Huafa Industrial (600325) today released its Q1 report of 2007: Operating income was 336 million yuan, up 46.38% yoy; net profit was 55.38 million yuan, up 13.79% yoy; diluted EPS was 0.18 yuan. Within the reporting period, operating income growth of 46.38% was mainly due to the carry-forward of Huafa New Town Phase III; growth rate of net profit was lower than that of operating income resulted from sharp increase of expenses due to business expansion in the period.
Land reserves are abundant and regional advantages are obvious. Zhuhai City and Zhongshan City have sufficient land reserves. At present, the entitlemnet floor area is about 3.66 million square meters. Even if the company adds no new land in the near future, it is enough for the company’s development in the next few years. Costs of most of the lands are so low that the company can enjoy higher profit margin in a longer period than similar companies. Moreover, the company has gained market shares of 14% in Zhuhai over recent years which is absolutely advantageous.
The development of Hengqin Island and connection with Macao’s house prices propelled investment value of real estate in Zhuhai. The development of Hengqin Island will greatly enhance the value of the entire city resources in Zhuhai, further promoting the potential of the real estate market in Zhuhai; Zhuhai is adjacent to Macau and connection with Macao’s house prices is likely. According to statistics released by the Census and Statistics Department, the average transaction price per square meter of Macao in Q4 of 2006 was RMB 10,466 (+5.5% yoy).
Two favorable factors improved the company’s investment value. Firstly, judged from internal factors, the company is a leading Zhuhai-based developer and has a good image and strong market appeals. According to the company's current existing settlement process, it has seen a vast upsurge of growth in the recent three years. Secondly, externally speaking, the major shareholder of the company, Huafa Group transferred the overall ownership of the company by open bidding, if the new shareholders of the group are powerful institutions with abundant funding, the image of Huafa brand can be built and product exportation can be fulfilled by the capitals and customer resources of the new controlling shareholders as well as project expansion. While Huafa Industrial (600325) is the core assets and the only capital platform of the group and the group’s major project reserves and core assets lie in Huafa Industrial (600325). Undoubtedly, it is an important opportunity of development for Huafa Industrial (600325).
Risks. 1. The real estate industry was influenced by policies and has entered into adjustment which will have impacts on the company’s earnings. 2. The limited capacity of the local market. 3. Impact of local details of the land value-added tax on the company’s earnings.
Valuation and recommendations. We maintain the prediction of the company’s diluted earnings per share in 07E and 08E at 1.04 yuan and 1.36 yuan respectively. Dynamic PE in 07E of the comparable companies in the industry is about 30 times, we believe, in view of the company’s regional companies leading position and good prospects for development, it is deserved premium of 10%. The company’s target price is 34.32 yuan. "Overweight" rating is lifted to "Buy."