A Chinese REIT from the Underground

11/22/2011 8:30 am EST

Focus: REITS

Yiannis Mostrous

Editor, The Capitalist Times

It’s off the beaten path, but there is a lot promise for this unique real estate play, writes Yiannis Mostrous of Global Investment Strategist.

Renhe Commercial Holdings (Hong Kong: 1387) develops underground shopping malls in prime commercial areas of key Chinese cities.

These spaces are actually civilian defense shelters designed to be used in times of war. Because no land-use rights are associated with these malls, the company avoids paying large, upfront land premiums for these properties.

Revenue is generated through the lease or sale of 40-year operating rights. This is a niche segment of China’s real estate market, and Renhe is quickly becoming a dominant player in the space.

Despite numerous advantages, Renhe operates in an unusual corner of the Chinese property market. This is not your typical Main Street stock, and some investors have been wary of Renhe. Add to this the ferocity of September’s market sell-off and Renhe’s low share price comes as no surprise.

That being said, the stock has rallied by about 40% from its recent lows. Renhe’s shares still trade at an undemanding price of 5.6 times earnings and 1.5 times book value. At the same time, Renhe has a high return on equity of 30% and minimal debt.

The company has booked about $1 billion in sales so far this year, representing about 65% of the full-year sales target. Renhe should be able to garner about $500 million to $600 million in additional sales by the end of 2011.

The company has two major projects in the eastern cities of Tianjin and Beijing that should be available for sale in 2012. Rental income should rise next year as the last project of 2011 comes online and begins to contribute to earnings.

The company’s properties are in high demand. In some areas, units were purchased on the same day they were put up for sale. In one instance, 1,800 buyers bid for 800 shops, at a price of about $8,000 per square meter (10.76 square feet).

In addition, the Chinese government remains very supportive of Renhe’s segment of the property market. In a speech during China’s sixth National Civil Air Defense Conference a year ago, Premier Wen Jiabao noted “the importance of civil air defense as a crucial part of emergency management and promotes the integration of civil air defense projects into urban development planning.”

The company’s business model calls for collection of sales to the tune of 30% per year, which has masked its success and unsettled investors. That being said, the company is moving toward changing the practice, which will be a huge benefit to the company and its stock.

Even after the recent rally, Renhe’s stock remains undervalued. It will take some time for market sentiment to turn and for the stock to approach fair value. But Renhe is operationally sound, with strong growth characteristics and a solid project pipeline.

Because of the low amounts of capital required for its operations and the niche nature of its business, the company has achieved solid profitability with very little debt. Its balance sheet boasts about $850 million in cash, which makes its shares all the more attractive. The company enjoys high net-profit margins of more than 60%, and the local shares feature a sustainable dividend yield of 8%.

Although Renhe trades at inviting valuation levels, it remains a high-risk stock, which is why we have placed it toward the bottom of our list of Portfolio holdings. Renhe Commercial Holdings remains a buy up to HK$2 for investors with a tolerance for risk. [Renhe closed at HK$1.01 on Monday.]

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