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Expecting distressed valuation in an economic downturn

Property sector
Downgrade to negative:
The KL property index has underperformed the FBM KLCI in recent months, declining 27% since early July compared with the FBM KLCI which fell 15.9% over the same period. Moving forward, we believe the property sector will continue to underperform the FBM KLCI as global economic uncertainty heightens and we reckon investors may avert exposure to property companies with high beta.

National Property Information Centre's (Napic) statistics continue to stay solid, but the numbers are always lagged by at least a quarter. The fact is property prices and transactions are heavily correlated to GDP growth. As the global economy is heading towards a possible "double-dip" recession, we believe property developers will be more cautious with their launches and sales target for 2012 will not be as aggressive compared with that in 2011. In the near future, however, we believe earnings of property developers will not be adversely affected.

Based on the latest House Price Index (HPI) data released by Napic, average house prices in Malaysia rose to RM208,725 in 2Q11 compared with RM206,513 in 1Q. Nevertheless, growth rates of average house prices decelerated for the first time since 3Q10. Average house prices grew 7.4% year-on-year (y-o-y) in 2Q compared with 9% y-o-y growth in 1Q. Growth rates of property hotspots which moderated include Selangor (+11.5% y-o-y compared with +12% y-o-y in 1Q), Kuala Lumpur (+6.17% y-o-y vs 8.68% y-o-y in 1Q) and Penang(+5.51% vs 6.23% in 1Q). The quarterly sequential growth rate suggested potential stabilising of house prices. House prices gained by 1.1% quarter-on-quarter (q-o-q) in 2Q and 1.3% q-o-q in 1Q, which is well below the quarterly growth rate of about 2.4% q-o-q from 2Q10 to 4Q10.

New housing launches decreased by 43% from 12,189 units recorded in 1Q10. Nevertheless, we are not worried as the preliminary data normally accounted for about half of actual launches. Overhang properties declined by 9.15% y-o-y suggesting a better absorption. Vacant space of shopping complexes was maintained at 19% and office vacancy worsened to 21.2% in 1Q from 20.9% in 1Q10. We maintain our projection of single-digit growth in transaction value in 2011 and we are mainly concerned about the oversupply in the high-end segment of residential properties and office development at this moment.

We are downgrading our view on the property sector to "negative". There are no clear indicators of a downtrend in the property segment and three out of five property companies under our coverage registered stellar earnings growth during the 1HFY11 results reporting season. The downgrading in our view is primarily due to uncertainties in the global economic conditions and weaker investor confidence. We have not revised our earnings forecasts for property companies as future earnings are supported by their impressive unbilled sales built up over the past two years of the property market upcycle.

Overall, our revision of percentage changes in target price of companies under our coverage range from -6% to -41%. We only had one "buy" call for Sunway Bhd with a target price of RM1.97 compared with other property developers. Sunway earnings streams are more diversified with other sources of income from construction, property investment, manufacturing and trading. — MIDF Research, Sept 28

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