A Rerating in the Horizon

We initiate coverage on Glomac with a Trading Buy call and a CY10 Target Price of RM1.83 based on 0.94x CY10 P/NTA, which is the average valuation for its closest comparable peers. Its cheap valuation, estimated at 0.7x CY10 P/NTA coupled with potentially strong earnings recovery in the immediate term, could well spur a rerating on the stock. As our expected broad sector rebound starting from late 2010/early 2011 pans out, the investment community will gradually be drawn to fundamentally sound and still-undervalued property stocks like Glomac.

Earnings recover. Armed with unbilled sales of RM549.7m (including the recent RM170.7m en bloc sale of an office tower in Glomac Damansara to Tabung Haji), which is equivalent to 1.6x its FY09 total turnover, Glomac’s near-term earnings growth prospects appear secure, even assuming there are limited new launches over the next 12 months.

Its FY10 and FY11 core net profit are anticipated to improve by about 20% and 12% y-o-y respectively, thanks mostly to higher progress billing of unbilled sales. Its earnings margin is set to improve in the near term as high-margin projects such as Glomac Tower - expected to be completed by FY11 - begin to contribute more significantly as construction works progress.

Merely conservative estimates. Our earnings forecasts have yet to include some of Glomac’s other major projects as the details are still sketchy. These projects include the remaining components in Glomac Damansara (collectively worth RM596m), the last remaining office block in Glomac Cyberjaya (RM100m), Phase 4 of Plaza Kelana Jaya (RM267m), the commercial project in Mutiara Damansara (RM235m) and another commercial project in Bandar Utama (RM400m).

Should some of these projects be launched within the next 12 months with commendable take-up and the company successfully sells en bloc some of its upcoming development projects and/or further monetize some of its mature properties at attractive valuations, these may well be the catalysts spurring an upward re-rating of Glomac.

Trading Buy based on CY10 target price of RM1.83. Glomac is currently trading at an estimated CY10 P/NTA of 0.7x, trailing behind even its most comparable peers such as Sunrise and YNH Property, which are trading at an average of 0.94x CY10 P/NTA.



Using its peer average as a benchmark, we derive a CY10 target price of RM1.83 for Glomac based on 0.94x CY10 P/NTA, representing a substantial >30% potential upside from the current level. A re-rating of the stock to this level is justified given its strong earnings recovery, more solid balance sheet today and the fast improving market sentiment, at least in the immediate term.

BRIEF BACKGROUND
A foothold in Klang Valley. Glomac is a Malaysian developer with its prime foothold in the Klang Valley for over 20 years whose principal activities are in property development, property investment, construction and property management. The company was listed on the Main Board of Bursa Malaysia on 13 June 2000. The company was born in 1988 when two entrepreneurs, Tan Sri Dato’ FD Mansor (Executive Chairman) and Datuk Richard Fong (Executive Vice Chairman), joined forces to form Glomac.

Its first project was a phase of single storey terrace houses in Taman Jasa Utama in Selayang. Glomac’s turning point came when it ventured into Kelana Jaya and transformed the area from swampland into a bustling new satellite city. Then it began to develop a 6-8 storey business centre followed by its first high-end condominium, Prima 16 located in Section 16 (Petaling Jaya). In 1997, Glomac ventured into its first township project called Bandar Saujana Utama in Sungai Buloh. Post listing in 2000, the group now manages 13 on-going projects, including townships in Kota Tinggi (Johor Bahru) and Rawang (Selangor) and various commercial developments.

It later moved into the development of gated and guarded communities with Aman Suria Damansara (PJ), which was followed by similar developments such as the Lakeside Residences (Puchong) and Suria Residen (Cheras). In 2007, Glomac moved a notch higher by venturing to KLCC with the development of Glomac Tower, which has since been sold en bloc to Kuwait Finance House at a record-high price. Its current foreign shareholding is estimated at about 17%.



Hands-on management team. Glomac owes its success to co-founders Tan Sri Dato’ FD Mansor (Executive Chairman) and Datuk Richard Fong (Executive Vice Chairman). Tan Sri Dato’ FD Mansor has about 26 years of experience in the real estate sector while Datuk Fong himself has more than 30 years of in the field of property development, building construction and engineering. Datuk Fong is currently the President of FIABCI Malaysia.

Actively managing the company currently is Dato’ Fateh Iskandar (Managing Director/CEO), the son of Tan Sri Dato’ FD Mansor. Dato’ Fateh has been with Glomac since 1991. He is currently the Vice President for REHDA Malaysia, Chairman for REHDA Selangor, Director of Malaysian Property Incorporated as well as a Board Member of Axis REIT Managers Bhd, a company which manages Axis Real Estate Investment Trust.

Developer with strong foothold in Klang Valley. Glomac’s experience as a property developer is firmly grounded in the Klang Valley. With the exception of its already existing township projects in Johor and Melaka, Glomac has no intention of venturing out from the Klang Valley in the near future as it continues to see potential in the region and given that it has more than a handful of huge development projects lined up for launch over the next few years.

Investment highlights. With over RM2.0bn worth of development projects in prime locations for launch over the next few years and high unbilled sales to be realised in the near future, Glomac’s prospects appear promising. The company’s outlook can be summarised in the following key points:

• Strong unbilled sales that is almost equivalent to almost 2 years of FY09 turnover;

• Many ongoing and yet-to-be-launched niche commercial projects in prime locations to underpin future earnings growth;

• Good track record in securing various institutional buyers to buy some of its commercial properties en bloc. Most buyers have strong financial backing and the risk of default is, therefore, minimal. Some 50% of the supposed cash collection from Kuwait Finance House (KFH) for the sale of Glomac Tower has been collected so far, thus substantially minimising the possibility of a default by KFH and the financial risk to Glomac should the inevitable happen;

• Involvement in various joint venture projects with landowners in good ‘cash flow’ development properties helps reduces Glomac’s holding cost; and

• Strong balance sheet.



High unbilled sales to underpin near-term earnings growth
Armed with unbilled sales of RM549.7m (including the recent en bloc sale of an office tower in Glomac Damansara to Tabung Haji), which is equivalent to 1.6x of its FY09 total turnover, Glomac’s near-term earnings growth appears secured, even assuming there are limited new launches over the next 12 months. The unbilled sales comprise primarily projects in Glomac Damansara, Glomac Tower, Galleria Hartamas and Glomac Cyberjaya. Even assuming limited launches over the next 12 months, the amount of unbilled sales due to be realised over the course of one to two years alone can largely sustain its earnings growth into FY11.

Glomac Damansara (PJ). Strategically located at the border of Kuala Lumpur and Petaling Jaya, the project is an integrated commercial development comprising a 16-storey office block, 5&8-storey shop offices, serviced apartments, boutique retail & office suites and a corporate tower. With a total estimated GDV of RM820m, the said corporate tower (25-storey) of the integrated development has been sold en bloc to Tabung Haji for about RM170.7m (or RM670psf, inclusive of 444 car park bays).

 Earthworks for the office tower commenced recently and the progress billings will buoy Glomac’s earnings significantly over the next three FYs. Earlier, during the launch of first phase of Glomac Damansara in March ’09, the 12 blocks of 5 and 8-storey shop offices (GDV of RM53m) were progressively sold and are now fully taken up.



Glomac Tower (KLCC). Located directly opposite the Petronas Twin Towers along Jalan Pinang, the corporate tower was sold to Kuwait Finance House (KFH) for RM577m (or a record price of RM1,120psf).

With construction progress now more than 30% completed and 50% of the en bloc consideration already billed and collected for cash, it is highly unlikely that KFH will abort the deal at this juncture, unlike what it had done recently on other en loc deals by developers such as The Icon on Jalan Tun Razak and Menara YNH on Jalan Sultan Ismail. Unbilled sales currently stand at about RM147m (Glomac’s portion from its 51% stake in the project), which will be realised in FY10 and FY11, when the project is completed.

Galleria Hartamas (Sri Hartamas). The 20 units of 4.5-storey freehold shop offices worth RM85m are located in Sri Hartamas, where Glomac has a 50:50 profit sharing agreement with the landowner, and were launched recently and is fully sold. Unbilled sales are expected to underpin earnings for the 1HFY11.

Glomac Cyberjaya (Cyberjaya). Glomac ventured into Cyberjaya about 2 years ago. Located within the Cyberjaya Flagship Zone, sales of its commercial properties there have been commendable. Phase 1 of the project, comprising 39 units of shop offices worth RM64m was launched in July ’09 and has now achieved a 70% take-up to date. Similarly, Phase 2 comprising 24 shop offices worth RM47m was launched very recently and has been fully sold.



Future launches of ongoing projects aplenty to support earnings
More to Glomac Damansara (PJ). After selling off all its 5&8-storey shop offices and the recent en-bloc sale of the corporate tower to Tabung Haji, Glomac will still have a remaining RM596m worth of projects to be launched and sold in the integrated commercial development. They comprise the 16-storey office block worth an estimated GDV of RM70m, which is to be marketed en bloc or alternatively to be kept as Glomac’s future headquarters, serviced apartments as well as boutique retail & office suites.

The former may be launched by mid-2010 (FY11) and the latter possibly only in FY11 or FY12. Note that until the launching details of these above mentioned projects are available, we will not be including them into our earnings forecast at this juncture.

The remaining office block in Glomac Cyberjaya (Cyberjaya). After achieving 100% take-up for both phases of shop offices in Glomac Cyberjaya, the only remaining parcel of the development project is the 15-storey office block, which is now being marketed en bloc for an estimated RM100m including car parks. To err on the conservative, the office block, which was previously planned for a data & call centre, is not included into our earnings forecast at this juncture.

Track record for en bloc sales - what this means? Of late, Glomac has had a pretty good track record in securing en-bloc sales for some of its commercial developments to certain institutional buyers. On one hand, Glomac has been able to monetize some of its matured commercial assets such as Wisma Glomac 3 and Glomac Business Centre (Block B) even during the economic downturn in 2009.

On the other, Glomac has also been able to secure en-bloc sales for its yet-to-be-completed developments such as the Glomac Tower to KFH and an office tower in Glomac Damansara to Tabung Haji. The latter is perhaps a partial reflection of Glomac’s recent change in strategy to quickly turn around its development projects to keep holding cost to a minimal.

The recent trend has been largely assisted by the boom period of the 2007/08 upcycle. Tabung Haji’s recent move to acquire one of the office towers in Glomac Damansara, most likely for investment purposes, must have been based on the belief that the office space performance is likely to rebound strongly on a recovering global economy.

Notwithstanding the strength of the economic rebound, whether such trend - particularly by those who seek investment assets - can continue in the very near term depends very much on how soon the market realises the reality of imminent oversupply of prime office space in Petaling Jaya and certain markets in the KL City and the gravity of the situation in the coming years.

Earnings from townships, residential and mixed development projects to support cash flow. In addition to developing niche and integrated development projects, Glomac is also involved in developing major townships (i.e. Bandar Saujana Utama, Saujana Rawang and Sri Saujana), residential developments (i.e. Suria Residen and Lakeside Residence) and mixed development projects (i.e. Seri Bangi and Taman Kota Laksamana). Supported by real demand from the domestic population, most of these townships grow organically and have provided a stable stream of cash flow to Glomac over the  years.

Bandar Saujana Utama in Sungai Buloh, for example, has to date delivered nearly RM1bn worth of residential and commercial properties over the last 13 years, with more than 30,000 residents residing in the township. Collectively these projects still have about RM1.4bn worth of developments for launch over the long term.

New projects in prime locations the catalysts for future growth
As the launch details on the following projects slated to be launched in FY11 and/or beyond remain sketchy, none of them is included in our earnings forecast at this juncture. Having said that, these are valuable projects given their locations in commercial developments with a combined GDV of approximately RM880m. Notwithstanding the volatility in the macroenvironment, these projects may therefore provide significant fresh catalysts for Glomac’s future earnings growth over the medium term.

4th Phase of Plaza Kelana Jaya. Next on Glomac’s launching list is Phase 4 of Plaza Kelana Jaya, which will be an integrated mixed commercial development project sited on a strategic 3.2-acres of freehold land in Kelana Jaya. Worth a total estimated GDV of RM267m, the project will comprise of a 3-level retail mall, 2 blocks of 5-10 storey office suites and a 16-storey office tower. Slated to be launched sometime in FY11 or FY12, the project’s launch details have yet to be finalised, however. As such and to be on the conservative side, we are not including this project in our earnings forecast at this point.



A project in Mutiara Damansara. The development of this upcoming project in Mutiara Damansara will be undertaken together with its partner Al Batha Group via Glomac’s 51%-owned subsidiary. Al Batha, the same organisation that Glomac is partnering with to develop Glomac Tower in KLCC, is a large private conglomerate in the United Arab Emirates.

This upcoming project in Mutiara Damansara, sited on 2.7 acres of freehold land, will also be an integrated mixed commercial development comprising retail space, office suites and corporate offices with a combined GDV of RM235m. Again, the management is looking to sell some of those components en bloc. Otherwise, it may consider developing them into serviced apartments. The proposed development site is surrounded by well-established commercial hubs such as Tesco, Ikea and the Curve. As this project is only slated for launch in FY11 and/or beyond and given that launch details are still scant, this project is not included into our estimates at this juncture.


 
Glomac Utama in Bandar Utama, Petaling Jaya. In November 2009, Glomac proposed to acquire 2 pieces of leasehold land measuring about 7.6 acres in Pekan Kayu Ara (Bandar Utama, Petaling Jaya) for RM31.2m, or about RM94 psf.

The S&P Agreement is expected to be completed in 6-9 months. The land is adjacent to mature residential and commercial developments such as Damansara Utama, Damansara Jaya and Bandar Utama. The area is also highly accessible as it is served by major roads such as the North Klang Valley Expressway (NKVE), Lebuhraya Damansara-Puchong (LDP) and SPRINT highway. The land is expected to be developed into a mixed residential and commercial development with an estimated GDV of about RM400m.



Near-term earnings recovery and stronger financially
Estimates on the conservative side. We are projecting for Glomac’s FY10 and FY11 core net profit to improve by some 20% and 12% y-o-y respectively, banking mostly on higher progress billing of unbilled sales comprising primarily high-margin projects. Given the lack of details on some of the other major projects and the fact that they are unlikely to be launched in the next 12 months (and, of course, to be conservative), we are not including these in our earnings forecast for now.

These projects include the remaining components in Glomac Damansara collectively worth RM596m, the remaining office block in Glomac Cyberjaya (RM100m), Phase 4 of Plaza Kelana Jaya (RM267m), the commercial project in Mutiara Damansara (RM235m) and another commercial project in Bandar Utama (RM400m). Its earnings margin is also expected to expand in the near-term as high-margin projects such as Glomac Tower, expected to be completed by FY11, contribute more significantly as construction works progress.



Stronger financial footing. Glomac’s current net gearing is close to nil compared with as high as 0.7x and 0.5x in FY07 and FY08 respectively. The vast improvement in its balance sheet has been primarily  due to the sale of treasury shares amounting to RM19.8m and collection of part proceeds from the disposal of Wisma Glomac 3 and Block B of Glomac Business Centre.

All else being equal, Glomac has potential to swing into net cash on collection of the remaining sale consideration from the recent en bloc sale of Block D Glomac Damansara. A fortified balance sheet does not only give Glomac ample room to gear up and capitalise on new opportunities but also enables it to ride out near-term difficulties arising from a weak economic environment such as that which prevailed in 2009.

INDUSTRY OVERVIEW
As we mentioned earlier, Glomac holds a decent track record for securing en bloc sales for some of its commercial developments to institutional buyers. These include its mature assets such as Wisma Glomac 3 and Glomac Business Centre (Block B) as well as its yet-to-be-completed Glomac Tower and an office tower in Glomac Damansara.

As one of Glomac’s supposed primary catalysts for further earnings growth is likely to the development of commercial properties, including office space, it is therefore instructive for us to forecast whether the Klang Valley office space will continue to perform favourably, at least in the next 3 years. Our findings reveal that the current trend can only stay favourable for so long before the office space sub-segment tips into a long-term recessionary phase within 3-5 years.

Trawling for yield. With so much domestic liquidity in the system, certain cash-rich institutional investors are still scouring around and seeking quality, defensive and high-yielding assets. In an environment of low interest rates and uncertainties such as that in late 2008 and 2009 when the market was wary of certain volatile asset classes such as the stock market, we saw some institutional investors ploughing their excess capital into existing quality office space with quality tenants at a reasonable gross capitalisation rate averaging about 7%-8%.

Some of such transactions include the en bloc sale of Menara Standard Charted by ING Insurance (2008), Menara Citibank by Hap Seng (2009) and Kenanga International by PNB (2009). As more landlords revise their asking prices lower to more realistic levels (estimated at a gross capitalisation rate of 7%-8% currently) and given an environment of low interest rates and flush liquidity, such a trend is likely to continue in the short to medium term. On the other hand, investments in new uncompleted office buildings have been viewed with caution since the onset of the global financial crisis in late 2008.

Favourable only for so long. Signs of a recovering global economy and improving business sentiment must have reignited the interest of institutional investors in investment properties, particularly in new uncompleted office buildings – a very rare phenomenon since the onset of the recent global financial crisis. Such a rare example would be Tabung Haji’s acquisition of Glomac’s yet-to-be-completed Tower D in Glomac Damansara recently. Having said that, expectation and optimism may not necessarily reflect actual reality. Until there is an assurance of a sustainable economic recovery, business expansion and therefore office space requirement will likely to remain soft in the near-term.

Notwithstanding the debate over whether the risk of an economic ‘double-dip’ is actually underway, the biggest threat to the Klang Valley office space will be the massive oversupply, as will be further discussed below. Therefore, whether such a rebound in investment in office buildings, especially at current valuations, can continue in the very
near term depends very much on how soon the market realises the reality of the oversupply on prime office space in Petaling Jaya and certain markets in the KL City and the gravity of the situation in the coming years.



Supply tide of office space a concern. Over the next few years, the growing weight of incoming supply will put considerable downward pressure on the Klang Valley office sub-segment as the market would not only struggle to absorb the new supply amid a less robust economy but also has to pick up the slack left over from the new supply not taken up during the Great Recession (see Figure 8) as well as vacancies arising from the downsizing of certain corporates.

KL City centre will have to brace itself for a massive influx of supply in 2011, particularly from KL Sentral. The Petaling Jaya market, however, after getting hit by a huge supply cycle in 2009, will likely get some breathing space in 2010 and 2011. Having said that, given the sharp fall in occupancy rates lately, the PJ market would still need to absorb this year the huge slack accrued from 2009. Finally, with waves of supply expected to hit PJ post-2012, this will likely drag the market into a mid- to long-term ‘recession’.

According to Jones Lang Wootton (Malaysia), even based on its ‘most reasonably bullish expectation’ of an annual take-up of 3.0m sq ft of office space in the Klang Valley, the market will clearly be unable to soak up the massive supply from 2011 onwards.

Make hay while the sun shines. Downward pressure on Klang Valley office space will likely peak temporarily in 2010. This is based on growing optimism and improving business sentiment given the recovery of the economy and the fact that supply pressure is likely to ease temporarily in 2010.

Although it is still difficult to imagine a situation where corporates are confident enough to expand their office space occupancy again soon, the apparent continuous search for yield by large institutional investors such as pension & insurance funds, given their current high cash-holding, and by Real Estate Investment Trusts (REITs), means that investment activities in corporate office space will likely pick up again soon given that some of these office buildings are currently offered at ‘attractive’ gross yields estimated at ?8% (versus ?6-7% during the peak in 2007/08). As such, Glomac should seize the opportunity to market the commercial office projects (that it intends to sell en bloc) aggressively now while current conditions are still conducive.

VALUATION & RECOMMENDATION
Initiate with a TRADING BUY call and CY10 Target Price of RM1.66. We are initiating coverage on Glomac with a Trading Buy call as we believe that a broad sector rebound starting from late 2010/early 2011 will soon spur investment interest in fundamentally-sound and still-undervalued property stocks. As we also believe that most mid- to big-cap stocks have somewhat fully priced in an anticipated rebound, value can now only be found in the smaller-cap property stocks such as Glomac as they are trading at a significant discount even to the mid-cap ones. As the 2011 rebound becomes more apparent, the risk premium on smaller caps is likely to fall and the valuation gap narrow. In the case for Glomac, the stock’s main draws are:

• Earnings recovery. We are projecting for Glomac’s FY10 and FY11 core net profit to improve by some 20% and 12% y-o-y respectively, mostly owing to progress billing of its strong unbilled sales comprising primarily high-margin projects. Earnings margins are also expected to expand in the near-term as earnings from high-margin projects such as Glomac Tower (which is expected to be completed by FY11) begin to contribute more meaningfully as construction works progress; and

• Cheap valuation, with an upside potential of >30%. According to Figure x, Glomac is trading at a mere CY10 P/NTA of 0.7x, trailing behind even its most comparable peerssuch as Sunrise and YNH Property, which are trading at an average 0.94x CY10 P/NTA (see Figure 9). Using the peer average as a benchmark, we derive a CY10 target price of RM1.83 based on 0.94x CY10 P/NTA, representing a substantial >30% potential upside from the current price. A re-rating of the stock to this level is justified given its strong earnings recovery, healthier balance sheet today and improving market sentiment, at least in the immediate-term 



Other factors backing a re-rating. As we mentioned earlier, our earnings forecasts are conservative and have yet to account for Glomac’s other major projects as the details are scant at this juncture. These projects include the remaining components in Glomac Damansara collectively worth RM596m, the remaining office block in Glomac Cyberjaya (RM100m), 4th Phase of Plaza Kelana Jaya (RM267m), the commercial project in Mutiara Damansara (RM235m) and another commercial project in Bandar Utama (RM400m).

The launch of these projects within the next 12 months with commendable take-ups, more success in en bloc sales of its upcoming development projects such as those mentioned above (see Figure 10) and/or further monetization of some of its mature properties at attractive valuations may well be the catalysts that will further justify an upward re-rating on Glomac.


 
Why only Trading Buy? As we mentioned earlier, if the rebound in the real estate sector becomes increasingly more evident, interest is likely to return to quality smaller-cap property stocks like Glomac soon as we believe that other mid- to big cap property stocks have already somewhat priced in the anticipated recovery. Having said that, we are only ascribing a Trading Buy call to Glomac (instead of an outright buy) because we believe that there is a risk that the impending rebound in the real property sector may not last beyond 2011.



As property stocks tend to react 9 to 12 months ahead of a change in the property cycle, this means that the valuations of Malaysian property stocks may also peak sometime in mid- to late 2010. Therefore, depending on the unfolding data on the real sector over the course of the next few months, we may potentially upgrade Glomac to an outright buy should the recovery is proven to be sustainable.