KE: Even if the real estate market is frozen, dividends provide a solid foundation.

On the evening of March 14th, before the U.S. stock market, KE (KE.US) released its 2023 fourth-quarter earnings report. Due to a significant decline in the real estate market in the third quarter, market expectations were not high. However, KE delivered much better performance than expected, with the following key points:

Existing Homes - Leading the way but facing strong headwinds

Due to the frequent restrictions on purchases and support policies for housing loans in various regions in the fourth quarter of last year, KE's existing home GTV reached 468 billion, a year-on-year increase of about 30%, showing a significant improvement compared to the previous quarter and slightly higher than expected. Breaking it down, Lianjia's GTV increased by 17% year-on-year, while GTV led by 3P stores increased by 41%. The rebound in transactions of existing homes in second-tier and below cities in the fourth quarter was higher than in first-tier cities, indicating the effectiveness of KE's platform in spreading the risk of self-operated stores.

However, due to the increasing contribution of GTV from 3P stores, the realization rate of the company's existing home business decreased by 0.1 percentage points compared to the previous quarter, resulting in only a 15% increase in actual revenue, in line with expectations.

Continuous defaults in real estate companies, immense pressure on new home business

The downward pressure on the new home market remains severe, with KE's new home transaction volume decreasing by 10% year-on-year, with no signs of improvement. However, the market had anticipated this and there were no unexpected defaults. In the increasingly challenging new home market, the value of customer traffic has become more apparent. Therefore, the commission rate of KE's new home business increased by 0.1 percentage points compared to the previous quarter. The revenue of KE's new home business also decreased by about 9% to 7.57 billion, which is consistent with expectations.

Rapid growth in new business channels, a potential hope for the future

The outlook for the core intermediary business is uncertain, but the rapidly growing second business channel (home decoration, home services, leasing, etc.) that the company has high hopes for may offset the potential contraction of the first business channel. Firstly, the revenue of the home decoration business increased by a large 74% year-on-year to 3.64 billion, also showing a 15% increase compared to the previous quarter. The revenue from other businesses mainly in finance, leasing, and home services increased by a significant 170% year-on-year to 3.9 billion. The actual revenue from new businesses exceeded expectations by 14%, making it the highlight of this quarter's revenue report.

Turning losses into profits in new business is also crucial

From a gross profit perspective, it reached 5.14 billion this quarter. Although the gross profit margin decreased by about 1.9 percentage points to 25.5% compared to the previous quarter, it exceeded expectations by about 13%, which is still good. Looking at the cost structure in detail, the increase in the contribution of GTV from 3P stores led to a nearly 4 percentage point increase in the proportion of commission split costs to revenue, dragging down the gross profit margin.

In terms of segments, the contribution of gross profit from existing homes and new home businesses was in line with expectations, while the gross profit contribution from new businesses reached 1.7 billion, accounting for over a quarter of the total, significantly higher than expected.If the intermediary business continues to shrink in the future, the key to driving the overall profit growth of the company lies in turning the new business from loss to profit.

Revenue is acceptable, but profits are collapsing

Although the revenue and gross profit are not bad compared to market expectations, a significant expansion of expenses has led to a severe deterioration in profits this quarter. On the expense side, apart from the 5% year-on-year increase in research and development expenses due to investment in new businesses, it is somewhat reasonable. Both marketing and management expenses have expanded significantly. Specifically, marketing expenses increased by about 400 million MoM, significantly higher than expected. This is mainly due to the investment in new businesses such as home decoration, which seems reasonable considering the high growth rate of new businesses.

Moreover, management expenses increased by about 800 million MoM, exceeding expectations by about 600 million, and were the biggest drag on profits in this performance. According to the company's explanation, this is mainly due to the recognition of a large amount of bad debt. Combined with the recent "accidents" of many leading real estate companies and the continued halving of new home transaction volume, the impairment of accounts receivable is also one of the market's main concerns.

Dolphin Research's view:

From the company's performance this quarter, although there were no significant surprises in the revenue end of existing homes and new home businesses, it is in line with market expectations and continues to demonstrate the company's leading countercyclical ability and the ability to diversify operational risks under a platform model. In addition, with the pressure on the core business of transaction intermediaries, the rapid growth of secondary businesses such as home decoration is expected to take over and become the main driving force for the company's performance growth in the future. Overall, the company's inherent strengths remain intact.

However, mainly due to the continuous defaults of domestic real estate companies, even high-quality leading real estate companies have recently reported negative news, and the bad debt risk of revenue from real estate companies has caused KE's operating profit to turn from positive to negative this quarter, falling far short of expectations.

The more critical issue is that compared to this quarter's performance, the market is more concerned about the future trend of the property market. Due to high-frequency data showing a nearly 30% YoY decline in existing home transactions and a nearly 50% decline in new home transactions from January to February, the market lacks confidence in the future trend of the property market. The company has stated that it will no longer provide guidance for the future, which reinforces this concern.

Fortunately, from a shareholder return perspective, the company has announced a $400 million annual dividend this time, in addition to the $200 million special dividend in the first half of the year, and more than $700 million in repurchases for the full year of 2023, resulting in an overall shareholder return rate of about 7.3% in 2023, which is quite considerable. During the conference call, the company also stated that it will ensure a shareholder return of no less than 5%.Therefore, although the company's future performance may decline due to the drag from the property market, in the case of low valuation, the company's ample cash reserves and the promised dividends + repurchases still provide a very high and stable return on investment.

Detailed Analysis of This Quarter's Earnings Report:

1. Existing Homes: Market Leader but Facing Strong Headwinds

Last year, in the fourth quarter, with many cities relaxing restrictions on home purchases and mortgage policies, the national real estate market, especially the second-hand housing sector, experienced a certain degree of recovery. As a result, KE's existing home Gross Transaction Value (GTV) reached 468 billion, a year-on-year increase of about 30%, showing a significant improvement compared to the previous quarter and slightly higher than expected.

Breaking it down, GTV led by Lianjia saw a 17% year-on-year increase, while GTV led by 3P stores on the platform increased by 41%. Despite the lower year-on-year growth in first-tier cities compared to second-tier and lower-tier cities during the fourth quarter, KE still managed to mitigate operational risks concentrated in self-operated stores in first-tier or new first-tier cities by relying on stores on the platform.

However, due to the stronger growth in GTV led by stores on the platform this quarter, theoretically leading to a decrease in KE's realization rate of income from transactions, the year-on-year revenue growth of KE's existing homes this quarter was 15%, significantly lower than the 30% GTV growth rate. This also resulted in actual revenue being in line with expectations, without any surprises.

The comprehensive realization rate of existing homes calculated based on revenue/GTV also decreased by 0.1 percentage points compared to the previous quarter. Apart from the increasing contribution of GTV from the platform, the downward adjustment of commission rates by KE in cities like Beijing may also be one of the reasons, given the continuous decline in industry prosperity.

The recent dynamics of real estate transactions are crucial. Following the policy stimulus in December and the pulse-like warming before the Spring Festival, the post-holiday heat in second-hand housing transactions has started to decline. According to third-party statistics as of early March, the annual cumulative transaction volume of second-hand homes has decreased by 27% year-on-year. Although there may be signs of a "mini spring" rebound in March and April, a substantial turnaround in the real estate market is not yet visible.

2. New Housing Business: Continuous Challenges and Immense Pressure

Compared to existing homes, the downward pressure in the new housing market remains more severe. Despite policy stimuli in the fourth quarter, KE's new housing transaction volume still decreased by 10% year-on-year. Although there has been some improvement compared to the previous quarter, expecting a turnaround, let alone a year-on-year halt in decline, is wishful thinking. However, the market had already anticipated this, and the actual performance is slightly better than the low expectations.

Due to the shrinking transaction volume, KE's new housing business revenue also decreased by 9% YoY to 7.57 billion, which is basically in line with expectations. The actual realization rate increased slightly by 0.1 percentage points YoY, and in the increasingly challenging situation of new housing transactions, the value of KE's customer source drainage becomes more apparent.

However, looking ahead, the cumulative sales of new houses by the top 100 real estate companies in the country in February 24 years ago dropped by 48% YoY, approaching a halving from an already low base, casting a very pessimistic atmosphere over the prospects of future new housing transactions.

3. The rapid growth of the new track may become the hope for the future.

Although the core agency business is severely affected by the pressure of the real estate market, the outlook is quite pessimistic. Fortunately, the company's second channel business, including home decoration, home services, and leasing, is growing rapidly, with the potential to offset the impact of a possible contraction in the first channel.

Firstly, the revenue of the home decoration business increased by 74% YoY to 3.64 billion, also showing a 15% QoQ growth. The revenue from other businesses mainly in finance, leasing, and home services increased by 170% YoY to 3.9 billion. The actual revenue of the new business combined exceeded expectations by 14%, making it the biggest highlight in this quarter's revenue performance.

Overall, the revenue from new housing and existing housing businesses is basically in line with expectations, but the performance of new businesses is impressive, leading to KE's overall revenue reaching 17.8 billion this quarter, with a YoY growth rate exceeding 20%, slightly higher than the expected 5%, which is quite commendable.

4. While there were no surprises in terms of revenue, there are significant issues with profit

First of all, in terms of gross profit, this quarter reached 5.14 billion, although the gross profit margin decreased by about 1.9 percentage points to 25.5% compared to the previous quarter, it actually exceeded expectations by about 13%. Breaking down the cost structure, the main reason for the decrease in gross profit margin is the increase in the contribution of GTV from new store openings, leading to a nearly 4 percentage point increase in the proportion of commission split costs compared to revenue, dragging down the gross profit margin.

As for expenses, apart from the 5% year-on-year increase in research and development expenses due to investment in new businesses, which is reasonable, this quarter saw significant expansions in both marketing and management expenses. Specifically, marketing expenses increased by about 400 million compared to the previous quarter, significantly higher than expected. According to the company's explanation, this is mainly due to investment in new businesses such as home decoration, which seems reasonable given the high growth rate of new businesses.

Moreover, management expenses increased by about 800 million compared to the previous quarter, exceeding expectations by about 600 million, being the biggest drag on profits in this performance. According to the company, this is mainly due to the confirmation of a large amount of bad debt provision this quarter. Combined with the recent "accidents" of several leading real estate companies and the continued sharp decline in new home transaction volume, bad debt provision is also one of the market's main concerns.

Although revenue and gross profit margin were slightly higher than expected, due to the drag from marketing and management expenses, this quarter's operating profit of KE turned into a loss again, reaching 170 million, lower than the market's expected profit of 430 million.

In terms of the contribution to gross profit from different business segments (excluding labor costs such as commission split, close to the gross profit margin), 1) In the existing home business, the increase in the contribution of new store openings led to a decrease in the realization rate, while the commission split increased, resulting in a decrease of about 4 percentage points in profit margin contribution rate compared to the previous quarter, slightly lower than market expectations.

In the new home business, due to a slight increase in commission rates compared to the previous quarter, the contribution to gross profit margin also increased slightly by 1 percentage point, in line with market expectations.

Although the contribution rate of the home decoration business and other emerging businesses has slightly decreased, the actual gross profit reached 1.7 billion due to the rapid growth in revenue, nearly 600 million higher than expected. Dolphin Research believes that if the scale of the real estate agency business continues to decline in the future, the expansion of new business revenue and turning losses into profits may be the greatest hope to make up for the shrinking scale of the agency business.