Evergrande Group – Initial Thoughts

Evergrande Group (3333.HK)

[August 28, 2019 ]

Interim Result Announcement @ Four Seasons

Background

The first time I looked at this stock was several years ago when I was doing internship in Hong Kong. Someone in the team registered the site visit but figured out the company was “not interesting” so the trip was left to the intern. I spent a day in Shenzhen, made a friend, and concluded the company was not investible. Leverage was the main concern on the long side and shorting on equity and debt were both expensive. It seemed the fund passed the stock when it traded around HKD 5-6/share. You know the price development in next one year.

The reason why I attended the meeting this time was that I feel I have some domain knowledge in real estate since I spent some time in real estate private equity.

The attendance was shocking to me (fellow investors are definitely used to it). It’s a real people mountain people sea. The company has already become so large and complicated that most questions came from the floor surrounded around macro / policy / industry (or the company answered that way).

The stock has been weak since this April. Macro / policy, leverage and new initiative might be the primary drivers.

Topics of Interest to me

The company spent a good amount of time discussing their EV business. I think it’s well known to the market but for someone who is not following the company like me I was a little bit surprised it’s doing EV. I soon realized that real estate developer leading the EV development / penetration actually makes sense to me. I think it’s more likely for a large real estate developer to deploy the infrastructure which leads to natural monopoly eventually. The company also teams up with another two large real estate developer and electricity grid provider to expand the network and gain exclusivity on the power supply side. Without intervention from future regulation, I can envision clear winner-takes-all scenario. Government will definitely regulate but before that how long it can enjoy the excess economic return and how the upfront costs look like.

The company is currently funding the EV initiative from its real estate business. To build up the EV ecosystem, real estate development will be part of plan so the company is thinking about negotiation with government to acquire land at a “cheaper price” to construct residential properties. The company views the profit generated from real estate (primarily selling residential properties and  probably operating / leasing commercial / retail properties) as a compensation of helping government build EV industry. The company expect the EV business won’t be profit making in the next five years. With the downward trend of real estate market and increasing loss when scaling up EV business, the shrinking of group level profit might be faster than the market expected and the group might be even loss making. With high leverage and increasing likelihood of group level loss, the stock price might be depressed for short to medium term.

The company even said a strategy of buy a house, get an EV for free. While it sounds funny, it’s actually a bundle that tries to acquire a customer.

Next Steps

  • Start following this company as the market dominant potential for EV is very attractive while it takes some time. We have more time to understand the industry, macro, the company and its business.
  • The stock might decline further due to the possibility to start losing money on group level and leverage concern. This might create an opportunity to build position.

 

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