E-House China (EJ) - Regulations Raise Opportunity
E-House China (EJ) is one of the premier agencies which contracts with real estate developers in China. The company has exhibited tremendous growth in both sales and earnings over the last five quarters while at the same time seeing its stock drop to levels not seen since its IPO in August of 2007. Much of the stock weakness appears to be due to investors concern over regulations in China aimed at easing inflationary pressure in housing. As more citizens use their newfound wealth to purchase living space, builders are struggling to keep up with demand in many cities. This causes price levels to rise sharply and raises concerns of long-term problems similar to what the US is currently experiencing.
Despite the negative macro headlines, the overall picture still appears very healthy for the selling agency. Similar to the US counterparts Remax or Keller Williams, E-House advertises and sells homes to individuals and collects a selling commission on each transaction. Currently the company generates the majority of its revenue from its primary real estate agency services. The primary services essentially denotes that this is the first time the property in question has been sold on the open market. Developers rely on EJ to sell these new homes and in a tightening market, they will be even more likely to retain a professional agency instead of trying to sell the properties themselves. Furthermore, EJ has begun “pre-selling” arrangements with developers where the company essentially pays for a portion of the developers inventory and then collects that capital back once the sales are complete. A healthy balance sheet and access to capital markets allows EJ to participate in these capital intensive transactions and essentially creates barriers to entry for agencies who do not have hundreds of millions to put on the line in a selling arrangement.
In addition to the primary real estate services, the company also is active in secondary real estate transactions. This represents transactions between existing homeowners who are selling to new buyers. While this only represented about 10% of revenue for the fourth quarter, it looks to be a growing part of the business as the company consolidates and strengthens its 160 regional locations across 5 Chinese cities. Strengthening this portion of its business provides diversification from the primary market, and gives the company additional choices to offer its purchasing customers.
Finally, E-House has a consulting and information services arm that is expanding quite rapidly. A new database product dubbed CRIC has been built and is now in the process of being rolled out to paying subscribers. One key relationship has been cemented wit Sina.com which should give the platform strong visibility among those searching for houses.
The most recent earnings announcement showed that the company pulled in $121m in revenue for 2007 which translated to earnings of $0.56 per share. Management is guiding expectations for 2008 of $210-240m in revenue which would essentially double last year at the high end. Analysts believe that this guidance is extremely conservative when looking at the selling agreements signed with certain development projects as well as the added benefit of the database subscriptions. The consensus earnings numbers for 2008 and 2009 are $0.87 and $1.18 which appear to be realistic given EJ’s strength in the market.
At those earnings levels, the stock appears to be very attractively priced. The company issued its IPO at $13.80 which could add some resistance short-term, but the fundamental backdrop should support much higher prices once investors become confident that the company will be able to grow earnings despite what is construed as headwinds for the sector. A break above $14 on high volume might be just the event necessary to break EJ out of its slump and signal to investors that the time is right to capitalize on this growing company’s bright future.
FD: Author does not have a position in EJ
