Tactical re-rating to OVERWEIGHT on Developers from our previous NEUTRAL call. There are improvements in residential loan indicators, although this is unlikely to translate into exuberant transactions growth as LDR remains high. Meanwhile, developers continue citing lower conversion of booking to SPA sales on loan approval difficulties. However, as highlighted in our earlier sector report, a bottom has been found as selective developers are showing healthier headline sales while most are looking at flattish trends. However, we expect unexciting earnings trajectory for most developers as unbilled sales, although remains healthy, have weakened to 1.1x. The odds of developers missing their sales targets are less likely this year while it may be possible that some may even exceed their targets after two years of adjustments but confirmation will only be seen in 1H17 figures. Landbanking is likely to remain patchy amongst a few developers (e.g. ECOWLD, SPSETIA, MAHSING, SUNSURIA) while our universe’s net gearing remains healthy at 0.27x. The sector is still lacking fundamental earnings catalyst, but one should ride on the broad market sentiment, for now. Sentiment is superseding fundamentals as the sector has yet to see a physical overdrive in sales, particularly since developers’ risks have been mainly priced-in while being a laggard over the last two years. YTD, the KLPRP (+10.7%) has outperformed the FBMKLCI (+4.6%) and our studies indicate that this could be driven by better broad market sentiment while beta play property stocks are more sensitive to a well-performing FBMKLCI. Our studies also show that the KLPRP tends to outperform the FBMKLCI every 1-2 years regardless of the physical market and as long as the FBMKLCI is expected to be positive that year which means the KLPRP could do better than the broad market over 2017-18. Hence, we have re-rated our valuations to reflect the sector reacting to a better broad market resulting in more OUTPERFORM calls (UEMS, SUNWAY, MAHSING, IOIPG, SPSETIA, ECOWLD, MATRIX and SUNSURIA). Our TOP PICKS are: (i) IOIPG (OP; TP RM2.30) as a beta play being a big-cap laggard with strong earnings momentum, (ii) SUNSURIA (OP; TP RM1.61) as our alpha play for its sales and earnings normalization resulting in the highest growth amongst our coverage with potential maiden dividends this year. Risk to our tactical play is that property stocks could be easily be sold down in tandem with any heavy profit taking on the market. The sector will require real fundamental re-rating catalysts to continue pushing valuations to higher levels.

Improvements seen in residential loan indicators. While LDR remains at a record high at 89.8%, there are improvements in 1M17 residential loans applied and approved data at +3.4% and +12.5% YoY, respectively. For residential loans applied, this marks the 3rd consecutive month of positive YTD-YoY movements while for residential loans approved data, this is the first positive month of growth in two years, which is very encouraging. We believe this could be largely driven by higher supply of affordable homes in the market from the government (e.g. PR1MA, Rumah Selangor-ku, Rumah WIP) and private sector. However, non-residential loans applied and approved data continued to be weak at -10.5% and -8.9% YoY for 1M17, respectively. In terms of the ratio of property loans applied to approved, 1M17 is still relatively low at 41%, with property loans to total banking system approvals ratio is still lethargic at 34%. It is noteworthy that our industry survey still indicates that banking liquidity to the sector remains challenging although some industry players have cited that ‘quality buyers’ are emerging, improving the odds of loans approvals. Given the record-high LDR while our Banking Analyst still expects moderate loans growth of 5-5.5% for 2017E, the improvements in the property loans indicator may not translate to overly exuberant property transactions, although we are glad to say that a bottom has been found.

Healthier headline sales, but not across the board. Overall, sales growth is starting to look healthier as our universe is indicating +5% YoY growth for FY17-18E, thanks largely to SUNSURIA*, ECOWLD and IOIPG, which are showing significant growth while the others are mainly flattish. Without these 3 developers, FY17-18E sales for our universe would be at -5% YoY.

However, earnings likely to be unexciting over 2017-18 for most developers. Our universe earnings growth is meek at +2% YoY for FY17-18E, while it will be at -5%YoY if we excludeIOIPG, ECOWLD* and SUNSURIA* as earnings normalization is still in process. The weaker earnings trajectory over the next two years is a function of 2015-16 soft sales numbers. Meanwhile, our universe’s unbilled sales have weakened slightly to 1.1x compared to a quarter ago -but as long as unbilled sales remain above 1.0x, the sector’s earnings for the next one year should be relatively intact.

Sales growth is not seen across the board as banking liquidity remains a challenge and only developers with lower sales base or the ‘right’ product positioning are seeing growth while others are likely to see flattish sales trends. We expect overall Malaysia residential sales, the biggest driver of the property market, to see flattish changes (-1% YoY) in transacted values in 2017 i.e. have bottomed. This also means that the odds of developers missing their sales targets are less likely this year.

As investors are forward looking, they pay less attention on earnings and turn their attention towards headline sales numbers, which some are seeing growth while others are largely flat. In fact, this year we may see developers exceeding sales targets, which will be much welcomed after the lull over 2015-16. At this juncture, it is too early to say which developers will positively surprise and the critical check-point is if developers can strongly deliver sales in 1H17. Hence, we make no revisions to our developers’ sales assumptions or estimates for now.

Expect landbanking news to remain patchy and developers that are likely to see landbanking news are ECOWLD, SPSETIA, MAHSING and SUNSURIA either by way of outright acquisitions or JVs. Aggressive landbanking will only likely to happen if sales momentum picks up significantly and/or if land prices become more attractive. However, checks with industry players are that land prices continue to hold largely steady with some pocket of opportunities. Currently, our universe’s net gearing levels remain healthy at 0.27x (refer to Appendix).

The sector is still lacking catalyst, but one should ride on the broad market sentiment now, particularly on developers with risks that have been mostly priced-in. What will drive the sector into a fundamental overdrive mode is if there are positive changes in policies (e.g. Budget-2018), continuous improvements in banking sector indicators or loosening of banking sector regulations to the sector; this may result in an upward revision. At this juncture, we are unable to provide updated national statistics data (e.g. HPI, demand, supply) as publication of 4Q16 data will likely be in Apr 2016.

So, why are property stocks doing so well this year? The FBMKLCI has done exceedingly well at +4.6% YTD* on the back of better investors’ sentiment as the Dow Jones hit new highs while the USD-Ringgit has somewhat stabilized. To our surprise, the KLPRP index (+10.7% YTD)* has outperformed the FBMKLCI despite the absence of major fundamental catalysts in the sector. Small-mid cap developers have done well at +15.6% YTD while big-cap players (>RM3b market cap) registered growth of +8.5%. We note there are more alpha plays in the small-mid cap spaces like SUNSURIA which earnings are about to reach an inflection point. There are also corporate exercise plays that excited investors like IWCITY (NOT RATED) given their merger with IWH which crown jewel will eventually involve the widely-anticipated Bandar Malaysia, while stocks like MALTON (NOT RATED) gained traction on potential news flows. Big-cap players, which are highly nationalized stocks, are being re-rated mainly on laggard plays as the broad market has done well. After all, the property sector is typically a high-beta sector, particularly when the broad market performs well.

Property stocks are more sensitive to a well-performing FBMKLCI. When the FBMKLCI performs positively, the KLPRP typically generates betas of more than 1.0 indicating that investors view the sector as a proxy to the broad market during good times. However, when the FBMKLCI yearly performance is in the red, we note that the KLPRP beta slides to 1.0x or lower, which shows a detachment to the broad market. The main weightage of the KLPRP index (94 members in total) is concentrated on these 10 property counters, which makes up 58% of the KLPRP weight; these stocks are mostly institutionalized counters, which would explain a less severe sell-down if the broad market tumbled into the negative.

When sentiment supersedes fundamentals. As highlighted earlier, we have yet to see property sales go into overdrive and the overall scene remains tricky on challenging banking liquidity. However, it is safe to say the ‘coast is clear’ as the sector appears to have found a bottom in terms of sales and earnings trajectory. Thus, the property sector maybe a proxy for the broad market, particularly as risks have been mostly priced-in while the sector’s share price performances have been lagging for the last two years. Consensus is now targeting the FBMKLCI to return more than 8% over 2017 and we believe more positive revisions of the market will materialize soon. In view of that, we expect the KLPRP beta will swing above 1.0 which will be positive for stock price performances.

The KLPRP “mini cycle” is detaching itself from the physical market. The ability of the KLPRP index to outperform or underperform the FBMKLCI is usually followed with positive or negative growth in the physical market, respectively, typically seen with a one-year lag since 2003. In 2011-13, we saw a departure of this trend where the physical market continued to register positive performance albeit the KLPRP underperforming the broad market. It appears that the performance of the KLPRP is mostly determined by the FBMKLCI as it seems to disregard the real impact of the physical markets, which could be due to our earlier arguments that this is a traditionally high beta sector and the bulk of the KLPRP are weighted by highly institutionalized stocks.

Even though the physical market is likely to remain flattish in 2017, it appears that the trend of the KLPRP outperforming the FBMKLCI every 1-2 years may likely repeat, supported by a better broad market as highlighted above. Positively, the KLPRP tends to outperform the FBMKLCI for two consecutive years even though the broad market appears to be weak. If history repeats itself, we can expect the KLPRP to outperform the FBMKLCI over 2017-18 unless there are severe cuts in property stock earnings again.

RECOMMENDATIONS

Tactical re-rating to OVERWEIGHT from NEUTRAL. Due to the improvement in the broad market sentiment and the consensus expectations of the FBMKLCI to churn a decent positive return of more than 8% over 2017, the high-beta property sector may move beyond its fundamental valuations. Upticks in news flows and speculation on Budget 2018 measures could excite share price further. Hence, we have decided to re-rate most of our stock coverage valuation levels by +0.25SD from the current applied discount levels. This has resulted in more OUTPERFORM calls in our sector which are mainly big caps like UEMS, SUNWAY and MAHSING while IOIPG, SPSETIA, ECOWLD, MATRIX and SUNSURIA remains as OUTPERFORM. Others are mainly maintained at MARKET PERFORM (except for KSL which is an UNDERPERFORM). (Refer to table below for changes in CALL/TPs or Appendix for detailed explanation).

While we have re-rated valuations for our Johor-based developers (e.g. UEMS, KSL, CRESNDO) in line with our tactical call, Johor remains extremely challenging in terms of demand. Nonetheless, our applied discounts to their RNAV/SOP are still below their respective historical mean levels, which are reasonable considering the challenges in Johor.

Since we are banking on beta plays on an improving broad market performance, suffice to say that laggard plays with strong upsides are preferred amongst our OUTPERFORM calls. Hence, a choice beta play is IOIPG (OP; TP: RM2.30) as our big cap TOP PICK where our FD SoP discount is pegged at only +0.25SD levels. IOIPG’s FY17E core earnings will be at record new high and will only be at 11x PER which is at trough valuations while its sales will be buoyed by overseas contributions, which could increase FY17E sales by 19% YoY to RM2.6b. While MAHSING (OP; TP: RM1.63) is also a laggard amongst the big-cap players, we note that its FD SoP discount is already at +1.50SD levels while our TP upside is not as high as IOIPG.

For alpha plays, SUNSURIA (OP; TP: RM1.61) is our TOP PICK. We like the company for its management team, healthy margins, light balance sheet, strong new sales and earnings growth mainly spearheaded by Sunsuria City, which enjoys catalysts such as the ERL station and Xiamen University. Estimating strong FY17-18E sales growth of 94-25% YoY while earnings normalization results in core earnings leaping by 167-60% YoY. We also expect maiden dividends this year given its earnings quantum jump in FY17.

Risks. Given our tactical play, property stocks could be sold down if there are heavy profit-taking activities on the FBMKLCI. This may cause retracement back to our pre-tactical valuations. We reiterate that the sector will require real fundamental re-rating catalysts to continue pushing valuations to higher levels.

Source: Kenanga Research - 21 Mar 2017