January 15 – January 21, 2016 – the janus observer

Dalian Wanda. Chinese Property Developers trading USD denominated debt for yuan debt. Construction input prices continue to fall.

As I mentioned last week, expect more interesting behavior from the Chinese property developers – granted, I’m sure the behavior has been going on for some time, it’s just that media coverage is increasing. This week the three articles I am focusing on are, 1) Jill Mao’s “Wanda Group Plans Five ‘Substantial” Acquisitions as Sales Slump” covered in Bloomberg, 2) Fiona Law and Carol Chan’s “No Place Like Home for Chinese Property Companies’ Debt” in The Wall Street Journal, and 3) is an interesting piece put forth in AZ Big Media “Construction material prices continue free fall”.

Additionally, I want to call attention to a few other things that can be found in the Other Interesting Articles below. First, as reported by Chris Flood in the Financial Times Vanguard continues to kick butt in terms of attracting cash to the low-cost index model. Last year they had net inflows of $256bn… “more than any rival and an increase of 5.3% on 2014. In the past five years total net inflows from investors are almost $1tn, substantially more than twice the sum attracted by the entire hedge fund industry over the same period.” You can imagine the pressure this is having on industry fees.

Second, covered by Max Seddon and Jack Farchy in the Financial Times, the Russian rouble continues to slide against the U.S. dollar. As of January 21, it had reached Rbs85.97 for each greenback as the Russian central banks has stepped back its intervention measures. In the summer of 2014, the trading range was in the Rbs30s. According to Ivan Tchakarov, chief economist for Russia and the CIS at Citibank “If the rouble gets to 100, we may see panic. But going from 30 to 80 is different from going from 70 to 85. People are psychologically adjusted.” Crazy how that works – to my behavioral psychologist readers, reference points…

Third, for my property developer readers, apparently in India property developers can use buyers deposits raised from one project on completely unrelated projects. WTF! It should be no surprise that there are unfinished projects in India as reported in The Wall Street Journal. Well rest assured, there is draft legislation “that would require builders to put 70% of the money they receive from home buyers into escrow for use on the project for which it was paid.” That may help, but definitely doesn’t address the conflict of interests.

To help break up the monotony of all this text and because there were a lot of good graphics this week:

From Bloomberg Graphics, stock markets around the world are feeling pain.

From The Wall Street Journal, private-label MBS is starting to make a comeback, albeit not really.

In the Financial Times, you can see the effect low oil prices is having on delaying oil projects.

Lastly, before I get to the articles I’ll leave you with two quotes. First in Tom Mitchell’s “The ugly subtext beneath China’s two-track economy tale” in the Financial Times.

“For years we have been waiting for China to make the tough choice and sacrifice near-term growth in order to stabilize macro balance sheets and stop its exploding debt cycle… the costs of taking real adjustment are clearly too high for the government to bear… Right now we put the initial potential crisis threshold at around five years.” – Jonathan Anderson at the Shanghai based Emerging Advisors Group

And second, as reported in the Lex column in the Financial Times’ “IBM: Where’s the growth?”

“IBM duly racked up its 15th consecutive quarter of falling revenues on Tuesday evening. At least the technology company’s nuclear winter has helped eradicate a couple of cliches. ‘Nobody ever got fired for buying IBM,’ is now said by nobody.“

*Note: bold emphasis is mine, italic sections are from the articles.

Wanda Group Plans Five ‘Substantial” Acquisitions as Sales Slump. Jill Mao. Bloomberg. 17 Jan. 2016.

To be fair, Dalian Wanda Group took advantage of China’s industrialization by being in the property sector and now that it is a behemoth company and the breakneck pace of growth in the property sector is behind, they are transitioning into a conglomerate with a variety of business lines that have a shot at meaningful growth going forward. I can imagine that many western public real estate companies are jealous as they are punished in the markets for not being anything but pure play real estate businesses in a specific sector. However, the reason I call attention to this article is that if the ‘smart’ money property developers are reducing their exposure to Chinese real estate, you probably should too.

“Dalian Wanda Group Co., the property-to-entertainment conglomerate headed by Asia’s richest man, is planning five “substantial” acquisitions this year as the company braces for a drop in sales.”

“Wanda’s pursuit of targets will focus on companies in the entertainment and sports industries…”

“Wang is increasingly looking toward entertainment to spur growth as China’s slowing economy undermines his main property business.”

Last week Wanda agreed to buy Legendary Entertainment for $3.5bn in cash (movies include Godzilla, Jurassic World and the new Batman films.)

“Legendary will join Wang’s growing global entertainment portfolio that already includes the likes of U.S. theater chain AMC Entertainment Holdings Inc., Infront Sports & Media AG and a stake in Spain’s Club Atletico de Madrid soccer team.”

“Wanda forecasts that sales will fall 12% in 2016 as slumping revenue from its main real estate business overshadows gains from the burgeoning entertainment operations.”

“Wang said that his firm is diversifying away from property – currently Wanda’s biggest revenue generator – because it’s not a long-term growth business.“

“Longer term, Wang said on Tuesday that Wanda’s revenue will climb at least 15% each year until it reaches $100 billion by the end of the decade as the group diversifies away from real estate property.”

No one would accuse Wang of not being ambitious.

No Place Like Home for Chinese Property Companies’ Debt. Fiona Law and Carol Chan. The Wall Street Journal. 19 Jan. 2016.

Property developers are large consumers of debt and Chinese developers have been large consumers of US dollar denominated debt. However, with the greenback appreciating against the yuan, many Chinese developers are raising yuan denominated debt to retire their US dollar obligations. Side note: this will only exacerbate capital outflows from China.

“Late last year, the company (China SCE Property Holdings Ltd.) sold bonds domestically worth a combined 3.5 billion yuan ($531 million), at an interest rate just above 5%, much lower than the around 11% coupon it used to pay for its dollar bonds.”

It helps that cost of debt in China has been declining, regardless of credit quality.

“Property companies have on average raised funds at interest rates two to three percentage points lower than their offshore borrowing costs, partly thanks to a series of rate cuts by the country’s central bank since the end of 2014.

The lower cost of borrowing at home is also down to home builders gaining much higher credit ratings from domestic agencies; abroad they are often rated as “junk”, or below investment grade. Domestic investors are often more familiar with the companies they are investing in, and hence demand a lower coupon on bonds. Chinese local governments have a history of bailing out failing companies, meaning domestic investors are less worried about bond defaults.“

What’s that phrase again? Oh yeah, moral hazard…

“Chinese property developers were given another boost last January when Beijing loosened restrictions on them raising debt in the domestic market, part of its efforts then to bolster the property sector.”

Construction material prices continue free fall. AZ Big Media. 15 Jan. 2016.

Basically, the input prices into the source materials for construction continue to fall. Yet, ask any property developer and follow the RLB cost indices and you’ll note that construction prices continue their quick ascent… So if the cost of the raw materials are declining, either the cost of labor is jumping or profit margins are expanding. Go ahead and ask your construction laborer friends if their wage rates have been increasing 5 – 20% per year. Granted, they may be making more simply by having more hours of work, but ask if their wage rates per hour have increased meaningfully over the past year and a half.

“Construction material prices fell for the sixth consecutive month in December, losing 1.2% on a monthly basis and 4% on a yearly basis, according to an analysis of the Bureau of Labor Statistics Producer Price Index released today by Associated Builders and Contractors (ABC).”

“Construction input prices have fallen 7.2% since peaking in August 2014, and have fallen in eleven of the previous sixteen months.”

“Construction input prices continued to sink to the end of 2015, due in large measure to global deflationary forces that have become increasingly apparent.” – ABC Chief Economist Anirban Basu

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Housing Starts in U.S. Unexpectedly Declined 2.5% in December

FT – Shipping’s globalization woes 1/14

FT – Amazon lands China ocean shipping license 1/14

FT – China borrowing surges in December 1/14

FT – US equity funds hit by outflows for second straight week 1/15

FT – What goes down eventually comes up 1/15

FT – Vanguard attracts record cash for fourth year running 1/17

FT – Mexico bank chief calls for EM monetary policy action 1/17

FT – How to wean the world off monetary stimulus 1/18