Investment Highlights

• 1QCY22 results were largely in line with our expectation. Out of the 7 companies under our coverage, 5 were in line with our forecasts while 2 were below expectation. Most of the developers posted weaker results YoY, with only Sunway, Mah Sing Group and UEM Sunrise (UEMS) registering improvement in their bottom lines (Exhibit 1). These are the salient highlights of the companies’ 1QCY22 performance:
  • The core net profits of Sunway, Lagenda Properties, IOI Properties Group (IOIProp), UEMS and S P Setia (Setia) were Within Expectations.
  • As a conglomerate, Sunway registered revenue growth in all segments with the main contributors from property development and property investment in 1QCY22. Meanwhile, IOIProp posted a stronger revenue in 1QCY22 driven by further progress works from ongoing projects and higher number of vacant possession of completed projects following the lifting of movement restrictions. UEMS returned to the black in 1QCY22, supported by higher earnings from both Malaysian and overseas property development, coupled with gains from divestment of non-strategic land.
  • Setia’s results in 1QCY22 were dragged by higher construction cost and lower property sales following a ramp-up in sales in 4QCY21. Lagenda’s revenue and profit fell YoY due to weaker sales on the absence of new launches and lower recognition of revenue from ongoing projects following the completion of some projects in 4QCY21.
  • YoY, Mah Sing recorded stronger growth in both revenue and profit with higher property sales in 1QCY22. However, it missed earnings expectation due to lower-than-expected average selling price of gloves and higher-than-projected operating expenses. Sime Darby Property’s (SimeProp) earnings missed our estimate due to lower-than-expected margin from the property development segment as a result of higher building material cost. Also, SimeProp was affected by labour shortage, which resulted in slower progress billings.
  • QoQ, all of the developers posted weaker results due to higher construction cost and slower sales (except Mah Sing and Sunway) following the expiry of the Home Ownership Campaign on 31 December 2021 as well as the lull period during the Chinese New Year holiday.
• Weaker new sales. New sales declined by 30% both YoY and QoQ. The developers attained 7%–34% of their FY22F sales target (average of 20%) vs. 15%–53% in the previous year (average of 30%). The weaker sales were attributed mainly to the expiry of the Home Ownership Campaign (HOC) and slower new launches in 1QCY22. Despite the end of the HOC, Mah Sing’s new sales surged YoY and QoQ due to stronger demand on affordable housing following a decline in transactions for mid-to-high-end properties amid the absence of stamp duty exemption. SimeProp also reported robust sales in 1QCY22 on the successful launch of attractive products at strategic locations, with close to 100% take-up rate (Exhibit 3).
• New launches fell short of expectations. Except for Sunway and Lagenda which did not have any new property launches, most of the companies attained 2%–14% of their FY22F planned launches (Exhibit 5). While the majority of the developers are confident in meeting their targeted FY22F launches, we see this as challenging because there is a risk of new launches being scaled back due to the recent softening property market, coupled with a hike in construction cost.
• Compressed margin as a result of rising construction cost. The cost of construction typically forms 50%–55% of a developer’s total gross development value. In 2022, we anticipate a 19% increase in construction cost. If developers pass on 100% of the cost increase to buyers, the selling price will rise by 9%–11%. In light of the current softening property market, we believe that developers, particularly those with lower pricing power, will absorb some of the cost increase and pass on only a portion of it to buyers to partly mitigate the margin compression.

• Negative impact with the possible reintroduction of GST. The purchase of residential property was previously exempted from GST, hence GST charged on building materials will be borne by developers. Developers may choose to absorb a portion of the cost increase and partially pass it to buyers. We expect a 1–2% increase in residential property prices if GST were to be reimplemented. Meanwhile, the impact on commercial properties and land is expected to be greater as 6% of GST was previously levied on the final purchase price. The property sector is still vulnerable to softer demand from higher product prices amid heightened housing affordability issues.

• Gradual recovery in property transaction volumes. In 1QCY22, Malaysia’s property transaction volumes rebounded 17% YoY. However, it slid 5% QoQ, owing primarily to the expiry of the HOC (Exhibit 6). While the country’s transition to the endemic phase coupled with the reopening of international borders on 1 April 2022 will support the recovery in the local property market, we are cautiously optimistic about the pace of growth amid concerns on future sales as new launches are likely to be scaled back.

• We reiterate our NEUTRAL stance on the property sector. In 2023, we expect a gradual recovery in property transaction volumes with improved post-lockdown market sentiments and higher property demand following the reopening of international borders. However, we expect property developers’ operating margins to be compressed in 2022 as a result of prolonged supply chain disruptions which have led to heightened building material costs. We are also concerned on the pre-existing affordability issue in the housing market, which has intensified since the Covid outbreak as consumers’ disposable income has been impacted. On a slight positive note, we see no further overhang deterioration for residential units and serviced apartments in 1QCY22 (Exhibit 7).

• Selection criteria. We like developers with healthy balance sheets (net gearing ratios of less than 0.5x) and sufficient cash flows to support land acquisition activities while also sustaining their businesses during an industry downturn. We also favour developers with a high exposure in sought-after affordable housing, particularly those launching in strategic locations.

• Top BUY is Sunway (fair value RM2.27) given the strong brand recognition established by its highly successful landmark developments and expanding healthcare business, supported by substantive unbilled sales and outstanding order book. We favour Lagenda (FV RM1.90) due to its focus on underserved landed affordable housing development in second tier states with a large population of the B40 and M40 income groups. We also like Mah Sing (FV RM0.85) for its focus on affordable housing developments at strategic locations as well as its savvy execution and quick-turnaround business model.

• We lower our fair value on Setia to RM0.86/share (from RM1.14/share) based on a higher discount of 55% (from 40%) to RNAV and SimeProp to RM0.59/share (from RM0.66/share) based on a higher discount of 55% (from 50%) to RNAV. This is to reflect increasing challenges on the sales prospect of their properties that are largely priced above the affordable segment.
• Re-rating Catalysts:

i) Government support for home buyers in the form of incentives and financing;

ii) stronger-than-expected recovery in economy, which supports property transaction volume; and

iii) faster-than-expected recovery in global supply chains, which could lead to a normalisation of building material costs.

• Downside Risks:

i) Stagflation which could lead to a higher unemployment rate alongside higher inflation, posing downside risk to property demand;

ii) a potential new wave of the pandemic, which could cause disruptions in business operations and construction progress; and

iii) any prolonged or worsening of supply chain disruptions which will impact the pace of economic recovery and heighten the cost of building materials, affecting our estimates for earnings growth of property developers.

Source: AmInvest Research - 14 Jun 2022