Upgrading Developers to NEUTRAL from UNDERWEIGHT as our pre-set major conditions for a review were met. Recall we had earlier highlighted that Aug 2016 reporting season would be a determinant of our sector call as we seek confirmation that the majority of developers’ (i) 1H16 sales must meet at least 40% of full-year targets, else posing higher risk of missing sales, and (ii) average unbilled sales must remain above one year. No doubt, the landscape today is increasingly tougher but savvy developers under our coverage have demonstrated the ability to grab market share from a shrinking pie. The sector has recently rallied on anticipation of positive Budget 2017 measures for affordable housing (e.g. DIBS for first home owners, widening EPF Ac.2 to 40% from 30% for housing withdrawals) and OPR cuts. However, our studies indicated that these are sentiment boosters at best as it may not translate into bullish demand cycles or address the actual affordability issues. We continue to expect CY16 Malaysia Residential Transacted Values to drop by 2% YoY. The sector rally has resulted in the sector’s average FD RNAV discount narrowing to 50.2% or close to historical mean levels of 49.7%. We expect the sector to be capped at mean levels as we are not on a bull mode and expect selective stock pickings. Additionally, investors may top slice slightly on Budget 2017 announcement given that we are likely to see sentiment-driven measures than “bull-run” ones. Should the anticipated good news fail to materialise, the share prices may correct sharply given the recent run-ups. Our CALLs are mainly MARKET PERFORM and our Preferred Pick is MATRIX (OP; TP RM2.65) as we believe it to be the best affordable housing proxy which sales is on track and offers strong yield of 5.8%.

Property share price runs ahead of Budget-2017 and more OPR cuts. YTD, the KLPRP Index is up by 2.8%, outperforming the FBMKLCI (+1.5%) as property counters rallied post sentiment boosters from the Jul 2016 OPR cut (-25bps) vs. last quarter when the KLPRP had declined by 3.5% YTD vs. the FBMKLCI (-0.1% YTD). Notably, big cap (>RM3.0b market cap) developers benefited the most with average +8.7% YTD vs. small-mid caps at -4.5% YTD. The top performer was UOADEV (+18.8% YTD) which was our Preferred Pick in the last quarter due to its product positioning, defensive and high-yielding qualities. Although we had indicated that interest rate cuts at this juncture will not significantly spur property transactions (refer to 8/7/16 Sector Report), it became a sentiment booster. Coupled with market rumours of positive measures during the upcoming Budget-2017, investors have taken some bets on the sector. The question is will investors take profit upon the good news as the physical property market remains challenging? Is the good news enough to push developers to show strong YoY growth in sales again?

Market expects goodies from Budget 2017. In our last sector report (8/7/16), we highlighted that Budget 2017 will still be very ‘rakyat-centric’ i.e. government housing schemes driven (e.g. PR1MA, My First Home Scheme) and expect the impact to be relatively muted for developers. Lowering or removing RPGT or increasing the 70% LTV cap on third home purchases is very unlikely as these are addressing ‘non-home ownerships’ markets; note that lowering/removing RPGTs at this juncture would be extremely detrimental to the primary market. We also mentioned that if there is an increase in EPF Account 2 (30% of EPF Account), this will help increase home ownerships, but again we stress that it may require more studies by EPF due to longterm repercussions on future retirees.

As housing affordability issues continue to persist while political pressure ensues, the government may be hard press to relax policies for first-home buyers and below are the recent market rumblings:

1. Bring back DIBS for first-time home buyers only? While it does help ‘buy time’ before servicing the mortgage during the construction period, it does not solve the issue of low margin of financing obstacles faced by many first-time home buyers. Additionally, many developers are offering rebates, financing schemes and other goodies to help these buyers make a purchase. The issue under DIBS is that many developers tend to price-in the DIBS cost into the property price resulting in higher property prices. We believe the odds of bringing back DIBS for first home buyers are less likely. Nonetheless, if it is brought back it would be a big sentiment booster but not as effective as the ones below.

2. Changing loan assessment methods for first-time home buyers? The biggest barrier to entry for first-time home buyers is typically financing of the deposit and hidden costs, especially when these buyers cannot secure the full 10% margin of financing. It will be a game changer if first home buyers get higher margin of finance (i.e. more than 90%) or change the method of how loan assessments are done for first-time home buyers; we reckon this may take some time for BNM to study the long-term impact on banking risks.

3. Increasing EPF Account 2 allocation from 30% to 40%? If there are concerns that it would revive property speculation as those with more significant sums in their EPF accounts will unlikely be first home buyers, the government could potentially limit this to first-time home buyers. We think this measure could be more meaningful compared to bringing back DIBS for first-time home owners as it raises the amount in EPF Account 2 by 33%. This will be quite helpful in servicing part or full 10% deposit or if one was unable to secure the full 90% margin financing. However, while helpful to the ‘rakyat’, the measure could take the form of alleviating current housing burdens unless the government limits it to first-time home buyers who have yet to make a purchase. Again only selective developers will benefit i.e. those doing affordable housing.

Is there a strong relationship between EPF Account 2 Housing Withdrawals and housing demand? We made a few observations, we noted that Annual EPF contributions YoY growth rate has slowed down to +5% in 2015 vs. +14% in 2011, which is in tandem with the trends observed with Active EPF members. In contrasts, the number and amount of Housing Related Withdrawals has sharply increased by 17% YoY to RM5.9b in 2015 vs. +1% in 2011. We also note that there is an inverse relationship between the annual growth rate in EPF withdrawals for housing vs. Malaysia’s Property Sales Transaction Volumes and Values, which saw -5% and -10% YoY in 2015. We reckon it is because the withdrawals may also coincide with completions in addition to initial house funding. Thus, there is no concrete relationship although we acknowledge that is has been extremely helpful in keeping the sector afloat as the amount of withdrawal per transaction is quite meaningful to alleviate financing or entry burdens. (Note: All Housing Purpose Withdrawals includes the following schemes: (ii) Buy first house, (ii) Buy second house, (iii) Housing loan monthly instalments, (iv) Reduction/Redemption of housing loan.)

Another OPR rate cut by year end? Average Lending Rates (AVL) has been trending down for a while and is clear indication that it is not interest rates that is slowing property growth, but rather, lending momentum given the multi-year high LDRs and household debts. In fact, 7M16 Residential (Non-Residential) Loans Applied is still soft at -2% YoY (-19% YoY) while Loans Approved continued to worsen at -21% YoY (-23% YoY). However, investors have decided to take a bet on the sector on expectations of another 25bps rate cut in addition to the 25bps cut in Jul 2016, as seen with the recent share price run-ups.

Provides some breathing room at best. Interestingly, banks are struggling to lower lending rates. Post the 25bps OPR cut in July 2016, banks’ average Base Rate fell only by 19bps as they continue to face NIM compressions (refer to Appendix). Based on this quantum, our scenario analysis for a RM500k house (refer to table below) indicates a reduction of 2.5% or RM78/mth in monthly housing instalments. Assuming another 25bps rate cut, this would reduce monthly instalments by another 3.3% or a cumulative effect of 5.7% or RM121/mth for the full 50 bps cut. For the same affordability ratio, a first home buyer can afford to buy a house worth RM530k vs. RM500k, previously, assuming 50bps cut this year or an increase in house value of 6%. This certainly helps affordability but is not enough to push the physical residential market into a bull-mode. It is noteworthy that there are countries with even lower interest rates, which are still facing weak property market. However, an OPR cut may warrant better consumer sentiment, which may buoy property share prices temporarily

2QCY16 RESULT REVIEW

Slight QoQ improvement. Earnings expectations wise, out of 12 developers under our coverage; (i) the disappointment ratio has declined to 25% (UEMS, IOIPG, SPSETIA) on margin compressions, (ii) only 8% or UOADEV positively surprised, (iii) remaining 63% came in broadly within expectations pending a stronger 2H. It is a slight improvement from last quarter (33% disappointments and 17% positive surprises). Notably, we observe that 58% of our universe are seeing YoY declines in earnings. This trend is expected given weaker sales last year and increasing A&P costs to offload inventories or expedite takeup rates. There is no discernible QoQ trend so far. We have revised earnings forecasts up to 33% of the developers’ (UOADEV, SUNWAY, IOIPG, CRESNDO) earnings while lowering forecasts for another 17% of developers (UEMS, SPSETIA).

Improvements seen in 2QCY16 sales momentum. Note that we deem sales to be within expectations if 1H met 40% of full-year targets. This time around, only 25% of our universe of developers missed targets (UEMS, SPSETIA, HUAYANG). Another 33% are deemed within expectations (MATRIX) to ‘broadly’ within (MAHSING, ECOWLD, MRCB) as their sales momentum strengthened over 2QCY16 as they rolled out popular mass housing products during the same period while they have indicated strong pipelines of similar products for the remaining 2HCY16. 33% of developers’ (IOIPG, SUNWAY, UOADEV, CRESNDO) sales exceeded our expectations. This was an improvement from last quarter (67% disappointments, 8% positive surprises). In terms of sales targets, only 17% (UEMS, SPSETIA) slashed their sales targets which again, is an improvement from the same period last year where 70% of developers cut their full-year targets. Developers are pushing out to roll out more affordable or mass housing products and are offering many incentives (low up-fronts via rebates/discounts, freebies, alternative financing, ’10- 90’ schemes) to combat the tighter lending environment. The sector’s average unbilled sales remained stable at 1.3 years’ earnings visibility which is comparable to the last quarter number of 1.3 years, but still weaker than 2015 number of 1.5 years.

RECOMMENDATIONS

Sector FD RNAV discounts improve to 50.2% or close to historical mean levels of 49.7%; it is also close to discount levels a year ago and is an improvement from 2QCY16 52.5%. Meanwhile the sector’s Fwd. PER/PBV has marginally expanded to 11.7x/0.89x (2QCY16: 11.5x/0.83x). The KLPRP Index is now trading above its 0.79x Fwd. PBV historical men levels at 0.83x. We still expect Malaysia’s CY16E residential sales value and volume to decline 2% YoY. NAPIC indicates poor primary sales performance as Datuk Faizan Abdul Rahman (Director-General of Valuation and Property Services Department) was quoted stating that in 1H16, new launches fell to 10,655 units in 1H16 vs. 49,280 in 1H15 while units sold were 2,732 units vs. 23,909 units, respectively; this is equivalent to a weak take-up rate of 25% in 1H16 vs. 48% in 1H15. As a result, we believe the sector’s FD RNAV discount should trade closer to mean levels at most, unless the sector returns to its bullish mode, which would require strong YoY growth in sales, implying limited upsides for the sector at this juncture. (Refer to Appendix for Fwd PBV/Fwd PER Tables).

Recall that we highlighted in our last sector report (8/7/16) that Aug 2016 reporting season will be important for developers and that we will monitor the following: (i) Majority of our universe of developers’ 1H16 sales must meet at least 40% of fullyear target, else it would mean higher earnings risks, (ii) Unbilled sales must remain above 1 year on average - if sector unbilled sales drop below 1 year, this is usually alarming as it means the next 2-3 years’ earnings trajectory will likely see a declining trend. If the majority of our universe of developers meets these conditions, we stated that would UPGRADE the sector to NEUTRAL, else we will maintain our negatively bias call.

Hence, we upgrade Developers to NEUTRAL from UNDERWEIGHT based on improvements seen in 1HCY16 while sentiment has turned positive on the sector on positive expectations on Budget 2017 and interest rate cuts (refer to Table below for changes in CALL/TPs). No doubt, the landscape today has gotten increasingly tougher but the savvy ones under our coverage have demonstrated their ability to grab market share from a shrinking pie. Much of this has been priced-in ahead by investors as quite a number have approached their mean valuations already. Majority of our CALLS are now MARKET PERFORM. Our Preferred Pick is MATRIX (OP; TP RM2.65) as we believe this will be the best affordable housing player proxy to Budget 2017’s potential measures while their sales is on track and offers strong yields of 5.8%.

But definitely not out of the woods. However, the challenges of tighter lending, changes in population landscape, affordability issues remains, which makes the future opaque for now. We still do believe the property sector is still undergoing a structural change which is seen by the changes in sales momentum compared to 2010-14, property prices are expected to be slightly weak or flattish going forward, while developers sacrifice margins and land banks to roll out affordable housing products in the name of sales targets, which has margin compression implications. Our house banking sector view is that lending momentum is unlikely to differ from 1H16. We still expect Malaysia’s CY16E residential sales value to decline 2% YoY. Budget-2017 measures need to have not just a sentiment effect but a real fundamental impact on the physical market before we can reconsider a bullish sector call.

What if Budget-2017 sees the anticipated measures such as: (1) DIBS for first home owners, and (2) EPF Account 2 of 40% (from 30%) for first-time home buyers. We are unlikely to upgrade our call/TP significantly as these measures are unlikely to turn the sector into a bull-mode; in fact, we expect investors to TOP SLICE slightly on the positive news flow and continue their trading stance until the next MPC meeting (potential OPR cut). However, if there are significant improvements in banks assessment of loans for first-time home buyers, we believe this will warrant a sector upgrade.

What if Budget-2017 sees none of the measures mentioned or no significant positive measures? Clearly, the market is expecting some good news since property stocks have been pricing this in of late. So an absence of any of the above-mentioned news may result in sharp profit-taking activities amongst those that have run up substantially. Furthermore, all eyes will be on 2H16 sales where there are still some sales target risks and we expect investors to return to fundamentals, which may weigh on property share prices.

Source: Kenanga Research - 2 Sep 2016