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Greentown Service Group 2869
June 04, 2020 - 1:07pm EST by
eightyeight
2020 2021
Price: 10.40 EPS 0.234 0.312
Shares Out. (in M): 2,950 P/E 44.4 33.3
Market Cap (in $M): 3,930 P/FCF 27.5 21.0
Net Debt (in $M): -237 EBIT 117 153
TEV (in $M): 3,693 TEV/EBIT 31.5 24.2

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Description

 

Investment Thesis
  • What's the change 
China property management sector is a rapidly growing sector driven by both volume (management area) and price (management fee per square meter) increase. It's a defensive sector that is less sensitive to economy cycle or regulation, and the leaders can mostly benefit from economy of scale 
  • Why is the change 
    • Top players even have reserved areas more than its current revenue bearing area under management. Assuming it takes 3 years to convert reserved areas to revenue bearing areas under management, areas under management can easily achieve a 30% YoY growth
    • Even the relatively smaller players, the reserved areas are 50% of area under management, which further illustrates the high growth nature of this sector (at least in the near term)
    • It is expected among 70,000+ players in the sector, the top 100 companies can expand their combined market share to 45% by 2020E
    • If you compares top 10 market shares of property managers and developers, top 10 managers has 10.8% market share vs 24% for top 10 developer, which also implies a potential consolidation 
    • Additionally, consolidation in property developers are underway. Top 5 developer market share is increasing and expected to further reach 32% in 2021 from 17% in 2017. Developers consolidation can also help drive manager's area under management (one collaboration with developer can bring more areas )
    • New constructed projects always have a higher management fee vs nearby old buildings 
    • High end China property managers charge RMB 3/sqm/month vs HKD 4+/sqf/month
      • You can also clearly feel the gap of property quality in China vs HK, eg China doesn't have a rule or practice to renovate an old building periodically like in HK or other developed countries
    • Even though in one contract period (2-3 years), it's not easy to increase the management fee. It's fairly usual for a manager to charge higher fee when renew a contract
      • Add 10 cents management fee (say RMB 3 to 3.3 /sqm/month) every month probably won't make a difference to many property owners (from RMB 300 to 330 each month for 100 sqm apartment), but it can lead to a 10% top line growth
    • Property manager acquires new management area (reserved area) through 1) parent property developer's new projects 2) winning management contract from 3rd party developers. Those "backlog" reserved area, which is disclosed by most public property managers, provide a certainty of management area growth
    • The property management sector is still fragmented, with top 10 and top 100 companies only account for 10% and 30% of total area under management. It's very likely the industry will see some consolidation, which may add on to the leading player's growth in area under management
    • Large new construction areas in the 5 years (not a strong argument, because estimations below are from some sources that I don't know the credibility)
    • Ample headroom for management fee
  • Additional highlight of the sector
    • Not matter what happens, you need a room to live, and someone needs to manage the building 
      It's rarely for a project to change manager. In fact, the renewal rate of manager's contract is around 94.1% to 98.21%(Top companies contract renewal rate were 95% in the past )
    • Compares to other services, property management is relatively standardized 
    • Managers and service professional at each projects play a key role in property management quality. But quite some service can be centralized to save cost / have limited marginal cost 
      • IT systems and any value add systems / app
      • Raw materials or vendor of gardening / clubhouse /  security camera etc  
      • Staff training
    • Professional property managers don't have a long history in China. It was mostly a neglectable department within a developer
    • Among top 10 developers in China, 1/3 doesn't have its own property management arm
    • Many smartphone and internet development in China is actually more advanced than US or any other countries. The technology is probably not cutting edge or disruptive, but the China's innovation in business model, application and service is recognized globally. Service and business model innovation, eg O2O service, children education, can provide more revenue streams for China property manager
    • Below are the examples for value added services. Those are the value added serviced provided by current players that already generating sizable revenue, not some future potentials   
    •  
    • Defensive sector with foreseeable and recurring revenues
    • Leaders have economy of scale
    • Scarcity of high quality property mangers with scale 
    • Additional upside from value add services  
  • What the market is missing
    • Even 1/3 of top 10 developers in China doesn't have its own property management business 
    • Chinese are a lot richer now, property management service upgrade follows the same logic of China consumer spending upgrade
    • People in China used to believe property management as an utility like company (gas/water/electricity)
    • Clear demand for high quality property management and service

Pick the winners in the sector

 

  • Ability to increase fees
    • The higher end buildings or projects with more exposure to higher tier cities is more likely to increase management fee
      • Favors Greentown Service, who is focused on high end projects and tier 1 cities (especially in 长三角)
      • Greentown also has the highest% of 3rd party projects, which proves its leading management capability among all managers

Risks

  • Labor cost is 53% of total costs, while the labor cost is rising in China, and management fee growth is less than minimum wages growth 
    • Most managers have a healthy gross margin around 30% and net margin of 15%, which leaves a lot of buffer before meaningful margin erosion 
  • Any management fee increases need to be approved by over half of owners in most projects, and most contracts last 2-3 years 
    • Management fee increasing can be achieved through value add service revenue, which also usually have a much better margin
    • New projects tends to have higher management fees 
  • Uncertainty in the sale and completion of develper's projects may affect the reserved areas conversion to revenue bearing management area
    • Current large scale reserved areas can provide some "margin of safety" to growth area under management
  • People don't pay if a recession hits 
    • If you stay in a building, you are legally obligated to pay the management fee> It's a must even more than consumer staples 
    • Current fee collection rate is high (pls refer to data below in comps benchmarking, around 95%), which can also provide some tolerance level for lower collection rate  
  • The valuation is very rich now

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

  • More spinoff IPOs from property developers
    • The spinoff method itself shows developers believe it's a promising sector with valuation and business prospects not fully appreciated by investors
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