Expanding High-Margin Services Will Drive Future Success In China's Housing Market

Key Takeaways

• KE Holdings' strong growth in home transactions and strategic collaborations could drive future revenue and market share expansion.
  
• Expansion in home renovation, furnishing, and rental services is expected to bolster revenue and margins due to their higher margin profiles.
  
• Ongoing challenges in home renovation, real estate market instability, and increased costs could impact KE Holdings' revenue growth, margins, and return on investments.

Catalysts

Through its subsidiaries, engages in operating an integrated online and offline platform for housing transactions and services in the People's Republic of China.

• KE Holdings has shown strong growth in its existing home transaction business, achieving a 44% year-over-year increase in transactions on its platform compared to a market growth of 21%, which is likely to drive future revenue growth by capturing more market share.
  
• The company is seeing impressive growth in the home renovation and furnishing, as well as the home rental services, with revenues increasing by approximately 33% and 118% year-over-year, respectively. These businesses are expected to bolster both revenue and net margins as they scale due to their higher margin profile compared to transaction services.
  
• KE Holdings expanded its platform by increasing the number of active stores by 14.6% and agents by 24,000 year-over-year, which is poised to enhance revenue and operational efficiencies, potentially boosting earnings.
  
• Strategic collaborations with top-tier developers are anticipated to strengthen KE Holdings' new home transaction business, which outperformed despite a market decline. This strategic focus could help sustain revenue growth and profitability.
  
• Improved platform efficiencies, such as higher average revenue per store and better support ratios, are expected to drive higher net margins and earnings over time through increased operational leverage and cost control.

KE Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming KE Holdings's revenue will grow by 10.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 5.0% today to 7.1% in 3 years time.
• Analysts expect earnings to reach CN¥7.9 billion (and earnings per share of CN¥8.1) by about December 2027, up from CN¥4.2 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥11.3 billion in earnings, and the most bearish expecting CN¥5.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 4.0x on those 2027 earnings, down from 40.2x today. This future PE is lower than the current PE for the US Real Estate industry at 27.6x.
• Analysts expect the number of shares outstanding to decline by 6.93% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.35%, as per the Simply Wall St company report.

KE Holdings Future Earnings Per Share Growth

Risks

• The home renovation and furnishing business, while growing, still faces fundamental unresolved problems in the industry, which could impact the ability to sustain revenue growth in this segment.
  
• Despite policy changes, the real estate market's recovery might not be sustainable without a fundamental improvement in the macroeconomic environment, which could affect overall revenue and net margins.
  
• The increase in fixed labor costs for both existing and new home transactions has led to a decrease in contribution margins, which could impact net income if this trend continues.
  
• The company's rapid expansion of store and agent networks requires ongoing investment, and there is a risk that the return on these investments will not be realized if market conditions worsen, potentially affecting earnings.
  
• The new home market remains in a bottoming-out stage with weak supply and demand, and lingering risks associated with real estate developers; this could continue to affect revenue and profit margins from this segment.

Valuation

• The analysts have a consensus price target of CN¥25.24 for KE Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CN¥32.9, and the most bearish reporting a price target of just CN¥17.74.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be CN¥111.8 billion, earnings will come to CN¥7.9 billion, and it would be trading on a PE ratio of 4.0x, assuming you use a discount rate of 8.3%.
• Given the current share price of CN¥19.01, the analyst's price target of CN¥25.24 is 24.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.