CIMB Research Report: Property - Undervalued and underappreciated

• Upgrade to OVERWEIGHT. We believe concerns over the 5% RPGT are overblown and provide investors a window of opportunity to pick up property stocks on the cheap. The sector’s fundamentals are improving significantly.
  
  In fact, we believe that one of the reasons why the government saw a need to curb excessive speculation via the RPGT is the sector’s strong prospects. We upgrade the sector from Trading Buy to OVERWEIGHT and upgrade all developers to Outperform.
  
  Potential re-rating catalysts include a pick-up in sales and a rebound in earnings.
  
  KLCC Prop stays an Underperform as it is a property investment company and will benefit the least from the uptick in the residential property segment.
  
  E&O remains our top pick as it continues to be the highest beta and most liquid property stock.
  
  SPSetia stays as a core holding due to its size and status as the sector bellwether.

• 2009 a year of rebound. Despite all the problems faced by the sector including squeezed margins, poor sales for most developers, rising unemployment and the economic recession, the property sector was one of the best performing sectors last year.
  
  This was because property stocks came from a very low base, having been bashed down in 2008. Share prices also enjoyed a big rebound because the sector is considered to be cyclical and high-beta, and would benefit from the rebound of the stock market.
  
  The sector, however, was dealt a temporary blow at end-Oct when the government announced a 5% RPGT that took effect on 1 Jan 2010.
• Prospects brighter in 2010. Property stocks reacted negatively to the RPGT announcement and have mostly been trading sideways since then.
  
  While we were also shocked by the move, we believe that the market has overreacted.
  
  Fundamentals are looking up as 1) the economy is forecast to return to growth in 4Q09 after being mired in recession in 1Q-3Q09, 2) the stock market’s spectacular 45% rebound in 2009 will help strengthen confidence and sentiment on properties, and 3) affordability of properties is near its all-time best and the low interest rate regime will encourage property purchases, especially with inflation preying on some consumers’ minds.
• Still prefer developers. We like all developers as they will benefit from a broadbased rebound in demand. We believe developers across the board will enjoy a recovery in sales and earnings in 2010. We upgrade E&O, Hunza Prop, Mah Sing, SP Setia and UM Land from trading buy to Outperform.
  
  We have also raised the target prices for E&O, Mah Sing and SP Setia by 1-12%. Potential re-rating catalysts include 1) a pick-up in launches and sales in 2010, and 2) a rebound in earnings for most developers as many were weighed down by a combination of high costs and weak sales in 2009.
  
  We continue to shun KLCC Prop as it has no exposure to property development. For investors seeking yield, we prefer Malaysian REITS in general and Axis REIT (AXRB MK; NR) in particular.

Review of 2009

Despite all the problems faced by the sector including squeezed margins, poor sales for most developers, rising unemployment and the economic recession, the property sector was one of the best performing sectors in 2009. This was because property stocks came from a very low base, having been bashed down in 2008.

In fact, the property sector was the worst performing sector in 2008 when the KL Property Index lost half its value.

Share prices also enjoyed a big rebound because the sector is considered to be cyclical and high-beta, and would benefit from the rebound of the stock market and economy.

The sector, however, was dealt a temporary blow at end-Oct when the government announced on 23 Oct a 5% real property gains tax (RPGT) effective 1 Jan 2010.

Property stocks under our coverage staged a rebound in 2009 but most of them did not enjoy as big a bounce as the property sector as a whole.

This was because two of them – SP Setia and Mah Sing – enjoyed relatively resilient share prices in 2008 as PNB bought big stakes in the two companies on the open market and their valuations were not as beaten down as other property stocks. Hunza Prop announced an EPSand RNAV-dilutive rights issue during the year, which threw a damper on its share price.

KLCC Prop as a property investment company also did not enjoy a big recovery in share price as the stock is tightly held and its dividend yields are not high. E&O was the biggest winner in 2009, nearly tripling in price after crashing 84% in 2008.

We initiated coverage on the stock in September.

Outlook for 2010

Property stocks reacted negatively to the RPGT announcement and have mostly been trading sideways since then.

We view this as a good buying opportunity as the outlook for the sector is improving. Prospects for the two major determinants of the property sector – the economy and stock market – are certainly looking up. We believe the fundamentals of the sector are increasingly promising as 1) the economy is forecast to rebound to growth in 4Q09 after being mired in recession in 1Q-3Q09, 2) the stock market’s spectacular 45% rebound in 2009 will help to strengthen confidence and sentiment on properties, and 3) affordability of properties is near its all-time best and the low interest rate regime will encourage property purchases, especially with inflation preying on some consumers’ minds.

Fundamentals 1: Economy to rebound from 4Q09 The economic recovery has started, evident from the clearer signs of improvement in both external and domestic demand conditions. Real GDP growth improved markedly to register a smaller contraction of 1.2% in 3Q09 from 5.1% in 1H09. We believe the  economy will rebound to positive growth of 2.0% in 4Q09, taking the full-year GDP estimate to a contraction of 2.3% against a growth of 4.6% in 2008.

Both consumer and business sentiments have turned the corner, which augurs well for private sector demand. This, along with the projected recovery in exports, will lift real GDP growth higher to 3.5% in 2010 and 5.5% in 2011.

The growth catalysts for 2010-11 will be (i) a firmer recovery of domestic demand as fiscal spending is stepped up and 9MP projects are completed, and (ii) a turnaround of exports as the global economy recovers. The recovery is expected to be broad-based, with private sector demand taking charge as the public sector gradually unwinds its fiscal support.

Private sector demand is estimated to rise 4.3% in 2010 while public sector expenditure is set to pull back 3.6%. Exports should rebound 8-10% after the collapse of global trade last year. Positive leads underpinning the export recovery are (i) the easing contraction of global trade, (ii) a moderate recovery for the major developed economies, and (iii) improved demand for consumer electronic goods.

Fundamentals 2: Stock market rallied 45% in 2009

2009 started all doom and gloom and the market continued its 2008 bear market slide in 1Q09. But the mood changed dramatically in Apr when the KLCI started rallying.

Although we turned bullish just before Dato’ Sri Najib Razak became the country’s 6th prime minister on 3 Apr, we too have been surprised by the strength and speed of the market resurgence. The KLCI’s 396 pt or 45% upswing in 2009 effectively reversed 2008’s vicious spiral.

A virtuous cycle is now in play. Although the KLCI’s gain in 2009 was certainly impressive, Malaysia is lagging behind its regional peers. This is not a surprise considering that the KLCI was one of the better performers in 2008, falling less than its peers.

Being a closely watched barometer of confidence for Malaysians, a high KLCI is good news for the property market. In fact, we often notice a high correlation between the asking prices for high-end properties in Kuala Lumpur and the daily movements of the KLCI, especially during uptrends.

We also observe a high correlation between the KLCI and the KL Property Index though the property index has a higher beta of around 1.4x.

The average bull market in Malaysia over the past five cycles lasted 21 months against 19 months for the property index. We are now into the 9th month of this bull market. Even if this bull market lasts only as long as the shortest bull market in the 1990s, i.e. 15 months, there could be another six months to go. As for the property index bull cycles, the shortest was the last one in 2006-7 which was shortlived at 11 months, having been interrupted by the US subprime crisis. We believe this property index upcycle should last longer and match that of the broader market in view of the 5% RPGT hiccup, which also prematurely and temporarily halted the uptrend.

Fundamentals 3: Affordability at all-time best

Due to moderate price appreciation, rising incomes and record low interest rates, affordability of residential properties in Malaysia is at its all-time best. In fact, average home prices in Malaysia have lagged far behind income growth ever since the 1997-8 Asian financial crisis (see Figure 7).

Affordability has never been better and banks continue to offer very attractive mortgage rates at around base lending rate minus 2% and in some cases BLR - 2.4%, which means interest rates charged are only slightly over 3%, not much higher than fixed deposit rates of 2-2.5%.

Although many people  will argue that the national average home price is not reflective of prices in the Klang Valley or Penang, surprisingly it is high-end homes that have enjoyed the strongest demand and price appreciation in recent years.

RPGT opportunity

The re-imposition of RPGT has shaken investor confidence about property stocks.

Although the government fine-tuned the tax on 23 Dec so as not to penalise nonspeculators, the damage is already done. Worst hit is E&O due to its high beta and very liquid nature. Also, E&O is exposed mainly to high-end residential properties, which is viewed as the segment where speculation has been most prevalent.

The KL Property Index has fallen 5% since the announcement of the 5% RPGT on 23 Oct, underperforming the KLCI which has gained 1%.

Before the government’s RPGT relaxation for properties held for at least five years, the property index was down 8% against a flat KLCI.

Since the fine-tuning, the sector has rebounded 3% compared with the KLCI’s smaller gain of 1%.

Overall, we believe investors have overreacted to the 5% RPGT.

Although the announcement was a shock to industry players and analysts including ourselves, the amount being taxed on gains is small and we expect potential property buyers to shrug it off.

SP Setia, the bellwether of the industry, in fact recorded its best monthly sales ever in November, right after the RPGT announcement.

The group sold a mindboggling RM293m worth of properties during the month, nearly 80% of which came from Klang Valley projects, 15% from Johor and the remainder from Penang.

Interestingly, the high-end development in Setia Eco Park chalked up sales worth RM61m. Bungalows priced at a record RM4m-4.5m for that location were snapped up.

Indications from other developers with strong marketing prowess also show similar promising progress. Mah Sing’s Perdana Residence 2’s superlink homes opened for registration in early December and attracted queues before 7am.

Phases 1 and 2 with GDV of RM142m have since achieved bookings of around 80%. Mah Sing also indicated strong interest in its upcoming Cyberjaya project. This was a pleasant surprise to us as we were cautious about prospects this far south of Kuala Lumpur.

The condo market also remains robust as Sunrise’s MK28 condos priced at close to RM800 psf in Mont’ Kiara have achieved take-up of a third since they opened for bookings in December. The pricing is at the higher end of the price range for that location but a significant sweetener is the 10/90 financing scheme where buyers pay no interest for five years.

Risks

Double-dip. The key risk to our bullish call on properties in 2010 is if a double-dip takes place and both the economy and stock market head south. Our economics team estimates that there is a 30% chance of a double-dip occurring, 20% probability of a V-shaped recovery and 50% likelihood of a square root-shaped recovery.

Nonetheless, we take comfort in the government’s goal of a relatively robust growth rate of 5% for 2010, higher than our estimate of 3.5%. Also, we remain positive about the outlook for the stock market this year with a KLCI target of 1,450 points.

Rising interest rates. There is some concern that if inflation rears its head, interest rates could start to rise and sap demand for properties.

But we are less perturbed as property market is more a function of confidence and sentiment – which are largely driven by the economy and stock market – and have in the past continued to do well even in a rising interest rate environment.

Moreover, our economics team expects interest rates to remain unchanged in 1H10 and expects increases in 2010, if any, to be marginal.

Commercial oversupply. We have yet to see glut of commercial space and occupancy rates of prime office and retail space in Klang Valley remain very high.

However, rental rates for newly completed office buildings appear to be soft due to the weak economic environment in 2009 and substantial new commercial space will be coming on to the market over the next 1-2 years.

Hotel occupancy rates weakened in 2009 even though tourist arrivals held their ground. We are less optimistic about the commercial property market and prefer exposure to residential development. Hence, our preference for developers over property investment companies.

Policy flip-flops. Should the government again impose even higher RPGT or propose new policies that could dampen the property market, potential buyers would stay on the sidelines for an even longer period of time due to further confusion.

We believe the chances of this happening are low as the authorities have seen the backlash from the 5% RPGT decision and ended up fine-tuning the policy.

In fact, we would not be surprised if the government threw in more incentives to give the sector a boost as the Prime Minister recently said he wanted to see “the property sector grow from strength to strength.

Valuation and recommendation

We like all developers as they will benefit from a broad-based rebound in demand.

Although blue chip developers such as SP Setia and Mah Sing registered outstanding sales in 2009, this was not the case for smaller developers with weaker marketing abilities. However, we believe developers across the board will enjoy a recovery in sales and earnings in 2010.

We believe concerns over the 5% RPGT are overblown and provide investors with a window of opportunity to pick up property stocks on the cheap. The sector’s fundamentals are improving significantly.

In fact, we believe that one of the reasons the government saw a need to curb excessive speculation via the RPGT is the sector’s strong prospects.

We upgrade the sector from trading buy to OVERWEIGHT and upgrade E&O, Hunza Prop, Mah Sing, SP Setia and UM Land from trading buy to Outperform.

Valuations remain undemanding as property stocks are still trading at big discounts to RNAV. We continue to shun KLCC Prop as it has no exposure to property development. For investors seeking yield, we prefer Malaysian REITS in general and Axis REIT (AXRB MK; NR) in particular.

KLCC Prop stays an Underperform. E&O remains our top pick as it continues to be the highest beta and most liquid property stock. SP Setia continues to be a core holding due to its size and status as sector bellwether.

Potential re-rating catalysts for the property sector include 1) a pick-up in launches and sales in 2010, and 2) a rebound in earnings for most developers as many suffered from a combination of high cost of weak sales in 2009.

We are raising our target prices for SP Setia and Mah Sing due to their status as the leading developers in the sector. SP Setia’s target price is increased from RM5.05 to RM5.51 as we up the RNAV premium from 10% to 20%, which is the lower end of the 20-70% range that the sector proxy has traded at during property upcycles.

Mah Sing’s target price is lifted from RM2.34 to RM2.60 as we narrow the discount to the 15x target market P/E from 20% to 10% as the company has been on a landbanking spree which should accelerate earnings growth. E&O’s target price has been nudged up from RM1.89 to RM1.90 after factoring in the recent disposal of the Lot 595 land in Kuala Lumpur for over RM2,000 psf, higher than our earlier estimate of RM1,800 psf.

We have also raised our FY10 net profit forecast for the stock by 45% to incorporate the RM31m gain from the sale. We make no changes to the earnings forecasts for all other property stocks.

Property developers’ strategies for 2010

Despite the 5% RPGT, developers are far more optimistic about prospects now than a year ago when most were beset by doom and gloom.

Last January, most developers’ strategies were to hold off on new launches, consolidate their business activities and change the product mix to weather the storm. But most were financially sound and looking for acquisition opportunities.

Since then, Mah Sing and UM Land have been most aggressive in acquiring new landbank while E&O, Hunza Prop and Mah Sing have proposed or undertaken cash calls to strengthen their balance sheets.

Most developers appear optimistic about longer-term prospects and are willing to take on more risk.

E&O – The key focus in 2010 will be its maiden condo venture at Seri Tanjung Pinang in Penang.

The RM1.8bn project will kick off with the official launch of the first block in January, which includes an aggressive awareness campaign.

E&O will also work towards the launch of a new condo project in Kuala Lumpur as the St. Mary Residence project has already reached a critical milestone with combined take-up of 60% for the two blocks.

The new condo will be located along Jalan Yap Kwan Seng and will be positioned as an “affordable” quality product. Also, to broaden its earnings base, we would not be surprised if E&O brought forward the development of its larger land bank in Kuala Lumpur, including the 310-acre Kemensah Heights project.

Hunza Prop – Following the completion of Infinity in 2009, the Penang property specialist’s focus in 2010 will now be on the massive Gurney Paragon project.

The group expects to commence construction of the long-awaited Gurney Paragon mall in the beginning of this year, with targeted completion by end-12.

As for its condo project, construction is ongoing and is on track for completion by end-10.

We do not expect any new launches next year. In terms of land acquisition, Hunza Properties will continue to be on a lookout for value landbank in both Penang and Kuala Lumpur.

But management has also hinted that it is interested in acquiring land in Guangdong, China. If this materialises, it would be the company's maiden international foray.

Mah Sing – Mah Sing was one of the few developers that were optimistic about prospects in early 2009 and was proven right by its strong sales during the year.

It remains one of the most active landbank acquirers, sealing six deals in Malaysia and one in China during the year. The Chinese venture marks a milestone for the group in its endeavour to spread its wings overseas.

Mah Sing remains the perpetual bull and is confident about the outlook for 2010 when it will be launching projects for its newly acquired landbank, in line with its successful “quick turnaround” business model.

The group was one of few companies that recorded an improvement in earnings in 2009, and should continue to post earnings growth in the coming years.

SP Setia – The group is targeting to sell a minimum RM1.6bn worth of properties in FY10/2010.

It will continue to focus on its core competency of township development but at the same time, lay the foundations for a big improvement in profits over the longer term from two fronts – commercial-type of properties in the Klang Valley and overseas contribution from Vietnam and China.

The RM6bn KL EcoCity project will be its key focus in FY10 and pre-marketing will begin in Jan before the official launch in Sep-Oct 2010.

SP Setia does not have big ambitions in China but due to the huge market size, it believes that profit contribution from China alone could match that of Malaysia over the long term. The group is also stepping up its domestic and international landbanking efforts, which signals its optimism about properties.

UM Land – The group’s launch schedule depends, to a large extent, on market conditions. Should demand rebound, UM Land would probably expedite the launches of several major condo projects including the mammoth RM2.2bn Jalan Mayang condo a stone’s throw from the Petronas Twin Towers, the RM305m serviced apartment project in Johor Bahru’s CBD and the RM147m commercial project in Lorong Ceylon.

More certain is the launch of the RM288m Suasana Bukit Ceylon condo in 2010. If conditions do not improve significantly, UM Land will continue to rely on its township projects in the Klang Valley and Johor as well as land sale gains to boost earnings.