This China Property Stock Could Bring Lots of Joy

Whether or not the 6.5% tumble on Shanghai’s stock market on Thursday was the result of Beijing’s intent to take some heat out of a market that had rallied for seven consecutive days is unknown. However, what is well known to be on Beijing’s agenda is a round of tummy tucks for China’s flabby state-owned enterprises.

While China has been on the path of reform since the late 1970s, Beijing’s reformist agenda has taken on a renewed urgency as it prods its asset-rich but clumsy SOEs to become leaner and meaner in a slowing economy. While a merger of China’s two locomotive manufacturers, CSR ( 1766.HK ) and CNR, has been the highest profile of corporate restructurings so far, analysts are betting there is more to come given the integral role of SOEs in the world’s second largest economy. “Many SOEs have underperformed their non-state owned counterparts operationally and have contributed to a number of macro imbalances in China,” notes Goldman Sachs analyst Chengjie Liu.

Spin-offs have a history of delivering some great investments for the investors in the West and cast-offs from China’s SOEs could offer attractive opportunities once freed from their parent. One stock that has caught the attention of Barron’s Asia is Joy City Property, a property developer and owner spun out of China’s largest food processor, China Oil and Food Corporation, better known as Cofco. The SOE’s collection of property assets looked decidedly alien in its portfolio spanning agricultural grain cultivation to commodities trading, especially as the conglomerate seeks to bolster its presence in global agri-business and emerge as China’s version U.S.-based Cargill Inc.

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The attraction of Joy City Property ( 207.HK ), which owns a collection of prime real estate including shopping malls and residential projects, is its potential to profit from further asset injections from its parent. The stock can trace its origins to July 2012 when Cofco acquired listed developer Hong Kong Parkview Group to create a shell company for its property assets. A number of asset injections followed, the latest being a transfer of a number of Joy City shopping malls to the Hong Kong-listed company, which was simultaneously rebadged to Joy City Property from Cofco Land Holdings. The malls were spun off to Joy City for HKD12.46 billion, a hefty 66% discount to the properties’ appraised value.

Given the lineup of prime real estate that still sit on Cofco’s balance sheet, the prospect of additional value boosting asset injections has excited Deutsche Bank analyst Tony Tsang about Joy City’s prospects. “Given the central government’s advocacy of more SOE reforms and the big scale and diverse businesses of Cofco, we see significant net asset value and earnings accretive restructuring within Cofco, which should benefit Joy City via further asset injections,” opines Tsang. The analyst initiated coverage of Joy City last week with a buy rating and a very bullish target price of HKD4.50 a share, which implies 110% upside.

Despite having run up 58% over the past two months, Joy City shares still look cheaper than those of other state-owned Chinese property developers. Currently around HKD2.14 a share, Joy City trades at a massive 67% discount to its estimated net asset value of HKD6.43 a share, which compares to the 38% discount among its Hong Kong-listed peers. Deutsche Bank’s Tsang expects an injection of the two Joy City malls that remain in Cofco’s books to take place soon, which would boost Joy City Property’s net asset value and provide a larger base for its share price to grow.

Joy City’s business model, however, makes it more than just a property developer. Unlike most listed Chinese developers, which mainly build property to sell, Joy City also keeps investment properties on its balance sheet to generate income. This gives it characteristics of both a traditional developer and a real estate investment trust. Joy City generates around 61% of its revenues from recurrent income, while the rest is mostly accounted for by property sales. The steady stream of rental income, which is expected to grow as new investment properties are added, should afford the company a relatively higher valuation multiple than traditional developers, argues Deutsche Bank’s Tsang. Some market participants note that Joy City’s business model is most similar to that of Dalian Wanda Group ( 3699.HK ), which trades at around a 28% discount to its net asset value.

Joy City is also well positioned to benefit from the recovery in China’s property market, given the bulk of its investment properties and development projects are situated in tier one or larger tier two cities. Higher tier cities have seen sales volumes and prices in their property markets pick up materially over recent months, while lower tier cities continue to remain in a slump and face dim prospects.

Besides the tantalizing prospect of asset injections, Joy City’s affiliation with its burly parent Cofco has also given it the luxury of a healthy balance sheet with below industry average debt levels and lower interest rates on its borrowings. Meanwhile, the possibility of Joy City pulling out the scalpel itself and spinning off its plump hotels portfolio, which includes the Waldorf Astoria Beijing and MGM Grand Sanya, is seen as another potential source of value.

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