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Sunway City (ECM Libra) buy; target price RM5

A big pay day

Largest M-REIT with RM3.7bn assets
Sunway City announced it will inject its 8 investment properties into Sunway REIT for RM3.7bn which will be satisfied by RM2.7bn in cash and 1,025m units in Sunway REIT at RM1 par. In turn, it will pay RM1.5bn cash to the other part owners of the assets. Sunway REIT will raise the RM2.7bn cash through (1) initial public offering of 1,655m units, and (2) RM1.0bn bank borrowings. Sunway City will hold 38.25% interest in Sunway REIT upon, listing.

Future earnings slightly diluted…
Sunway City’s earnings will be lower due to dilution of its stakes in the investment properties to be injected. However, this will be mitigated by
management fee from Sunway REIT and improving earnings visibility from property development division. Consequently, we tweak our FY10, FY11 and FY12 earnings by -0.7%, -5.0% and +0.8%% respectively.

…but massive value unlocked with RM1.2bn cash
Sunway City will receive net cash proceeds of RM1.2bn which will effectively cover all its existing debts. We believe Sunway City will reinvest the cash but do not rule out possibility of a special dividend.

Malaysian CapitaLand in the making?
Although it is premature to draw any conclusion at this point in time, we believe the company is making all the right steps by lowering its debt and lighten its balance sheet while embarking on regional expansion. In theory, the company can boost its remaining GDV from the current RM13bn by another RM6bn to RM12bn by utilising all its net proceeds to buy more landbank. As we have not accounted for this possibility, we believe there is immense potential over the medium term.

• Reiterate BUY, TP raised to RM5.00
Sunway City is one of our top picks for the sector. At current market capitalisation, investors are not only paying 21% discount for the net cash
proceeds and 38.25% in Sunway REIT valued at RM2.2bn but also get all its property development landbank for free. We raise our TP from RM4.33 to RM5.00 based on 14x P/E which is one standard deviation higher than average forward P/E of 9.9x. We believe this is justified given (1) 18.7% EPS CAGR over next 3 years, (2) unlocking hidden value in investment properties, and (3) potential upside from further expansion. Our revised TP is also supported by RNAV of RM6.36 (previously RM5.77).

altLargest M-REIT with RM3.7bn assets
Sunway City finally announced last Friday the 8 investment properties will be injected into its soon-to-be listed Sunway REIT at a combined value of RM3.7bn, which is poised to be the largest REIT listed on Bursa Malaysia. The proposed listing which has been approved by the Securities Commission is still subject to the approval of Bursa Malaysia and Sunway City’s shareholders at an extraordinary general meeting to be held. Further details on Sunway REIT will be revealed in its prospectus to be issued at a later date.
Sunway City will receive RM2.7bn in cash and 1,025m units in Sunway REIT valued at RM1 par. Since Sunway City does not wholly-own all the 8 assets to be injected into Sunway REIT, it will pay RM1.5bn cash to the other vendors, of which the majority goes to Government of Singapore Investment Corporation Pte Ltd (“GIC”). Sunway REIT will raise the RM2.7bn cash required to pay Sunway City through (1) initial public offering of 1,655m units, and (2) bank borrowings, which we estimated at RM1.0bn. Upon listing of Sunway REIT, Sunway City will hold 38.25% interest and Sunway REIT will have a debt/asset ratio of 0.28x which is well below the maximum 0.5x threshold.

Future earnings slightly diluted…
Post-listing of Sunway REIT, Sunway City’s earnings will be lower due to dilution of its stakes in the investment properties to be injected. Sunway City’s effective 60.3% stake in the value of assets before the divestment and listing will be lowered to just 38.25% upon listing of Sunway REIT. However, this will be mitigated by fee income from managing Sunway REIT and improving earnings visibility from property development division.
Sunway City is stepping up its property launches in FY2010 with a target of RM1.5bn, including new projects in China and India. To note, there will be no earnings impact from the disposal of investment properties into Sunway REIT as these assets will be transferred at revalued amount as at FY2009. Consequently, we tweak our FY10, FY11 and FY12 earnings by -0.7%, -5.0% and +0.8%% respectively.

…but massive value unlocked with RM1.2bn cash

Despite lower earnings from investment properties going forward, Sunway City has unlocked massive value in its prime assets, particularly Sunway Pyramid which account for 62% of Sunway REIT’s assets. Net of the amount payable to other vendors of assets to be injected into Sunway REIT, Sunway City will receive net cash proceeds of RM1.2bn which will effectively cover all existing debts of the group. With such massive cash hoard, we believe Sunway City will utilise the cash by reinvesting it to buy more landbank and/or build more commercial properties for injection into Sunway REIT in the future. We also do not rule out the possibility of Sunway City distributing special dividends to reward its shareholders.

Malaysian CapitaLand in the making?
As the Sunway REIT listing drawing closer to completion, Sunway City is transforming itself from an asset heavy domestic developer to a more nimble regional developer with presence in Malaysia, China, India and Australia. In a way, we could draw parallel of Sunway City transformation to that of CapitaLand, South East Asia’s largest property developer. Since the merger of Pidemco and DBS Land in 2000 to form CapitaLand, the company has embarked on a regional expansion and in 2002, injected its portfolio of prime retail assets into Singapore’s maiden REIT, CapitaMall Trust. The rest is history.
Although it is premature to draw any conclusion from recent developments in Sunway City i.e. expansion into China and maiden REIT listing, we believe the company is making all the right steps by lowering its debt and lighten its balance sheet while embarking on regional expansion. In theory, the company can boost its remaining GDV from the current RM13bn by another RM6bn to RM12bn assuming it utilises all the RM1.2bn net proceeds from Sunway REIT listing to buy landbank which typically makes up 10% to 20% of project GDV. Further to that, the company has in its pipeline more commercial projects such as remaining phases in Sunway Integrated Resort, Sunway Velocity and Sunway Tower which can be injected into Sunway REIT in the future. As we have not accounted for these possible scenarios, we believe there is immense potential in Sunway City over the medium term.

Reiterate BUY, TP raised to RM5.00
We remain bullish on Sunway City and rate it as one of our top picks for the property sector. At current market capitalisation of just RM1.8bn, investors are not only paying 21% discount for the net cash proceeds and 38.25% in Sunway REIT valued at a combined RM2.2bn but also get all its property development landbank for free. We raise our target price from RM4.33 to RM5.00 based on 14x P/E which is one standard deviation higher than average forward P/E of 9.9x. We believe the higher valuation is justified given (1) 18.7% EPS CAGR over next 3 years, (2) unlocking hidden value in investment properties, and (3) potential upside from further expansion. Our revised target price is also supported by our supplementary RNAV valuation of RM6.36 which has been revised from RM5.77.
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