Maintain NEUTRAL on Property Developers. Our strategy is largely unchanged from last quarter as the sector dynamics remain largely unchanged and weak. We believe 2016 will be challenging and it is too early to tell if 2H16 will be better than 1H15; recall most developers are also facing limited demand visibility, as experienced over 2015, while tight lending liquidity to the sector persists. Hence, Malaysia Residential Transacted Values (MRTV) is seeing its sharpest decline in 10 years in 2015 where 9M15 MRTV declined 11% vs. 5-year average growth rate of 15%. We estimate that our universe of developers should average +7% YoY growth in terms CY16 sales. However, many developers have yet to provide official guidance on their pipeline of launches and sales targets. Developers’ net gearing levels (average: 0.3x) remains healthy, so landbanking could improve next year since land prices have stabilized; however, our past observations indicate that property stocks tend to be less sensitive to such newsflow during down-cycles as landbanks are not realizable immediately. Positively, property share prices and valuations appear to have bottomed, while we observe rotational plays amongst various developers based on our Floor and Ceiling prices. Undeniably, the sector lacks catalysts and may require positive policy changes (particularly monetary) for the sector to re-rate convincingly, implying that the next major event to look out for is Budget 2017 announcement in 3QCY16. We like UOADEV (OP; TP RM2.22; net cash position and net yield of 6.8% with IDRP) as a defensive pick. For those willing to take longer term view on deep value developers, we recommend HUAYANG (OP; TP: RM2.20) which trades at compelling 4.4x Fwd PER (close to historical trough) with high exposure to the affordable housing market in Klang Valley and offers very strong yield of 7.0%. We also expect a re-rating of ECOWLD (OP; TP RM1.90) closer to its EWI listing (1QCY16).

A weak 4Q15 and 2015. YTD, the KLPRP has eased 8.2% in tandem with the weak sector performance this year and we observed that big-cap developers (>RM3b market cap) saw greater downsides vs. small-mid cap developers (<RM3b market cap) which saw more decent gains over the year (Appendix Fig1, Fig2). Under our universe, we observe similar trends over 4QCY15 (Fig 3) with average returns of - 0.3% over the quarter. To recap, the recent 3QCY15 reporting season saw QoQ deterioration where 25% of our universe of developers’ earnings came in below expectations (2QCY15: 8%); however, positively, headline sales saw improvement as 67% were on track to meeting sales targets (largely due to earlier trims) (2QCY14: 14%). Momentum of lowering TPs/CALLs has also appeared to have slowed down.

Lacklustre banking system indicators for the property sector continue to persist. We see no significant improvements in property loans applied/approved data, which is still on a downtrend; this has been the case for most of the year (Fig 4,5,6). The banking system Loans-to-Deposit Ratio (LDR) has weakened further, reaching historical high of 86.3% (Oct-15) (Fig 7). We do not foresee the current lending environment to improve over the next 3-6 months, indicating that property transactions could still be slow.

Developers' sales and physical property market data remain weak. The Malaysia House Price Index (HPI) is still showing growth albeit at a slower pace. 9M15 Malaysia HPI grew by 5.3% but is lower than its 10-year’s average growth rate of 6.4% while other major states are showing similar trends too (Fig 8). 9M15 Malaysia Residential Transacted Values (MRTV) has declined by 11% YoY (Fig 9), which is close to our prediction (refer to Property Strategy Report, 7/10/15) where we anticipated 2015 MRTV to decline by 10% YoY (Fig 16). Our universe of developers is also indicating similar trends where average FY15/16E and FY16/17E sales growth is expected to be -15% to +7% while earnings growth is at +14% to +15% (Fig 10,11), respectively. However, we qualify that there is risk to 2016 sales assumptions, and thus future earnings, as majority of developers have yet to provide official guidance for 2016; the exception is ECOWLD, which is one of the rare few to guide growth in sales (largely due to EWI), while the others are likely to target flat or declining sales targets. If there is risk to 2016 sales assumptions, it may mean weaker FY16-17E earnings growth.

Pent-up demand? Industry players are speculating that 2H16 will be better than 1H16 due to pent-up demand. We like to highlight that many developers also anticipated similar ‘better 2Hs’ trends over 2015, which was not the case. We reiterate than until lending liquidity to the sector improves or increase of affordable housing supply is more readily available, ‘pent-up’ demand may not be realized. Having said that, we expect listed and/or reputable developers to fight for market share in a shrinking pie to sustain sales targets.

Developers will have to work harder in terms of concept offerings, incentives and ultimately the right pricing at the right location. Landbanking newsflow may pick up over 2016, thanks to a few developers. Under our universe, it appears net gearing (Fig 12) remains healthy at an average of 0.3x which provides room for landbanking; note that: (i) net cash developers are UOA and KSL, (ii) developers with net gearing exceeding 0.6x are ECOWLD and MRCB. We gather that land prices have started to stabilize although land owners are not in an overly desperate state to low-ball land pricings. Meanwhile, quite a number of developers are generally turning cautious and may prefer to lean towards a lighter balance sheet strategy until there is more economic stability; the exceptions are (i) ECOWLD and MRCB which are on an aggressive growth path and are using JV platforms to drive more sizeable land acquisitions, (ii) UEMS due to their need to diversify out of Johor, (iii) MAHSING as their Seremban and Puchong land acquisition deals did not go through while they have funds ready for acquisitions from previous cash-calls. However, in the past we observe that developers’ share prices tend to be less sensitive to landbanking newsflow when the sector is in a down-cycle.

Other catalysts that could excite the sector. Infrastructure stories (e.g. High-Speed-Rail) are also unlikely to revive the sector in the near-term as these catalysts are longer-term play. However, if there are reversals of negative sector policies or introduction of catalytic ones (particularly banking system related measures) during Budget-2017 announcement, the sector may see re-ratings. Industry players have been pushing to bring back DIBS for first-time home owners and if introduced, will buoy sales for a lot of affordable housing developers (e.g. HUAYANG, MATRIX, KSL). However, it appears there are a lot of concerns raised on whether it will cause future issues with default rates if these buyers do not have the right credit standing to start off with. We also think the main issues lie with the barriers of entry where first-time home buyers without sufficient credit standing are given lower margin of finance. In terms of corporate exercises like M&As, we believe that persistently weak valuations over 2016 may result in privatisations or mergers and we will reassess this after 1QCY15.

Valuations bottomed over 4QCY15. In our universe, the average RNAV discount stood at 53% vs. last quarter’s 54% (Fig 13) while Fwd PER/PBV valuations are mainly between trough to below average levels (Fig 14,15), indicating that the sector could have stabilized close to a bottom. However, without any compelling sector catalysts and improving headline sales figures, it will be tough for the sector to re-rate in the near-term unless investors are taking a more-than-12 month view. …but still concerned about potential sector de-ratings. In our last strategy report (refer to Property Strategy Report, 7/10/15) we had highlighted risks of further de-ratings. To recap, we mentioned that during the Global Financial Crisis (GFC) of 2008-09, the KLPRP Index Fwd PBV hit a low of 0.5x which was in tandem with the slowdown in MRTV back in 2009 of +1% YoY (Fig 17). Over 2010-14, the MRTV achieved a healthy average growth rate of 15% YoY (range: 6%-22%) while the KLPRP Fwd PBV valuations remained above 0.6x (-1.0SD). Since we anticipated declining MRTV in 2015 and potentially flat-todeclining MRTV in 2016, it begs the question of; will the sector de-rate to 2008-09 levels if the Malaysia Residential Transacted Values (MRTV) shows its sharpest decline in 10 years? We are reluctant to make this call at this juncture because: (i) most developers’ balance sheet are healthy, (ii) developers’ earnings visibility ranges between 1-2 years and, (iii) the property sector is one of the few Shariah compliant sectors. However, if 2016 headline sales figures continue to deteriorate while we see further rollback in new launches, we may have to revisit our sector call with a downside bias. For now, we expect 2016 to see slight growth in sales of +7% based on the simple average amongst developers under our coverage.

Maintain NEUTRAL on Developers. Even though the sector has bottomed in terms of valuations as much of the negatives have been priced-in, it still lacks compelling catalysts while sector visibility remains hazy. We reckon it is still too early to call for a meaningful bottom-fishing strategy until we get further clarity on 2016 outlook from developers’ pipeline of launches and sales targets. In general, we prefer developers with some or all of these components; (i) a very light balance sheet, (ii) strong exposure to the Klang Valley residential market (affordable housings), (iii) is already at cheap valuations and/or, (iv) offers very strong yields of >6% (better than MREITs).

Our recommendations are largely unchanged save for (refer to Fig 21,22 for details):

1. UEMS which we have maintained as MP but lowered TP as rumour of privatisation has died down. We have been adamant in the past that privatisation of UEMS would be unlikely,

2. MRCB which we reiterate MP but lowered TP due to weakening sentiment on the stock from dilution of existing shareholders from the new placement and RAM’s downgrade of the Southern Link’s junior sukuk,

3. IOIPG where we maintain our TP but downgraded the stock to UP from MP. While sales from China will help to buoy headlines sales (flattish), we see no major exciting catalysts. Additionally, we note that its share price has been moving up post the announcement of the land acquisition next to IOI City Resort and the 17% placement to major shareholders of the company for payment of the land at RM2.21/share. However, the new landbank will not be immediately earnings accretive and we reckon post placement, share price may see sharp correction due to dilutions.

For defensive picks, we like UOADEV for its net cash position, superior development margins, i.e. more earnings for every Ringgit invested, strong net dividend yields of 6.8% with IDRP while its product positioning is largely between RM500k- RM900k/unit and being located in Kuala Lumpur.

Rotational plays. In our last strategy report (Property Strategy Report, 7/10/15), we had derived Floor and Ceiling prices as we felt that property stocks may see potential rebound for year-end window dressings; back then, our Floor Prices provided an average 9.6% downside risk while the Ceiling Prices provide an average 13.3% upside potential. Based on the last price, it appears not much has changed as respective downside and upside potentials are now at 8.8% and 14.4% (Fig 19,20). This suggests that the sector is still in a flux. However, this could provide investors some trading opportunities when certain stocks approach our floor valuations. We also reckon ECOWLD’s share price could be more buoyant even though fundamentals are tough to ascertain (ECOWLD’s earnings will only normalize in FY17), given positive newsflow in its pipeline, including: (i) listing of EWI in 1QCY16, followed by more overseas ventures, (ii) JV partners for its Kuala Selangor land acquisition, and (iii) other local landbanking news with partners.

Long-term investment horizons. Property valuations are quite low but due to the uncertainties of the broad market and sector challenges, even property stocks with very cheap valuations (e.g. HUAYANG, KSL) will require a 12-month view or longer for ‘long-term’ value to emerge. However, these stocks offer very compelling net yields: (i) KSL @ 8.8% with IDRP, (ii) HUAYANG @ 7.0%. Between the two, we prefer HUAYANG due to its affordable housing exposure in Klang Valley where demand appears more resilient than Johor i.e. KSL’s market. Nonetheless, we cannot ignore KSL’s light balance sheet, strong margins, cheap valuations, superior dividend yields and one of the few developers to enjoy strong recurring income (close to 1/3 of income) although we are aware it will take quite a while for the stock to re-rate i.e. a Johor or Iskandar Malaysia angle must play out first. 

Source: Kenanga Research - 7 Jan 2016