Description

Binjiang Services is a very high-quality Chinese residential property manager trading on 15x P/E and growing top line and bottom line ~40 and 30% respectively. This is a very capital-light business and mgmt is committed to paying out 2/3 of net profit in dividends. Market cap ~ USD 764m and daily trading is more limited. This company is known for its high service quality in Hangzhou.
 
This is a property management business which is more about the stock of existing houses and is less impacted by the turmoil in the Chinese real estate market now.

Valuation

Binjiang Services should compound earnings by around 15% for the next five years with revenue growth of around 20% which implies meaningful margin dilution from the current 23% net margin to 13-15% margin by 2026. Assuming a 66% pay-out ratio (the company has a clear dividend policy) and no multiple expansion, this investment can yield 17% IRR based on a relatively conservative set of assumptions.

Just a quick general note on the Chinese property management sector:

• Residential property management business in China is an better-than-average business but not great business. Most urban Chinese people live in gated living communities with high-rise buildings called Xiaoqu（translated as a small community but it is actually not small by most standards). A typical Xiaoqu has around 5000-10000 residents

• The residents will elect representatives to form housing associations that can appoint the property manager and every resident who lives in the gated community pays property mgmt fees to the property manager

• The property mgmt sector is very fragmented with the top 5 contributing only 18% of the total market

• Historically, property mgmt is an afterthought for property developers. But as they recognised the beauty of recurring property mgmt revenue, they start to spin off their prop mgmt business in HK

• It is a very common practice for these spun-off prop mgmt businesses to get support from the parent developers. The most common form of support is to give new home projects to the property managers

Binjiang Services generates revenue from three business activities - 1) basic property mgmt 2) value-added services to the residents 3) value-added services to developers

1. Basic property mgmt (64% of rev & 20% GPM)

• This revenue stream is very sticky because unless the property manager is absolutely atrocious, the property manager will not be replaced. And hence the very low churn and very high switching cost. And hence the residential property managers earn recurring earning with a very capital light model.

• Binjiang earns ~20% gross margin in this business which is on the high end within the industry. Many of its listed peers range in the low teens. This higher gross margin is explained by two factors - 1) Binjiang's projects are relatively recent and newer projects has higher prop mgmt fees and more importantly 2) Binjiang is heavily concentrated in Hangzhou (75% of its rev is in Hangzhou) and enjoys local economies of scale

• Local economies of scale are derived from leveraging the local fixed cost base over a larger number of projects within each city. For example, each project manager can manage more projects due to the closer proximity of each project. The repair and maintenance team can do more jobs every day. The security guard can do more shifts per day. These local economies of scale are critical to Binjiang's high gross margin

2. Value-added services to Residents (10% of rev & 75% GPM)

• This includes the provision of home decoration services and real estate brokerage business to residents. The idea here is to think of residents as captive customers and the property manager tries to sell them as much as services as possible. Greentown Services, another prop manager, even tries to do nursery and supermarket.

• Binjiang is experimenting with a bunch of ideas and nothing has really taken off so far. The home decoration business could be quite interesting if it works out

• One can see this as upside optionality on a captive customer base as the company iterates various businesses to see which one works

3. Value-added services to developers (26% of rev and 45% GPM)

• Arguably this is the lowest quality business line and I see severe margin dilution risk as well as top-line risk

• Prop managers help developers manage the new home sales process (arranging security guards and setting up showrooms)

• There is definitely some related party risk here. People argue that developers are transferring profit to their property mgmt company which has a higher multiple. This is largely true for most prop mgmt companies and probably also true for Binjiang to a lesser degree

• Hence I model declining revenue base and declining margin for this business to reflect this risk

• And I should not this business line is more related with flow of new projects and hence not recurring in nature and deserve a low multiple even without the related party risk

Growth drivers
I believe Binjiang can grow its managed gross floor area (GFA) with the support of its parent company and third-party projects. Currently, parent co contribute only 23% of new GFA in 1H 2022 and third-party GFA contributed 77% of new GFA.

Binjiang has a pipeline of guaranteed projects that is 60% of the current GFA under mgmt. In another word, even if Binjiang cease all sourcing new project initiatives, it would still grow by over 60% in the next 3-4 years. And GFA is very directly correlated to revenue growth.

Binjiang's growth strategy is focused on organic growth. It grows by the strong reputation of its service quality unlike other competitors in this sector which actively pursue M&A driven growth. Binjiang focuses on relatively higher end projects and delivers on excellent service which would drive word of mouth and nearby projects would actively seek out Binjiang if they want to switch their property manager. This goes back to the local economies of scale point since Binjiang growth tends to have this concentric growth pattern.

This organic growth has a very low project acquisition cost as evidenced by the meagre S&M cost (0.4% of rev). This means that each project has excellent unit economics - low acquisition cost and a recurring revenue base with very low churn.

So why don’t competitors also copy this growth strategy? This growth strategy is much slower in comparison. For example, Vanke property management, largest player in China, is using M&A to maintain 20% growth rate. Binjiang is able to achieve 40% GFA growth rate because its base is so small.

For example, Binjiang GFA is 35m sqm while Vanke, Country Garden and Greentown are 660m, 765m and 304m sqm respectively. So Binjiang is tiny in comparison.

But I fully expect Binjiang's GFA growth rate to decelerate from 40% to 20% over the next 5 years.

Pricing

Generally, Chinese prop managers lack pricing power. This is due to a combination of legacy government policies of price control and cultural acceptance of price increases with regards to prop mgmt fees. And this lack of pricing power is the key reason why prop mgmt is only an above-average business and not a great business in my view.

Binjiang, in my view, is in a relatively good position to increase prices to at least keep pace with cost inflation. Because Binjiang projects have good building quality. The resident would not be happy with the prop managers if they constantly have to face leaking water and burst pipes. Residents would not be satisfied with the prop manager even if they provide the best service but the building quality is terrible. Satisfied residents is easier to exercise price increases than unsatisfied residents.

Binjiang is mostly in economically prosperous regions and within that, they are focused on higher-end projects which have higher-income residents. Richer residents are more willing to pay a premium for high-quality services.

But I should note it is really difficult to raise prices in China even for Binjiang. So this is a key long-term risk to watch out for.

Corporate governance

Binjiang Services is controlled by the Qi family (45% shareholding). The parent developer, Binjiang Real Estate (listed on A share) is in rude health and it is one of the few private developers to maintain growth in 2022 despite the carnage in the Chinese real estate sector. This is a good example of a developer that maintained a conservative balance sheet and delivers some of the highest quality buildings in China.

Key risks

• Rapid expansion of 3rd party projects = deteriorating project quality

• Growth often means diseconomies of scale due to mgmt complexity which might lead to lower service quality

• Expansion into new cities = temporary lost local economies of scale. But this could be offset by growth as long as Binjiang retains its focus on quality

• Even for Binjiang, it might be hard to raise the price

Summary

• Binjiang is a high-quality prop manager with strong GFA growth ahead and it uses a high service reputation to drive GFA growth which carries a very low project acquisition cost

• Binjiang enjoys recurring revenue from prop mgmt and enjoys industry-leading gross margin due to local economies of scale

• This is a capital-light business and very cash flow generative

• Most importantly, this business is available at 15x P/E with a 5% dividend yield with highly visible earning growth of 15% for the next 5 years

Catalyst

Continued business performance and dividend pay out