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A “Tactical” Play In A News Flow Driven Market
We are upgrading the construction sector to Overweight from Neutral as we foresee construction stocks to generally outperform the market in 2H2010, buoyed by news flow, particularly, from: (1) The RM36bn KL mass rapid transit (MRT) project; and (2) The RM7bn Ampang and Kelana Jaya light rail transit (LRT) line extension project.
Assuming the KL MRT project is to eventually materialise and the contract goes to the 50:50 Gamuda-MMC Corp JV, between now and the actual award of the contract, a series of events can buoy, if not sustain Gamuda’s share price. These include: (1) The expected almost daily doses of news and commentaries on the KL MRT project and the Government’s plan to improve the public transportation system in the Klang Valley under the newly announced 10th Malaysia Plan (10MP); (2) The green light for the project from the Cabinet; (3) The thumbs up for the project from businesses, particularly, property developers, and the public; and (4) The commencement of the actual physical works, particularly, site preparation, as we believe the Gamuda-MMC Corp JV is inclined to start ahead of the formal award of the contract (as in the case of the SMART tunnel a few years ago).
For the much delayed Ampang and Kelana Jaya LRT line extension project, it now appears that it is finally getting off the ground. Syarikat Prasarana Negara (Prasarana), the national public transportation system holding company (an SPV wholly-owned by the Ministry of Finance Incorporated), was recently quoted by the press as saying that a “pre-bid briefing” and a “site visit” for pre-qualified main contractors (see Table 16) were held on 22 and 27 Jun 2010 respectively and the contractors were given six weeks to submit their tenders after the site visit (that means by around mid-Aug 2010). Next, Prasarana would need three months to evaluate the tenders before the award of contracts would take place (that means by around mid-Nov 2010). It said that “construction work should start by the end of the year”. The news flow on the project is expected to sustain interest on construction stocks that have been shortlisted as main contractors and segmental box girder sub-contractors to the project (also see Table 16).
In addition, news flow can also come from other public projects earmarked for implementation under the 10MP (see Table 17) as well as “high-impact” projects worth RM62.7bn “under consideration” to be implemented via the private finance initiative (PFI) model, backed by a RM20bn “facilitation fund” set up to “bridge the viability gap for private sector investment in projects with high strategic value to the nation and multiplier effects” (see Table 18).
While we believe the market is fully aware that certain negative elements are still lingering in the sector, we feel that it is likely to “brave” these negative elements and forge ahead with its move to position itself ahead of the curve, underpinned by the collective “buy-first-on-news” mentality. These negative elements include: (1) A 23% lower “hard” gross development expenditure of RM138bn under the 10MP, compared with RM179bn under the 9th Malaysia Plan (9MP); (2) The still slow pace of the roll-out of public projects as taking the delivery system to the next level appears to be an uphill battle; (3) A highly competitive market and declining dominance of established players in large-scale projects locally; and (4) The not-so-rosy outlook and increased operating risks in key overseas markets (following the Dubai credit crisis, Dong’s devaluation and rising arbitration cases).
Our top “tactical” pick for the sector is Gamuda as we believe its share price will be buoyed by the sustained news flow from the RM36bn KL MRT project. Our top “value” pick for the sector is Sunway due to its undemanding valuation of 7-8x 1-year forward earnings on a fully-diluted basis, coupled with its strong earnings visibility stemming from its firm construction margins and growing non-construction profits.
Still Room For Growth For Developers, M-REITs Poised For More Re-Rating
In 2H2010, we believe news flow will take precedence over fundamentals in driving the share price performance of property developers. Positive news flow is likely to come from: (1) The formal awards of Federal land parcels (see Table 39) to “master developers” and the subsequent farming out of the sub-divided smaller land parcels to various developers; and (2) The increased interest and hence prices in land and properties including residential, commercial and industrial in Iskandar Malaysia on expectation of rising investment and hence economic activities in the growth corridor, on the back of the improving ties between Malaysia and Singapore.
On the flip side of the coin, share prices of developers may take a beating if the International Financial Reporting Interpretations Committee 15 (IFRIC 15) is to be adopted as per scheduled on 1 Jul 2010. Basically, IFRIC only allows property development income to be recognised on a “completion” basis, vis-à-vis “progress” previously. This will result in high earnings volatility due to lumpy profit recognition. Naturally, developers with a large portfolio of projects (including township development) and investment properties (such as SP Setia, IJM Land, Mah Sing and SunCity) will be less affected, while project-driven developers especially those in the high-rise and commercial segments (such as Glomac, YNHP, Sunrise and Hunza) will take the full blunt.
Fundamentally, we expect key property developers to continue to report sales growth in 2H2010 as well as into 2011, underpinned by: (1) Improving economic outlook; (2) The still relatively easy monetary conditions; and (3) The rising inflationary expectation.
The improving economic outlook eases the concern that sales may fall off the cliff once the pent-up demand from the crisis years of 2008 and 2009 is gradually exhausted. A better economic outlook will provide an extra kicker to growth in baseline demand for properties, in addition to favourable structural attributes such as a young population, rapid urbanisation and the continued shift to nuclear families from extended families in Malaysia.
Bank Negara Malaysia (BNM) raised the Overnight Policy Rate (OPR) by another 25bps on 13 May 2010 to 2.5%, following 25bps on 4 Mar 2010 to normalise interest rates. We expect BNM to raise the OPR by another 25bps during its Sep 2010 policy meeting. While we acknowledge that, ceteris paribus, the rising OPR will have some negative bearing on property sales as it erodes affordability, based on our projections of 2.75% by end-2010 and 3.25-3.50% by end-2011, the OPR is still below the historical average of 3.00-3.50% in 2010, before it normalises in 2011.
Our top developer picks are Mah Sing (opportunistic land acquisition strategy, fast turnaround time; OP, FV = RM2.09), IJM Land (highly diversified geographically as well as in terms of product offering; OP, FV = RM3.11) as well as SunCity (an established commercial/high-end residential property developer primarily in the Klang Valley; OP, FV = RM5.33).
We believe the M-REIT sector is due for another round of re-rating, thanks largely to the rising investability of the sector on the back of a quantum-leap in the sector’s size after the listing of at least three new M-REITs comprising Sunway REIT, CapitaMalls Malaysia Trust and Qatar REIT. While there has been a re-rating of the M-REIT sector in recent years, it has very much gone unnoticed due to the lack of research coverage. We believe this is about to change.
The re-rating of the M-REIT sector, which we define as the valuation convergence between M-REITs and their more established peers S-REITs, has actually become apparent since 2007. On a normalised basis (i.e. excluding 4Q08, 1Q09 and 2Q09 at the height of the recent financial crisis), the yield gap between M-REITs and S-REITs has narrowed from 316 bps in 2007 to 197 bps in 2008, and further to 132 bps in 2009-2010 (see Chart 24). With the more-than-doubling in the M-REIT sector’s market value from about RM5bn currently to RM11bn over the near term that will bring along with it a much improved relative investability of the M-REIT sector vis-à-vis the S-REIT sector, we expect the convergence/re-rating to accelerate further.
Our top pick for the sector is Axis REIT (proven track record with hands-on management and its aggressive acquisition plans; OP, FV = RM2.35).
We are upgrading the construction sector to Overweight from Neutral as we foresee construction stocks to generally outperform the market in 2H2010, buoyed by news flow, particularly, from: (1) The RM36bn KL mass rapid transit (MRT) project; and (2) The RM7bn Ampang and Kelana Jaya light rail transit (LRT) line extension project.
Assuming the KL MRT project is to eventually materialise and the contract goes to the 50:50 Gamuda-MMC Corp JV, between now and the actual award of the contract, a series of events can buoy, if not sustain Gamuda’s share price. These include: (1) The expected almost daily doses of news and commentaries on the KL MRT project and the Government’s plan to improve the public transportation system in the Klang Valley under the newly announced 10th Malaysia Plan (10MP); (2) The green light for the project from the Cabinet; (3) The thumbs up for the project from businesses, particularly, property developers, and the public; and (4) The commencement of the actual physical works, particularly, site preparation, as we believe the Gamuda-MMC Corp JV is inclined to start ahead of the formal award of the contract (as in the case of the SMART tunnel a few years ago).
For the much delayed Ampang and Kelana Jaya LRT line extension project, it now appears that it is finally getting off the ground. Syarikat Prasarana Negara (Prasarana), the national public transportation system holding company (an SPV wholly-owned by the Ministry of Finance Incorporated), was recently quoted by the press as saying that a “pre-bid briefing” and a “site visit” for pre-qualified main contractors (see Table 16) were held on 22 and 27 Jun 2010 respectively and the contractors were given six weeks to submit their tenders after the site visit (that means by around mid-Aug 2010). Next, Prasarana would need three months to evaluate the tenders before the award of contracts would take place (that means by around mid-Nov 2010). It said that “construction work should start by the end of the year”. The news flow on the project is expected to sustain interest on construction stocks that have been shortlisted as main contractors and segmental box girder sub-contractors to the project (also see Table 16).
In addition, news flow can also come from other public projects earmarked for implementation under the 10MP (see Table 17) as well as “high-impact” projects worth RM62.7bn “under consideration” to be implemented via the private finance initiative (PFI) model, backed by a RM20bn “facilitation fund” set up to “bridge the viability gap for private sector investment in projects with high strategic value to the nation and multiplier effects” (see Table 18).
While we believe the market is fully aware that certain negative elements are still lingering in the sector, we feel that it is likely to “brave” these negative elements and forge ahead with its move to position itself ahead of the curve, underpinned by the collective “buy-first-on-news” mentality. These negative elements include: (1) A 23% lower “hard” gross development expenditure of RM138bn under the 10MP, compared with RM179bn under the 9th Malaysia Plan (9MP); (2) The still slow pace of the roll-out of public projects as taking the delivery system to the next level appears to be an uphill battle; (3) A highly competitive market and declining dominance of established players in large-scale projects locally; and (4) The not-so-rosy outlook and increased operating risks in key overseas markets (following the Dubai credit crisis, Dong’s devaluation and rising arbitration cases).
Our top “tactical” pick for the sector is Gamuda as we believe its share price will be buoyed by the sustained news flow from the RM36bn KL MRT project. Our top “value” pick for the sector is Sunway due to its undemanding valuation of 7-8x 1-year forward earnings on a fully-diluted basis, coupled with its strong earnings visibility stemming from its firm construction margins and growing non-construction profits.
Still Room For Growth For Developers, M-REITs Poised For More Re-Rating
In 2H2010, we believe news flow will take precedence over fundamentals in driving the share price performance of property developers. Positive news flow is likely to come from: (1) The formal awards of Federal land parcels (see Table 39) to “master developers” and the subsequent farming out of the sub-divided smaller land parcels to various developers; and (2) The increased interest and hence prices in land and properties including residential, commercial and industrial in Iskandar Malaysia on expectation of rising investment and hence economic activities in the growth corridor, on the back of the improving ties between Malaysia and Singapore.
On the flip side of the coin, share prices of developers may take a beating if the International Financial Reporting Interpretations Committee 15 (IFRIC 15) is to be adopted as per scheduled on 1 Jul 2010. Basically, IFRIC only allows property development income to be recognised on a “completion” basis, vis-à-vis “progress” previously. This will result in high earnings volatility due to lumpy profit recognition. Naturally, developers with a large portfolio of projects (including township development) and investment properties (such as SP Setia, IJM Land, Mah Sing and SunCity) will be less affected, while project-driven developers especially those in the high-rise and commercial segments (such as Glomac, YNHP, Sunrise and Hunza) will take the full blunt.
Fundamentally, we expect key property developers to continue to report sales growth in 2H2010 as well as into 2011, underpinned by: (1) Improving economic outlook; (2) The still relatively easy monetary conditions; and (3) The rising inflationary expectation.
The improving economic outlook eases the concern that sales may fall off the cliff once the pent-up demand from the crisis years of 2008 and 2009 is gradually exhausted. A better economic outlook will provide an extra kicker to growth in baseline demand for properties, in addition to favourable structural attributes such as a young population, rapid urbanisation and the continued shift to nuclear families from extended families in Malaysia.
Bank Negara Malaysia (BNM) raised the Overnight Policy Rate (OPR) by another 25bps on 13 May 2010 to 2.5%, following 25bps on 4 Mar 2010 to normalise interest rates. We expect BNM to raise the OPR by another 25bps during its Sep 2010 policy meeting. While we acknowledge that, ceteris paribus, the rising OPR will have some negative bearing on property sales as it erodes affordability, based on our projections of 2.75% by end-2010 and 3.25-3.50% by end-2011, the OPR is still below the historical average of 3.00-3.50% in 2010, before it normalises in 2011.
Our top developer picks are Mah Sing (opportunistic land acquisition strategy, fast turnaround time; OP, FV = RM2.09), IJM Land (highly diversified geographically as well as in terms of product offering; OP, FV = RM3.11) as well as SunCity (an established commercial/high-end residential property developer primarily in the Klang Valley; OP, FV = RM5.33).
We believe the M-REIT sector is due for another round of re-rating, thanks largely to the rising investability of the sector on the back of a quantum-leap in the sector’s size after the listing of at least three new M-REITs comprising Sunway REIT, CapitaMalls Malaysia Trust and Qatar REIT. While there has been a re-rating of the M-REIT sector in recent years, it has very much gone unnoticed due to the lack of research coverage. We believe this is about to change.
The re-rating of the M-REIT sector, which we define as the valuation convergence between M-REITs and their more established peers S-REITs, has actually become apparent since 2007. On a normalised basis (i.e. excluding 4Q08, 1Q09 and 2Q09 at the height of the recent financial crisis), the yield gap between M-REITs and S-REITs has narrowed from 316 bps in 2007 to 197 bps in 2008, and further to 132 bps in 2009-2010 (see Chart 24). With the more-than-doubling in the M-REIT sector’s market value from about RM5bn currently to RM11bn over the near term that will bring along with it a much improved relative investability of the M-REIT sector vis-à-vis the S-REIT sector, we expect the convergence/re-rating to accelerate further.
Our top pick for the sector is Axis REIT (proven track record with hands-on management and its aggressive acquisition plans; OP, FV = RM2.35).
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