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Maintain neutral: First quarter of 2018 was a weak reporting season for developers as margin issues arising from higher overheads and lower product margin mix plagued earnings, resulting in the fourth consecutive quarter of downward earnings revision. This was poorer than the previous quarter where we cut earnings for 46% of our universe while only raising estimates for 32% of our coverage.
Sales outlook remains unexciting on looming margin risks with our universe’s total sales/earnings expected trajectory of -9%/-9% year-on-year (y-o-y) in 2018/2019 forecasts and +3%/+11% y-o-y in 2019/2020 forecasts. Our universe’s average unbilled sales are at 1.1 years or at a slight improvement from the previous quarter (0.9 year) and average net gearing is at 0.23 times, which is healthy.
Many developers held back new launches running up to the 14th general election as buyers were holding back given the uncertainties. Also, this year, most developers are looking to clear inventories and take-up rates of these inventories can be sporadic or unpredictable.
We observe very heavy marketing campaigns by most developers, thus there is still a possibility that developers could catch up with sales in the coming quarters. Additionally, we note that developers are giving discounts/rebates/freebies and are extensively using agents to clear inventories, which will also have negative implications on margins. Nonetheless, we reckon that it is better for developers to clear inventories to unlock capital rather than retain margins at this juncture.
The zero-rated goods and services tax (GST) will help offer some relief for developers’ margins and/or allow them to pass on savings to buyers to improve affordability. However, since most developers’ product pipelines are largely residential and GST savings will only be felt in the newer launches, impact on margins may not be immediately significant. As a result, we do not think this will be seen as a major catalyst for the sector.
Noticeably, the big boys were mainly on track with sales targets largely due to their stronger marketing abilities and wider market reach, while the smaller players saw weaker sales performances.
Revalued net asset value (RNAV) discounts are now mainly at -1 standard deviation (SD) to -2 SD level with more trading closer to their own through values which may be lower than the -2 SD level. Also, most of our universe are hitting historical low forward price-to-book value (PBV) valuation level of 0.3-0.8 times. At such level, it means that the company’s valuation implies no further development profit and its assets (mainly land banks) are trading below current market prices of land as land costs are typically stated at historical values and those trading at much deeper PBV discounts are typically developers with very low land costs. We think this could give way to potential mergers and acquisitons, or even privatisation plays. The sentiment on the sector is likely to be subdued because of the absence of catalysts, oversupply, and affordability issues, while policy clarity will likely be made known during Budget 2019 announcement.
Year to date, the KL Property Index has declined by 15% versus the FBM KLCI (-2%). In view of an unexciting sector outlook with emerging value, we think that the bashed-down big boys with deep value, firmer earnings trajectories in the near term and decent balance sheets are tactical options. Our preferred picks are UEM Sunrise Bhd (outperform, target price [TP]: 97 sen) and Malaysian Resources Corp Bhd (outperform, TP: 70 sen).
UEM Sunrise is now trading at 0.5 times financial year 2018 (FY18) PBV forecast, which we believe is unjustified as the company is still profitable while its net gearing is below our comfort threshold of 0.5 times (net gearing is expected to drop to 0.4 times by FY19). With the adoption of Malaysian Financial Reporting Standards 15, we believe that earnings momentum for second half of FY18 (Australian project deliveries, which should result in big bullet contributions over FY18-FY19) should excite investors while there is also the prospect of exceeding its own sales target of RM1.2 billion. We also like its active inventory clearing efforts and disposal of non-core assets. Active value unlocking of its asset in Johor via land sales is also welcomed while the group is also building up its Klang Valley and overseas pipelines.
Malaysian Resources is another preferred pick due to: i) share price came off the most to date by 49% among the big-boys; ii) currently trading at historical record low price-earnings ratio of 0.6 times; iii) improving earnings outlook (FY18 forecast +33% on-year) backed by the construction progress of light rail transit 3 and its ongoing property projects (total order book and unbilled sales at RM6.5 billion providing at least three-year visibility) albeit recent earnings disappointment; and iv) disposal of JB Eastern Dispersal Link expressway, which could further lighten its balance sheet from current net gearing of 0.61 times to 0.37 times, and to a comfortable level of below 0.1 times, should they be able to conclude their land disposals, ie Bukit Jalil, German Embassy, and Semarak City. — Kenanga Research, June 5
This article first appeared in The Edge Financial Daily, on June 6, 2018.
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