KE Holdings Deconstructed by Slumping Real Estate Market

Key Takeaways:

• KE Holdings swung to the red in the first half of the year on the back of a slumping Chinese real estate market
• The company is trying to offset anemic property trading income with new businesses that are growing but still account for just a small share of revenue

By Tina Yip

The Chinese real estate market has moved into the doldrums, the result of government curbs on housing speculation combined with weak demand amid a slowing economy. With new funding hard to come by, debt-heavy developers are teetering on the brink of insolvency, leaving many housing projects unfinished due to lack of money to continue construction.

The existing home market is equally anemic, with trading volume by area in 15 major Chinese cities plummeting nearly 50% in the first half of the year from a year earlier, according to data from the China Index Academy. That plunge has dealt a similar-sized blow to KE Holdings Inc. BEKE, China’s top residential real estate broker whose green Lianjia shops are a fixture throughout the country.

The company’s interim results published last week show its revenue plunged 41.3% year-on-year to 26.3 billion yuan ($3.9 billion) in the first six months of the year. That pushed it into the red with a net loss of 2.49 billion yuan for the period, versus a 2.17 billion yuan profit a year earlier. Things went from bad to worse within the six-month period, with much of the interim loss – nearly 1.87 billion yuan – logged in the second quarter as several major cities went into lockdown to control outbreaks of the highly contagious Omicron variant of Covid-19.

As the slowdown in its core business was building, KE’s Chairman and CEO Peng Yongdong unveiled a “one body, two wings” strategy last December, whereby the company would enter the home renovation and home rental services businesses to completement its mainstay as a residential property broker. Those three areas turned in mixed performances in the first half of the year.

The company’s gross transaction value (GTV) fell 46.5% during the period to 1.23 trillion yuan. Its “body” – the company’s core home transaction services business – saw GTV for existing and new home transactions fall by 42.1% and 50.6%, respectively.

It blamed the drop on pandemic disruptions, as well as lack of new product coming onto the market. Some developers failed to deliver housing projects on time and even pulled the plug on some midway through construction. The company set aside 2.21 billion yuan as provisions for bad debt from its dealings with such developers, seriously denting its overall performance.

Share buyback

Surprisingly, the company’s Hong Kong-listed shares surged by 15.2% in the two trading days after the announcement for several reasons. First, the company announced a share buyback worth $1 billion. Second, investors have high hopes for its home renovation business. And last but not least, its cost-cutting efforts are bearing fruit.

In April, the company completed its acquisition of Shengdu Home Renovation, giving it 136 stores in 24 Chinese cities. As a result, revenue from its home renovation and furnishing business jumped 9.4 times to 1.1 billion yuan in the first half of the year, while GTV rose from 100 million yuan to 1.5 billion yuan. Management has vowed to keep the breakneck growth going, aiming to breach the 10 billion yuan mark by an unspecified time.

Its other wing, the home rental services business, also fared well. Its revenue from “emerging and other services” in its financial statement dwindled by 17.1% to 1 billion yuan in the first six months due to lower financial-service income; but revenue from custody and leasing services grew. Many believe that despite falling demand from home buyers as speculators drop out of the market, rental demand from real tenants will remain high and thus the rental business is more promising.

But in order to take flight with its two new wings, the company needs to trim some fat. It started to lay off workers and close stores as early as last year, allowing it to lower operating cost by a sizable 38.4% to 21.4 billion yuan in the first half of the year. Most of the cuts owed to a 19% decline in its store count to 42,831, and a 24.4% decline in its agent headcount to 414,900.

Kenny Wen, head of investment strategy at KGI Asia, said the home renovation business would make only limited contributions to KE’s overall revenue, while its core home transaction business would not start to recover until the latter half of next year due to China’s slowing economy and the resulting sluggish real estate market.

Partnering with state-owned developers

KE’s founder Zuo Hui died of lung cancer last May at the age of 50, leaving the reins to Peng, who joined KE in 2010 after being handpicked by Zuo. While Peng hopes his “one body, two wings” will position the company to fly again soon, he is also strengthening its risk management and choosing established state-owned developers as partners to reduce possible bad debt.

A Goldman Sachs research report said KE’s shift in its choice of partners allowed it to reduce the time required for collection of outstanding bills to 72 days from 100 days in the first half of the year, resulting in an additional 3 billion yuan in operating cash flow in the second quarter. The bank thinks KE will gain market share and sustain its business growth as the industry consolidates, and thus maintained its “overweight” rating for the company while upwardly revising its target price from HK$60 to HK$63.

Zuo took the company public in the U.S. in 2020, and its valuation at one point exceeded $80 billion. But growing China-U.S. tensions and Beijing’s crackdown on numerous sectors hit KE’s shares, sending them down by more than 75%. To hedge against a possible delisting from the U.S., the company made a Hong Kong IPO in May using a local method called listing “by way of introduction” that involves no capital raising and is faster than a more traditional listing.

The company’s current dual-primary listed means both markets are major venues for trading of its shares, so its Hong Kong status won’t be affected even if it is delisted from the U.S.

KE opened at HK$30 per share on its Hong Kong debut day and rose to HK$53 over the next month. After some fluctuations in July and August, it now trades at about HK$49, more than 60% higher than its Hong Kong IPO opening day price.

KE said it expects its third quarter revenue to decrease by 6.1% to 8.8% year-over-year, a significant improvement from the second quarter, as large-scale pandemic lockdowns ease and Beijing announces a raft of new measures to prop up the real estate market. While such measures could provide some short-term relief, more time may be needed to see if Peng’s new “bird” strategy can help the company take off again to reach some of its former heights.