Will E-House Suffer Collateral Damage amid Property Sector’s Downturn?

Recently, several sectors such as the property market in China are suffering from the implementation of various government policies. Against the backdrop of increasing regulations, rising mortgage rates and tightening credit lines, the real estate agency business has also been severely affected.

How can E-House brave through the storm and repay its debts?

Mediocre 1H21 Operating Results

Established in 2000, E-House was listed on the HKEX in July 2018 (Stock Code: 2048.HK), and has a current market capitalization of approximately HK$2.1 billion. The Group's key brands include E-House Marketing, which mainly acts as the sales agent for new houses; Fangyu, a brokerage service provider for second-hand houses; and CRIC, a real estate data application service platform.

In 1H21, the Group’s total gross transaction value of real estate agency services amounted to 222.6 billion RMB, an increment of 51% YoY. After completing its acquisition of a 56% stake in real estate digital marketing platform Leju (Stock Code: LEJU.US) in November 2020, the Group’s revenue increased 120% YoY to 6.3 billion RMB after the consolidation of its income statement.

However, if we exclude the 2 billion RMB revenue contributed by Leju, E-House’s standalone revenue growth is not as impressive. Due to the low base effect, it only rose 50% YoY, and did not have any growth compared to the same period in 2019.

Since Evergrande is E-House’s single largest customer, the Group decided to raise its loss provision of receivables to 1.94 billion RMB, which led directly to a net loss of 1.6 billion RMB in 1H21. According to S&P’s estimates in early August, the scale of E-House’s receivables from Evergrande was about 3.5 billion to 4 billion RMB. Therefore, even if E-House decided to discontinue sales of Evergrande’s houses, the remaining loss provision in future is still close to 2 billion RMB.

Decent Liquidity Status; But Leverage Level is Worsening

Although it faces an issue with its receivables, E-House’s cash and bank balance was about 6.1 billion RMB, with an extra 1.2 billion RMB in restricted cash. The total borrowing size approximates 7.3 billion RMB, translating into a net gearing ratio of almost 0% and an unrestricted cash to short-term debt ratio of 1.5 times. The Group's leverage level and liquidity status are decent (see Table 1).

Table 1: E-House’s Key Credit Indicators

However, compared to last year's net cash position, E-House's leverage level is still deteriorating. If we remove the cash of around 2 billion RMB in Leju’s assets (Leju does not own any debt), and subtract the 1.5 billion RMB that will be invested in TM Home, the short-term liquidity of the Group will be tightened significantly. After adjustments, the unrestricted cash to short-term debt ratio will fall to 0.64 times, and the net gearing will also rise to about 50%.

Considering that the investment in TM Home will be settled using payables and E-House is still owed about 1.4 billion RMB in financial liquid assets, we think E-House’s present liquidity status is satisfactory, with manageable one-year repayment risk, given that more than half of its short-term debt (2.1 billion RMB) are bank loans that should be able to roll-over.

Long-Term Outlook is Weakened with Heightened Risks

In recent years, competition among real estate agents has become increasingly fierce. E-House’s main competitors include Beke, 5I5J, Fangdd, 58.com, etc. Stock prices of these real estate brokerage companies have also fallen sharply alongside the Chinese tech stocks since the beginning of the year (see Table 2).

Table 2: E-House’s Key Competitors

E-House announced in early September that they are collaborating with Alibaba through a joint venture named TM Home, where ownership is 7:3 for E-House and Alibaba respectively. As a result, the Group will indirectly control the exclusive right to operate Tmall Haofeng. However, as we mentioned in the beginning of the article, the recent downturn in real estate sector will cause E-House’s long-term competitiveness to deteriorate.

Under the worst-case scenario, if sales in the sector plummets by nearly 30% next year, E-House may bear the brunt of being a relatively small agency. In the past, the Group's free cash flow (cash flow from operating activities minus capital expenditures) has been unsatisfactory. In fact, it was negative for three consecutive years, before the net inflow of 410 million RMB last year. On 9 August, S&P also downgraded the E-House’s issuer rating from BB- to B+ due to cash flow considerations.

With the storm gradually spreading to the entire real estate sector, we should not be overly optimistic this time, even if regulatory policies may be slightly loosened before the end of the year. The ripple effect of developers collapsing will reach the agency industry, and therefore we find that the long-term outlook of E-House is significantly weakened.

Consider Only the Bond Due in 2022

Currently, the two USD bonds issued by E-House will mature in April 2022 and June 2023 respectively. Assuming that the market sentiment does not recover and all financing channels are blocked, investors should only consider the bond due in 2022, given its decent liquidity at this moment.

Although E-House is not the biggest victim of this sell-off, its EHOUSE 7.625% 18APR2022 CORP (USD) bond only has 0.546 year to maturity, and the yield to maturity has reached 27% (see Table 3). We believe that it will be attractive to investors who are pursuing high yields while being able to withstand short-term price fluctuations.

Table 3: E-House’s USD Bonds

Corporate Risks

Similar to other developers caught in this sell-off, E-House is facing a higher risk of refinancing. After all, it is difficult to predict when the overall sentiment of Chinese real estate sector will recover. If bond yields remain high, the Group may be unable to refinance, leading to further tightening in cash flows.

In addition, E-House and property developers are in a mutualistic relationship where their revenue and earnings will be badly hit if the industry falls into a slump. There may also be other credit events similar to Evergrande, causing the Group to fail to recover its receivables. This will seriously damage the management's expectations of future cash flows.

Conclusion

E-House recorded a mediocre performance in 1H21. Its future earnings may not see an upward trend due to the negative impact brought by its major partner, China Evergrande.

The Group has a decent liquidity profile, which translates to a manageable repayment risk within one year. However, we have to keep a close eye on its deteriorating leverage.

China’s property market has come to a turning point. E-House’s long-term prospects do not look rosy given the keen competition among property agencies, hence increasing its risks in the long run. Right now, only its bond due in April 2022 which offers a yield to maturity of 27% is worth considering. 

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