Zhonghui Bao
Elevator Pitch
My investment rating for KE Holdings (NYSE:BEKE) [2423:HK] is a Hold. Investors need to assess both the prospects of the Chinese secondary real estate market and potential regulatory risks, before they consider BEKE as a potential investment candidate. My analysis of the above-mentioned factors leads me to the conclusion that a Hold rating is fair for KE Holdings, as there are both positive and negative factors associated with the stock.
Company Description
In its fiscal 2021 20-F filing, BEKE calls itself “the leading integrated online (“Beike” portal) and offline (“Lianjia” property broker brand) platform for housing transactions and services” in China. The company claimed to be the market leader in Mainland China’s property brokerage market in 2019 based on the “number and GTV (gross transaction value) of existing and new home sales” as indicated in an earlier March 2021 investor presentation.
KE Holdings generated 52%, 40%, and 8% of the company’s full-year FY 2021 gross profit from existing home transaction services, new home transaction services, and other services, respectively, in RMB terms as per its 20-F filing. I will be largely focusing on BEKE’s existing home transaction services business for the purpose of this article, as this segment contributed more than half of the company’s gross profit last year.
BEKE’s Share Price And Valuations
BEKE’s shares were first listed on the NYSE on August 13, 2020, with an IPO price of $20. The company’s last done share price was $13.53 as of November 11, 2022, which implies that KE Holdings’ current stock price is -32% below its IPO price. In the last one year, BEKE’s share price fell by -42%, which is far worse than the S&P 500’s -14% pullback in the same time frame.
In line with its share price weakness, KE Holdings’ consensus forward normalized P/E multiple has compressed from its all-time peak of 107 times recorded in October 2020 to 23.7 times as of November 11, 2022, based on S&P Capital IQ data.
Improved Outlook For The Chinese Secondary Real Estate Market
According to data sourced from real estate data company Zhuge Zhaofang, the existing home transactions for the 10 largest Mainland Chinese cities declined by -4.3% MoM in October 2022. This represents a significant improvement from the -23.7% MoM contraction in existing home transactions for September 2022. On a YoY basis, October 2022 witnessed a +63.3% jump in existing home transactions for the 10 biggest cities in China versus a +14.5% YoY growth for September.
KE Holdings’ internal data tells a similar story. Based on an October 11, 2022, China Daily news article, “the 50 key cities surveyed by Beike (KE Holdings’ online platform) Research Institute” saw existing home transactions increase by +54% during China’s National Day holiday in early-October 2022.
The improved performance of the secondary real estate market in China in the recent month was likely boosted by the introduction of a new government policy. Bloomberg reported on September 30, 2022, that “residents (in China) who buy new homes within one year after selling old homes will enjoy refunds for personal income tax on the sale” going forward as per a new initiative introduced by Chinese policymakers.
There were also other favorable policies introduced to support the Chinese secondary property market in prior months as well. As an example, some cities in China “suspended or relaxed a measure to set reference prices for second-hand homes” in August 2022, as highlighted by a news service focused on China known as Yuan Talks.
Looking ahead, the Chinese secondary real estate market’s outlook seems better, taking into account the policy support offered by China’s government. BEKE is a key beneficiary, given its status as the biggest real estate brokerage in the country.
Regulatory Concerns Shouldn’t Be Ignored
It is encouraging that Chinese policymakers are putting in place initiatives to support China’s secondary real estate market, and the recent monthly data for October seems reasonably decent. But there is no assurance that KE Holdings will be able to take advantage of the improved outlook for the Chinese secondary home market and realize higher earnings.
In the preceding section, I mentioned about how China has recently introduced a new tax rebate to stimulate existing and new home real estate transactions. This is a double-edged sword, as investors are now worried that regulators in China will continue to rely on lowering transaction costs for property transactions as a means of driving housing market demand higher. Specifically, the market is expecting the Chinese government to impose a ceiling on real estate broker commissions in the near future.
If the bears are right, KE Holdings’ future profitability might be negatively impacted by this potential new measure to a substantial extent.
To understand the extent to which a cap on commissions might depress BEKE’s future earnings, it is worth referring to Morgan Stanley’s (MS) November 9, 2022, report (not publicly available) on the Chinese real estate brokerage market titled “Investor Feedback.” MS estimates that it will have to reduce its full-year fiscal 2023 normalized earnings for KE Holdings by as much as -37% based on the assumption that China decides that the maximum property commission rate that real estate brokers are allowed to charge is 2%.
Closing Thoughts
I rate KE Holdings’ stock as a Hold. The risk-reward for BEKE is fairly balanced, taking into account both regulatory risks and the improved outlook for China’s secondary housing market.
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