We are downgrading PROPERTY to UNDERWEIGHT from NEUTRAL. We believe the recent exuberance in property stocks was largely based on expectations of positive monetary measures from the new BNM governor and on bottomed-out valuations. However, we take a cautious view as the sector is going through structural adjustments, i.e. issues beyond demand-supply, but rather an industry dynamics issue extending into the banking system. There is no easy monetary solution in sight and measures like DIBS for first-time home buyers may not impact developers’ sales meaningfully due to the current rebates/easy financing schemes in place but may present more future risks for the banking system. While affordable housing remains a theme, it can be a negative to most developers’ group margins, especially those which are not traditional affordable housing developers; ironically, targeting such markets means such pool of buyers is also facing one of the highest loan rejection rates, as observed by REHDA’s recent survey. Notably, CY15 Malaysia Residential Transacted Values (MRTV), used as our developer’s sales proxy, declined by 10% YoY or the first time in 10 years and we predict a weaker CY16 MRTV (-2% YoY). For our universe, average developers’ sales growth for FY16E is -9% (FY15: -20%); however, if 40%-50% of launches do not take by mid-2016, expect developers’ sales targets to be trimmed, meaning that earnings risks still remain. Industry players expect a stronger 2H16, implying that the banking system’s loans growth needs to move in tandem; our view on banking sector remains NEUTRAL and expect loans growth to be weak. Developers’ earnings cycle has weakened for FY16-17E, implying that valuations may remain compressed. Average RNAV discounts are now at 53% or slightly below its historical average of 49% or Global Financial Crisis peak levels of 64%. So, can we truly say that property valuations have bottomed if there are still earnings risks in the near horizon? At this juncture, we see no real reason to change our valuations (mostly at -1.0SD to historical average). As a result of the recent property stocks rally, we downgrade UEMS, IOIPG and KSL to UNDERPERFORM while our previous preferred pick UOADEV is now a MARKET PERFORM (other recommendations are largely unchanged). For investors who have positions or have recently jumped onto the bandwagon of positive property measures, we advise investors to top slice while sentiment is positive. For investors who have not taken position in developers, we strongly suggest avoiding the sector for now. We will reassess our sector call again once we have confirmation that key launches from our universe of developers have taken place and that take-up rates are expediting.

Reasons the market is drumming-up for property stocks. The broad market has been rebounding on the back of a strengthening Ringgit while economic outlook appears to have stabilized. Developers, being a traditionally high-beta sector, are viewed to be a natural proxy to the economy. We note that the market is looking at bottom-fishing opportunities on a hypothesis that the sector is trading at bombed-out valuations. It also appears the market is thinning out on investment ideas; hence, the plays for market laggards or bombed-out sectors, which naturally points towards the Property sector. There are even talks that the new Bank Negara Malaysia (BNM) Governor could introduce new measures to revive the market (e.g. DIBS for first-time home owners, reassessment on LTV methods). Hold your horses!!! However, fundamental data is revealing that the sector may be undergoing a structural change which may change the traditional property cycle altogether.

Also, can we truly say that developer’s valuations have truly bottomedout if there are still earnings risks? Easing monetary policies, wishful or realistic? With the changing of guards at BNM, investors expect the new BNM governor to introduce measures to boost the property sector within the first 6-9 months of his/her new office. REHDA and other property developers continue to campaign to bring back DIBS for first-time home owners; if introduced it will buoy sales for affordable housing developers (e.g. HUAYANG, MATRIX, KSL) while larger township developers (e.g. ECOWLD, SPSETIA, MAHSING, IOIPG) are expected to release more of such products. However, it appears there are a lot of concerns on whether it will be a strain on the banking system’s future asset quality or if it will cause more default rates down the road if these loan applicants do not have the right credit standing to start off with. We also think the main obstacle lie with the barriers of entry where first-time home buyers without sufficient credit standing are given lower margin of finance. As it is we are seeing a wide amount of rebates and various financing schemes to aid developers; it also means the introduction of DIBS for first-time home owners may not be as impactful to the sector. Another possible monetary measure is increasing the 70% LTV cap on third home purchases onwards; but we think this is unlikely as it means that the policy is targeted at investors rather than addressing home affordability issues. We believe BNM will face challenges balancing between the longer-term health of the banking system and asset qualities vs. loans growth, i.e. no easy monetary solution in sight.

Structural rather than a demand-supply issue. Overall, the banking system is going through an era of slowing loans growth. According to our banking analyst, the banking system Loans-To-Deposit Ratio (LDR) has hit another high of 87% at Jan-16, indicating that lending liquidity may remain tight even in the event of a lower interest rate (refer to APPENDIX for lending rate trends). Both Residential (Non-Residential) Loans Applied and Approved continues to deteriorate at -6% YoY and -34% YoY (- 22% YoY and -44% YoY), respectively, for Jan-2016. Meanwhile while banks are still lending, they are clearly limiting property exposure as the ratio of Property Loans Approved to Total Banking System Loans Approved has dropped to 31% in Jan-2016 or back to Global Financial Crisis (GFC) 2008-09 levels. Unlike the strong rebound in the property market observed post the GFC, the sector is now in a different era where tight lending liquidity persists on the back of high LDRs while house prices are much higher than it was five years ago. 

Source: Kenanga Research - 25 Mar 2016