Maintain NEUTRAL on Developers. The KLPRP index has underperformed the FBMKLCI for the second consecutive year, although the gap has narrowed. While some may argue that ‘pent-up demand will result in higher property transactions for 2017’, this may be capped by affordability issues and tight banking liquidity to the sector, as seen in the recent leading indicators such as loan approvals. Sale trends remain unexciting with the Malaysian 9M16 residential transactions declining by 10% YoY while affordability issues remain as HPI (+5.4%) growth trends persisted, albeit at a slower pace. Our universe average sales growth is expected to be at -5% and -2% for FY16-17E and FY17-18E. Meanwhile, average unbilled sales visibility is relatively stable and comfortable at 1.3 years while forecast earnings trends are also unexciting. The sector lacks near-term sector catalysts while outlook remains opaque. Note that most developers have yet to guide on their 2017 outlook. Malaysia residential absorption rate of incoming supply has continued to deteriorate but have hit a 14-year low while our PGDP ratio is also at a 14- year low, indicating that the bottom could be within reach. We project CY17E residential transactions to decline marginally by 1%. Our universe average net gearing remains relatively stable at 0.3x. However, land banking news are still likely to be patchy as most developers are still waiting for bargains and will be cautious about cash-flow utilisation. The sector average FD RNAV discount is at 53% vs. its historical average of 50% and we expect it to hover close to historical levels as most of the negatives have been priced-in. Our CALLs are maintained while we trimmed TPs for IOIPG and HUAYANG. We recommend investors to stick to developers with strong balance sheet, ability to meet earnings via ‘urban affordable housing projects’, sustainable annual sales levels of less than RM1.5b, offers above average yields and are gaining market share. Our Preferred Pick is UOADEV (OP; TP RM2.54). Upward sector call revisions will only take place if there are meaningful sector catalysts, which includes favourable banking sector indicators and policies, which directly impact the property sector.

Property stocks weakened over 4QCY16. Over 4QCY16*, the KLPRP Index was bashed down by 5.8% QoQ, which was worse than the FBMKLCI (-0.7%); big-caps (>RM3.0b) under our coverage fell by an average of 8.0% while small-mid cap players dropped by 7.2%. To recap, property stocks, particularly big-caps did fairly well running up to the 25bps OPR cut in Jul 2016 and pre-Budget 2017 announcement as the market anticipated credit loosening policies, including further OPR cuts by end 2016. However, Budget 2017 was muted while the US Election results have dampened overall market sentiment while Ringgit continued to be depressed. Meanwhile, some developers also trimmed their 2016 sales targets during the recent reporting season. Thus, the KLPRP Index marginally underperformed the FBMKLCI with YTD* decline of 5.3% and 4.1%, respectively. This marks the second consecutive year that the KLPRP Index underperformed the FBMKLCI. Our Preferred Pick for throughout the year (1Q-3Q16), UOADEV, was the best big-cap performer at +12.0% YTD vs. average big caps (+1.5% YTD).

Property loan indicators remain weak. While 11M16 outstanding loans for purchase of Residential (Non-Residential) Property was up by 8.4% YoY (+5.5% YoY), leading indicators like loans applied and approved were feeble. 11M16 Residential Property Loans Applied was flat (+0.8% YoY) while corresponding Non-Residential Property Loans Applied continued to worsen (-12.2% YoY). 11M16 Residential Property Loans Approved was still weak at -15.5% YoY (Non-Residential Property Loans Approved: -16.9% YoY) which is below the 11M16 Total Banking System Loans Approved (-11.7% YoY). The stronger growth in Residential Loans Applied vs. Approved indicated that demand is still strong but access to borrowings remains stiff with 11M16 Property Loans Approved to Applied ratio at 40% which is the lowest since CY06. Meanwhile, Property Loans Approved to Total Banking Sector Loans Approved ratio at 35% for 11M16 paled in comparisons to its peak of 43%-44% over CY13-14 but still higher than that of CY07-09 of 25%-33%, indicating numbers could weaken further.

The Jul 2016 OPR cut had minimal impact in changing loans liquidity to the property sector, as we had highlighted in our previous sector reports. At best, it has helped eased financing burdens of those with loans as lending spreads thinned slightly. Meanwhile Nov 2016 LDR remains high at 89.6%, which does not help with lending liquidity. However, the KLPRP Index has held up relatively well albeit weak loan indicators which could be largely due to the top 10 KLPRP components accounting for 59% weightage of the index; we note these stocks have strong institutionalized holdings and are mostly Shariah-compliant which provides some stickiness to share prices.

House price growth has eased… Malaysia HPI* is still on an uptrend but growth in 3Q16 eased at 5.4% YoY vs. the 10-year average of 7.2% and most key states are seeing similar trends. The exception is Selangor where 3Q16 growth rate of 7.5% is on par with its 10-year average; this is not surprising given the high urbanization rates in Selangor which continued to drive demand for homes. Selangor (6.3m population) has the highest population growth rate and its proportion to Malaysia’s population has increased to a high of 19.9% while KL (1.79m population) has seen a dwindling of population. Hence, most of the major developers have and will continue to emphasis on Selangor, particularly township products.

* We also note that the HPI data is based on gross instead of net prices, and in view of rampant rebates/discounts in the primary market, HPI growth maybe 5%- 10% lower; but even after adjustments, HPI growth is still there.

…but average transactions per unit have increased. While there is more affordable housing supply in the market, 9M16 Malaysia average residential transactions per unit have increased by 5% YoY. There has been a divergence between HPI and CPI after 2010 or when the world was flooded with liquidity; the divergence is likely driven by higher replacement costs as land prices were escalating and have yet to ease significantly while construction costs have risen on the back of higher material and labour costs.

So, will we ever see a sharp reversal in House Prices? While we observed that the secondary market pricings have weakened slightly over the last 12 months, many property owners are unwilling to let go below their entry cost and rather ‘hold’. Meanwhile, the primary market offers ‘price incentives’ and developers are offering smaller units to achieve more digestible absolute prices while maintaining price psf. Developers have also opted to hold back from launching new projects. This will be an on-going trend until there are significant increases in interest rates which weakens holding power or if unemployment rates rise sharply (currently unemployment rates are stable at 3.5%)

Residential transactions continue its decline. 9M16 Malaysia Residential Transacted Values (All Property Values) and Units (All Property Units) have declined YoY by 10% (-15%) and 14% (-11%), being the 7th and 6th consecutive quarter of YTD-YoY decline, respectively. Although new unit launches over 2016 is lower than the last two years, absorption rates of supply continued to deteriorate. Nonetheless, Malaysia’s 3Q16 absorption rate (Demand/Supply) of incoming supply is now at a 14- year low of 5.9%. Hence, we believe that the sector may be ‘bottoming’, supported by 3Q16 PGDP Ratio (Property Sales to Nominal GDP) of 4.3% which is now at a 14-year low. Thus, we project that CY17E residential transaction values and units to decline marginally by 1% and 2%, respectively.

Does pent-up demand matter? Not as much. Some have cited that 2017 will be a better year given ‘pent-up’ demand as many have held back purchases. We believe the issue is not about ‘pent-up’ demand, but rather a mismatch in supply, affordability issues and population dynamics. Since first-time home buyers form the large chunk of base residential demand, we did a study. Our population analysis indicates there will be an average of 372k people p.a. (404k people) over CY16-20E (CY11-15A) turning 30 years of age (assumption of ‘first home buyers’) while the ratio of residential units transacted to those turning 30 years of age is c. 60%. Using this as a projection driver, the number of residential transactions will be an average of circa 220k units p.a. over CY16-20E vs. the average 255k units p.a. over CY11-15A. So clearly, it will be some time before we see demand hitting the highs of CY11-15.

There is a mismatch of supply in the market. Demand is clearly for properties priced around RM500k/unit for Klang Valley (9M16 average residential price transactions for Klang Valley is RM513k/unit and Malaysia at RM320k/unit) while developers are finding it tough to launch new properties at these prices given our earlier argument of higher replacement costs.

Affordability is still an issue and without strong lending liquidity from banks, it will cap property transaction growth; a survey amongst developers reveals that they are seeing 50%-60% conversion of booking to SPA sales compared to the highs of 80%-90% due to unfavourable margin of finances. Additionally, with relatively weaker GDP growth compared to CY11-15, most property buyers will be more discerning about big ticket items purchases. Our PGDP Ratio (Property Sales to Nominal GDP) of 4.3% is now at a 14-year low.

The two-year mini cycle may no longer be valid. After 2002, the KLPRP Index underwent a 2-year mini cycle where it outperformed the FBMKLCI for 2 years and underperformed it for another 2 years; 2016 marks the second consecutive year of the KLPRP underperforming the FBMKLCI. The stock market had implications on the property sector as there was a similar but lagged trend on the physical residential market. However, after 2009 or post the Global Financial Crisis, when the world was flushed with liquidity and commodity prices fared extremely well, the physical residential market had detached itself from the stock market and continued its run for 5 years (2010-2014), which was similarly observed prior the Asian Financial Crisis of 1997-98. Even if the KLPRP manages to outperform the FBMKLCI, we think that the two-year mini cycle in the physical market may not repeat itself this time around given the extended 5-year run (CY10-14). Additionally, while our Strategist targets endFY17E FBMKLCI index of 1,732 which would be an increase of 5% YoY, we see no real catalyst for the KLPRP to outperform the FBMKLCI significantly given unexciting earnings and sales trajectory.

Developers’ sales trajectory remains weak. Based on our universe, FY16/17E-FY17/18E new sales are on a declining trend of -5% and -2%, respectively. Developers that are showing growth are: (i) ECOWLD which is commendable given that their base is the highest amongst our coverage and probably for the industry, (ii) CRESNDO and UOADEV are showing growth after last year’s low-base effect while MRCB growth in FY16/17E is largely driven by inclusion of its disposal of Menara Shell into its sister company, MQREIT. The others are reporting either flattish to negative trend in sales. Note that during the last reporting season, UEMS, MAHSING, SUNWAY and HUAYANG have reduced their headline sales targets significantly for this year by 8- 33%; most have cited reasons of deferment of launches or poor conversion of booking to SPA sales. Most developers have yet to guide on their official targets for FY17/18E, which will be made known during the next reporting season.

Unbilled sales visibility is stable, but earnings trends are uninspiring. As sales trends from the last two years and the current year have been weak, earnings impact is now being felt. However, the decline in earnings is not as severe because many projects now have a longer development period and developers are more cautious with costs. Also, developers like SPSETIA, UEMS (ECOWLD as well once EWI is listed) have overseas contributors which provide strong bullet contributions in delivery years. This is also the main reason that our universe’s average unbilled sales visibility remains healthy at 1.3 years, with those having overseas contributions seeing much higher visibility. While those in our universe are still profitable, we can expect most of them to see weak to flattish earnings trends over the next 2-3 years unless there is dramatic change in sales trajectory; there are of course exceptions like ECOWLD which are seeing normalization of their earnings

Developers RNAV discounts are unlikely to exceed historical average levels in the absence of strong sector catalysts. Developers FD RNAV/SOP discount has dropped by 3.5ppt QoQ to 53.1% or below its historical average of 49.8% as investors top-sliced after a muted Budget 2017 and no further rate cuts. In fact, it has reverted to its level one year ago. In terms of Fwd. PBV/PERs, most developers are trading at trough to average levels (refer to Appendix). Average Fwd. PBV levels have also fallen slightly to 0.85x. However, average Fwd. PERs had expanded to 16.6x due to ECOWLD as we had cut forecast earnings substantially while its share price had held up relatively well; excluding ECOWLD, average Fwd. PER is relatively stable at 11.4. We believe that RNAV discounts will hover close to historical average levels given high institutionalized holdings while these developers are still profitable with an average of 1.3 years earnings visibility. However, if the sector’s average unbilled sales visibility drops below 1 year, it may trigger further de-rating in valuations.

Government ramps-up affordable housing efforts. Federal and State Housing programs are launching more aggressively recently (e.g. PR1MA, Rumah Selangorku) and end-financing issues are likely to improve given the following; (i) Budget 2017 introduction of a new end financing scheme for the 1Malaysia People’s Housing Program (increase of margin of financing to 100% from 90% with 100% stamp duty exemption for first-time home buyers for PR1MA homes up to RM300k/unit) with the collaboration of BNM, EPF and 4 local banks (Maybank, CIMB, RHB and AMBANK), and (ii) Youth Housing Scheme by BSN MyHome-I for young married couples (100% financing for homes between RM100k-RM500k with 50% stamp duty exemption with RM200/mth government aide for 2 years). So, will this take away market share from developers?

Developers step up on urban affordable housing supply. We also note that over the last 2 years, developers have also released more ‘affordable housing’ in urban areas but pricing range is more likely between RM300k-RM500k/unit as urban area replacement costs is still relatively high. However, the majority are seeing declining market shares. Many developers under our coverage are offering incentives (e.g. rebates/discounts, deferment of payments, ‘guaranteed’ loans, 10-90 schemes, risk coverage, freebies) to clear inventory while new property launches are mainly seeing rebates/discounts. We even notice some agencies (not within our coverage) offering variations of ‘rent-to-own’ schemes. However, most developers under our coverage are experiencing declining market share (Malaysia sales only) as a proportion of Malaysia’s Property Sales Transactions. The exceptions are: (i) ECOWLD which is leaping ahead as it has a lot of new launches while its sales and marketing efforts are visibly more enticing than competitors (ii) SPSETIA, MATRIX and UOADEV are seeing gradual market share recovery via more affordable housing product positioning in the right location along with incentives. Overall, our universe** market share as a proportion of Malaysia’s Property Sales Transactions is now at 13.2% for 9MCY16 vs. the high of CY13 (11.9%); if we were to exclude ECOWLD, our universe** market share is at 7.6% for 9MCY16. Notably, over 1H16, Primary* Property sales performance dropped to 25.6% vs. 48.5% in 1H15 while the number of units launched fell to 10.7k units (-78% YoY) over the same period.

Expect land banking news to be patchy in 2017. Under our coverage, developers that have done heavy land banking in 2016 are ECOWLD, SPSETIA and IOIPG and these companies have also announced cash-calls during the year. Our channel check indicates that land prices have stabilized but developers’ feedbacks indicate that they are still waiting for bargains to emerge – lower land cost is required given that demand is largely for affordable housing. Additionally, developers are also cautious on overloading their books with land banks as sales remains challenging while they concentrate on cashflow and light balance sheet. We believe local land banking news in 2017 will remain patchy (e.g. SPSETIA, ECOWLD) while overseas expansion may be challenging given the weakened Ringgit. Positively, our universe average net gearing is still healthy at 0.3x.

RECOMMENDATIONS

What does this all mean for developers? Developers will need to go all out to woo buyers as the pool of eligible buyers has shrunk. Besides location and connectivity, developers will need to fight hard in terms of product positioning, value propositions and service to gain market share. The big cap developers are likely to have more of an advantage compared to small-mid cap ones given more prominent branding and broader product offerings.

Maintain NEUTRAL on Developers. Our CALLs are maintained while we trimmed TPs for IOIPG and HUAYANG by 6% and 17%, respectively (refer to Appendix for details). At this juncture, we reckon that most of the negatives have been priced-in; weak loan indicators and further cuts in sales targets appear to have softer impact on developers’ share prices. However, an upward sector call revision will only take place if there are meaningful sector catalysts, which includes banking sector indicators and policies which directly impact the property sector. The story of the Singapore-KL High-Speed-Rail and Johor RTS are longer term catalysts, which are likely to have more of an impact towards 2020. However, if the sectors unbilled sales visibility drops below 1 year, this may warrant further sector de-ratings. We recommend that investors stick to developers with strong balance sheets, ability to meet earnings via urban affordable housing projects, have sustainable annual sales levels of less than RM1.5b while also offering above average yields. Our Preferred Pick is UOADEV (yield: 6.4%). Stocks with above average dividend yields that investors may favour are SPSETIA (5.2%) and MATRIX (5.9%), although we admit that our recommendations may change pending guidance on CY17 sales targets or their ability to maintain their current sales momentum. We expect ECOWLD to benefit from the listing of EWI in 1QCY17 as the latter is expected to see heavy land banking news-flow post listing. Note that our OUTPERFORM calls are for developers seeing rising market share.

Source: Kenanga Research - 5 Jan 2017