Morgan Stanley Downgrades China’s Property Sector on Policy Risk

(Bloomberg) -- Morgan Stanley downgraded its outlook on China's property sector amid risks policy makers may take steps to cool down the overheated market and further prompt developers to cut their debt levels.

The U.S. brokerage lowered its recommendation on the real estate sector in the world's second-largest economy to “in-line” from “attractive” in a note published Thursday. Strong sales continue and land sales “haven't cooled off yet, therefore policy risk is still to the downside,” analysts led by Elly Chen wrote.

China's property firms are under pressure as Beijing moves to curb leverage in the debt-laden sector that has propelled a record wave of corporate bond defaults this year. This comes at a time when authorities have been attempting to stabilize some of the highest property prices in the world and concerns are rising over the financial health of China Evergrande Group, the nation's most-indebted developer.

NOTE: Evergrande Meets One of China's Three ‘Red Lines' on Debt

“We expect government property policy to remain relatively tight, and cities with overheated markets may need to tighten further,” the Morgan Stanley analysts wrote. That may potentially include the introduction of a property tax pilot program and inclusion of commercial paper into ‘three red lines' evaluation.”

The brokerage also sees China continuing its deleveraging push by tightening funding channels and setting property-related loan caps for lenders. It expects gross margins for developers under its coverage to fall 0.4 percentage points in the 2021 fiscal year due to bookings of low-margin projects with high land cost and capped selling prices.

Chinese municipal governments are set to announce more home-purchase curbs, “casting a shadow over developers' contracted sales outlook in 2H,” Bloomberg Intelligence analysts Kristy Hung and Lisa Zhou wrote in a note.

Meanwhile, concern about Evergrande is also spilling over into the rest of the offshore high-yield bond market, which is dominated by developers. Premiums on those notes at their highest since May last year, according to a Bloomberg Barclays index.

Morgan Stanley slashed price targets for 27 firms under its coverage, with the biggest cut of 33% for China Aoyuan Group Ltd. -- which it downgraded to equal-weight from overweight. It reduced targets for Sunac China Holdings Ltd. and China Vanke Co. by 30% and 14%, respectively.

Overall, “although valuations are already at trough levels, we see lack of short-term catalysts,” the analysts said.

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