 billion. Judging from the company’s gross and net profit margins, LVGEM (China)’s gross profit margin has remained above 45% for the past four years, and its net profit margin has remained above 25% for the past four years. Taking into account that the actual income is about 80% of the value of goods, the company’s gross profit and net profit will also reach more than RMB14 billion and RMB8 billion, respectively. Compared with the company’s revenue of only RMB4.3 billion in 2021, this also means that once Baishizhou starts pre-sale, LVGEM (China)’s revenue and profits will usher in a qualitative leap. At the same time, its anti-risk capability will also be comprehensively consolidated and strengthened.


Considering that the current development of the Greater Bay Area is moving from incremental to stock, the opportunities for urban renewal are becoming more and more prominent. LVGEM (China), which focuses on urban renewal, will be blessed and favored by more high-quality resources in the future after launching the Baishizhou project, and continue to gain market opportunities in the field of urban renewal. In particular, the Baishizhou project will bring the company’s overall strength to a higher level. After the industry has experienced storms and ushered in a new stage, the company could also gain more new market opportunities.


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