We think the supportive policy and fast GFA-driven earnings growth have been almost priced in the current valuation. Looking forward, as GFA competition is getting more intensive and fee hike has uncertainty/little impact in the near term, we expect the growth engine to switch to Community VAS because it has 5-10 times upside from now with high entry barrier and margin. The successful sector players in VAS would further differentiate and lead to re-rating.
- Community VAS the new growth engine: we believe residential PM sector would switch to VAS-driven model to differentiate given 1) its 5-10 times upside from now. Currently the industry VAS per managed GFA is only RMB4/sq m on average compared to RMB50-56/sq m in US/Japan leading firms such as FirstService/Nihon Housing (despite the salary difference). 2) high entry barrier on the expertise and capital investment as most of traditional PM firms are not equipped with the experience. 3) Potential margin uptrend for operating leverage especially for market leaders with large GFA under management. We think the key to drive up VAS per managed GFA is through expansion into high-margin services (retail/asset management/media with gross margin >50%). Quality M&A with synergy would be the way of achieving it based on US/Japan experience. Market leaders like CGS have already made the first move for media/insurance acquisitions. With its strong capital, CGS may have huge growth potential.
- Shopping mall management another blue sea. Property management in shopping mall has the advantage of high entry barrier, fee marketization and high margin, compared to other types. With rather fragmented market, major players could have huge upside in consolidation via acquisitions/asset light model. In the near term, we expect consumption to pick up on high saving rate in 2020 and wealth effect. Major players (eg. CR Land/Longfor) may record 30% rental income growth and thus benefit the service providers. In the mid term, we like service providers of mid-to-high end shopping malls located in Tier 1-2 cities on high rent/sales ratio and less e-commerce cannibalization.
- Impact on potential management fee rise is limited in short term: As MOHURD’s “21 points” on 5 Jan encouraged floating-fee scheme, we expect it may only affect the new delivery, as it is difficult to change for the existing community. We also developed a model to analyze its quantitative impact by assuming a national progressive rate on floating-fee residential GFA as % of new delivery. Our base case shows the floating-fee GFA as % of total GFA would reach 20% by 2025E but only 1%/3% in 2021E and 2022E.
- Short-term catalysts: We think there are two major coming catalysts as 1) South bound inclusion to be announced on 26 Feb: based on our analysis, many stocks like CR MixC and S-Enjoy are very likely to be included and may benefit from south bound inflow. 2) 2020E results beat in March: We forecast 55% of earnings growth in 2020E for the major players.
- Rating change/Top picks: We downgrade A-living and Poly services to Sell rating and continue to prefer market leaders with 1) high exposure to shopping mall businesses; 2) high VAS potential and 3) high earnings visibility. Therefore, our top picks are CGS/Ever Sunshine (on VAS and high earnings visibility), and CR MixC Lifestyle/Powerlong Commercial (on shopping mall).
