BEKE - KE Holdings: Real-Time Proxy Of China's Property Market

2024-01-03 03:53:27 ET

Summary

• China's property market will require several quarters of healing confidence building before any structural recovery.
• Any signs of recovery in China's housing market may show up in property equities like KE Holdings first.
• Based on the macro and fundamental context, BEKE is likely to remain rangebound in a large trading range with the potential to reach the upper end in 2024.

China Real Estate likely has sporadic greenshoots throughout 2024 within a rangebound context

2024 has begun with China's A-Shares and H-Shares market exhibiting high volatility as traders debate the future of business policy, the real estate market, and consumer spending trends from the Mainland.

One of the top tail risks for the year among institutional investors surveyed is that China Real Estate is a potential source of a credit event.

Given real estate's outsized importance in China's economic trajectory, where the Housing market goes will likely bring China's other sectors along for the ride.

Surprisingly, a top weighted name in the [[KWEB]] China Internet ETF is real-estate centric KE Holdings ( BEKE ) and this company managed a double digit return in 2023. The company has been range bound since the property crackdown in 2021 and has been searching for signs of recovery in Tier 2-3 cities in China where an influx of home supply has far outweighed any potential demand despite numerous rounds of price cuts.

The company's range-bound action is likely to persist until we see more dovish real estate policy, but its wide trading band between 13 and 19 means there are opportunities to trade Support & Resistance levels.

The Catalysts for BEKE and Fundamental Outlook

KE H olding s has 48 million monthly active users ((MAU)) as of Summer 2023, and is one of the largest brokerage companies in China for housing with both online and offline presences. The business model essentially covers the whole home-buying process with a highly rated user experience and has a strong brand presence on China's most popular app WeChat (owned by Tencent (TCEHY)). The company has about a 30%+ market share in gross property transaction value for existing houses and roughly a 9% market share within new homes transactions.

To adjust to the soft macro climate in housing in China, the company has been extending its business model to include home improvement and home refurbishment services after acquiring Shengdu Home Decoration in 2022. This business segment has helped the company diversify purely from focusing on growing gross property transactions and has helped to offset fee compression which have lowered operating margins. This home improvement segment has posted over 20% contributed margins for BEKE and is likely to help the company further diversify away from pure housing commission transactions.

BEKE has a unique method to keep real estate agents on their platform (they have roughly ~400,000 agents) as they split responsibilities between buyer and listing agents and rewarding both parties to encourage acquiring home sellers. This is particularly important so that agents work together to create a flywheel effect to benefit existing users on the platform. Together, they represent a decent amount of transaction volume in China's entire existing and new homes property market.

As sentiment towards homebuying has been very weak in Tier 2-3 cities in China, real estate developers have flocked to platforms like BEKE (and its largest competitor Anuke) to gain more exposure on their new listings. And in their relationship with developers, BEKE is usually paid first as it requires its highest risk developers to prepay most commission fees to avoid default of paying the platform if the developer's cash flow gets crunched.

Company management also committed to its recently doubled share repurchase program of $2B through August 2024 indicating that today's current share price levels are potentially attractive in the long-term to management. The firm also has discussed that it is planning to issue dividends at a later point once it sees stabilizing margins.

Risks, Thoughts on Entry and Valuation

For the foreseeable future, BEKE relies heavily on China's existing home sales market, which has been very sluggish over the past 12-18 months. In order to drive further top-line growth for the firm, BEKE will be targeting a larger market share within new home gross property transactions. The risk is that new homes have longer selling timelines due to the ongoing housing market woes and weak consumer spending trends. The company's most important catalysts are associated with consumer confidence which is currently weak and property market sentiment which has yet to recover. These two macro variables hold the key to any sustainable rebound in its shares (beyond a tradable bounce).

The company's valuation at 1.7X Sales has been rangebound since mid-2021 and it will take a large reset in real estate policy to re-rate the valuation significantly higher from here. For now, I view that scenario to require at least several more quarters.

In the meantime, however, the company is supported by China's ongoing agenda to prevent the real estate sector from sliding into further deceleration and that means the aggregate gross property transactions may begin to stabilize in the months ahead.

This means the range-bound action is likely to persist throughout 2024 with the opportunity for upside optionality if/when China decides to pursue more aggressive measure to revitalize its economy with stimulus measures to boost consumer spending and property sales.

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