S P Setia may be unable to rely on UK to drive new sales

S P Setia Bhd (June 27, RM3.01)

Maintain neutral with a lower target price (TP) of RM2.91 from RM3.10: How big is the Battersea Power Station (BPS) project to S P Setia Bhd? The BPS project accounts for about 20% (by effective stake) of S P Setia’s total portfolio gross development value (GDV) and revalued net asset value (RNAV).

Maiden earnings from phase 1 (GDV: £846 million [RM4.65 billion]) will kick in from the fourth quarter of 2016 (4Q16) to 1Q17, making up 9% to 15% of the company’s financial year 2016 (FY16) to FY17 profit before tax. A total of 46% of its unbilled sales of RM8.6 billion come from the BPS project.

As the full implications of the UK’s exit from the European Union will take time to unfold, we believe the associated political and economic uncertainties, coupled with the resulting impact on the British pound would make UK assets, including commercial properties, unattractive over the medium term.

Even if the British pound is to depreciate further, we believe both foreign and local buyers will likely hold back on their purchases, as they wait to see how the developments will affect UK property prices.

S P Setia will, therefore, be unable to rely on the UK to drive its new sales. BPS sales have already started slowing down since late-2014, due to the UK elections and stamp duty hikes in the past, and we think the momentum will worsen given the latest development.

Since its launch in October 2014, the take-up rate for BPS’ phase 3A has only achieved 60%.The GDV for phases 1 and 2 commercial components are worth £1.78 billion. This could be a drag on the company.

About 4.2% of S P Setia’s debt is denominated in British pounds. While a weaker British pound may be favourable in terms of foreign exchange, we are concerned about the potential callback on UK borrowings if real estate values depreciate sharply, as the loan-to-value threshold may be triggered. However, we think this risk will likely be mitigated by the backing of both Sime Darby Bhd (“neutral”, TP: RM7.60) and the Employees Provident Fund in this BPS project.

We maintain our FY16 to FY17 earnings forecasts for now. Note that every 5% depreciation in the British pound against the ringgit would lower our earnings projection by 0.5% to 1% (we currently assume RM5.50 versus £1).

Further downside could come from sale cancellations if sentiment gets worse.

Although the longer-term outlook for the London property market should remain intact given its status as an international financial hub, the uncertain outlook over the medium term has prompted us to cut our TP to RM2.91 from RM3.10, based on a larger 40% (from 35%) discount to RNAV to account for the heightening risk.

If conditions in the UK deteriorate, this may also affect market confidence in taking up the company’s proposed issuance of Islamic redeemable convertible preference shares.

Key upside risk to our call would be a swift recovery in market confidence if the UK exit is done smoothly and faster than expected. — RHB Research Institute Sdn Bhd, June 27

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This article first appeared in The Edge Financial Daily, on June 28, 2016. Subscribe to The Edge Financial Daily here.