When Land Matters - Penang (RHB Research Property sector update Feb 8, 2011

? Developers started their actions. The rising foreign interest on direct investment into Penang should continue to hold up property values in the state, underpinned by higher demand from both local and foreign buyers. While some developers continue busy hunting for landbank, news flow started firstly from CapitaMalls Asia buying Queensbay Mall at generous valuations and SP Setia securing a RM300m project to build and operate the PICC. In our opinion, taking a cue from the Government of Singapore and Hong Kong, the Penang state government may enhance their revenue via land tender. The process could be fasttracked in anticipation of the general election being held this or next year.

? E&O-a crown jewel. If what we expect comes true, we believe E&O, being one of the largest land owners in Penang, will be the crown jewel given its 740-acre piece of Seri Tanjung Pinang 2 land to be reclaimed. We understand that E&O has the right to reclaim the land until 2019, and the company has formally submitted its development plan to the state government recently. It would mean an immediate value enhancement for E&O once the approval is obtained as it can start its reclamation and accelerate its landbank turnaround time. News flow on strategic partnership should follow as it was indicated that partners are needed to undertake the development which could amount to RM12bn GDV. Considering the background of the shareholders (apart from Dato’ Terry Tham) – Goh Yew Lin/Goh Geok Khim (via GK Goh) and Tan Sri Wan Azmi, we will not discount a Singapore link.

? Benalec is the land and value creator. Besides E&O, we also see Benalec as a potential beneficiary under the renewed foreign investment interest in Penang. As property development and economic activities speeding up, multi-billion worth of land reclamation jobs will be upped for grabs. Among the big and impending projects in Penang include E&O’s STP 2 and IJMLD’s 103-acre Phase 2 of The Light nd 2nd Penang Bridge. If can be replicated in Penang, land in-kind as settlement for jobs done would be valuable as land prices appreciate in the Penang island.

? Risks. Key risks are: 1) regulatory risks; and 2) country risks.

? Overweight. Our picks for the sector remain the same: SP Setia (OP, FV = RM7.39) and IJMLD (OP, FV = RM3.50) for big caps; and KSL (OP, FV = RM2.78) and Mah Sing (OP, FV = RM2.50) for small-mid caps. Although we currently do not cover E&O and Benalec, we have an indicative fair value of RM1.85 and RM1.93 for these two stocks, respectively.

When Land Matters - Penang

? Property players started their actions. The renewed foreign interest in foreign direct investment in Penang should continue to hold up property values in the state, particularly the island. Apart from the sustained demand for properties from local buyers (perhaps for investment purposes), we believe there will be more inflow of foreign buyers under the MM2H (Malaysia My Second Home) programme.

A significant event took place just before the end of 2010. CapitaMalls Asia, which is a unit of Southeast Asia’s largest property developer CapitaLand, announced its acquisition of Penang’s largest shopping mall - Queensbay Mall for RM657m (US$209.9m). The mall is built on a reclaimed land. At an initial property yield of 5%, valuations seem rather generous. While landbanking activities will still continue going forward, this year we saw SP Setia starting off with news flow on securing the RM300m project to build and operate the Penang International Convention and Exhibition Centre. In our opinion, taking a cue from the Government of Singapore and Hong Kong, the Penang state government may enhance their revenue via land tender. The process could be fast-tracked in anticipation of the general election being held this or next year.

? E&O will be the crown jewel. If what we expect comes true, given the relatively high valuations attached by CapitaMalls Asia on Queensbay Mall (which is built on reclaimed land), we believe E&O will be the crown jewel, as it is one of the largest landbank owners on the Penang island. Bulk of its landbank is concentrated at Seri Tanjung Pinang (STP) – Phase 1 240 acres and Phase 2 740 acres (to be reclaimed).

We understand that E&O has the right to reclaim the land until 2019, and the company has formally submitted its development plan to the state government for approval recently. It would mean an immediate value enhancement for E&O once the approval is obtained as it can start its reclamation and accelerate its landbank turnaround time.

News flow on strategic partnership should follow as it was indicated that partners are needed to undertake the big development which could amount to RM12bn GDV (in comparison to just about RM3bn for Phase 1). We note that, currently its major shareholders Dato’ Terry Tham holds about 16% stake in the company, Goh Yew Lin/Goh Goek Khim (via GK Goh) has about 12% and Tan Sri Wan Azmi has 10%. Considering the background of the shareholders (besides Dato’ Terry Tham) – Goh Yew Lin/Goh Geok Khim (via GK Goh) and Tan Sri Wan Azmi, we will not discount a possible tie-up with Singapore players in a foreseeable future.

? E&O in deep value. At yesterday’s closing price of RM1.36, E&O is trading at a huge 56% discount to our estimated RNAV per share pf RM3.08. Our estimate is based on the assumption of land price of RM160 psf for STP2, and higher cost of reclaimation as it is a deepwater area. Given its landbank size, E&O will be the prime player to capture the rising local and foreign demand for properties in Penang. Based on a 40% discount to RNAV, our indicative fair value on E&O is RM1.85, which is some 36% upside from current price. The stock is currently not rated.

? The land creator - Benalec. Besides E&O, we also see the newly-listed marine construction service provider Benalec as a potential beneficiary in light of the renewed foreign investment interest in Penang. Although its current reclamation works are largely concentrated in Melaka, the company is targeting to enter the Penang and Singapore market more aggressively this year. As property development and economic activities speeding up in Penang, multi-billion worth of land reclaimation jobs will be upped for grabs (see Table 6). Apart from E&O’s STP 2 and IJMLD’s 103-acre Phase 2 of The Light, other projects include the 2nd Penang Bridge, North Butterworth Container Terminal Ph 3 and North Channel Dredging etc.

? A value creator. We like Benalec’s business model. Margins for its business have been lucrative, ranging from 25-30%. Apart from earning profit from its marine construction business, the company also charters out its unutilised vessels to third party, and receives land in-kind and progressive cash payment as settlement for its reclamation jobs done. Currently the company has about 230 acres of reclaimed land in Melaka that has yet to be sold. It is worthwhile to note that, potential profit from its disposal of reclaimed land in Melaka is huge, at around RM25 psf versus its cost of only RM12-15 psf.

Every year, the company is confident to sell 50-100 acres of reclaimed land, which is in line with historical record. Although Benalec has yet to have a wide presence in Penang, if the company could secure a land reclaimation job in the state and similar settlement structure can be replicated, it will be an icing on the cake, as scarcity of land on the Penang island will drive the valuations on prime seafront reclaimed land. This potential cannot be  underestimated in our opinion. Based on our SOP valuation, we have an indicative fair value of RM1.93 on Benalec, assuming an average selling price of only RM24 psf for the reclaimed land in Melaka that is ready for sale and RM23 psf for the land to be reclaimed (until 2016)  that Benalec can sell in future. The stock is not rated.

Key Risks for the sector

? Risks. Key risks for the property sector are: 1) regulatory risk; 2) discontinuation of incentives offered bydevelopers; and 3) country risks.

Valuations and Recommendations

? Maintain Overweight. We maintain our Overweight stance on the sector. Our top picks remain SP Setia (OP, FV = RM7.39), IJM Land (OP, FV = RM3.50), KSL (OP, FV = RM2.78), and Mah Sing (OP, FV = RM2.50). We believe news flow on Penang will come going forward, and E&O and Benalec will be the theme play for Penang. We have an indicative fair value of RM1.85 for E&O and RM1.93 for Benalec. Both stocks are currently not rated.