Downgrade to NEUTRAL from OVERWEIGHT as the sector has done well YTD with riskreward turning downside bias as investors train their attention to headline sales delivery. The KLPRP Index has outperformed the FBMKLCI on a YTD basis. Recall that our tactical upgrade to OVERWEIGHT last quarter was premised on sentiment superseding fundamentals due to reduced earnings risks and high beta plays on improving broad market performance. Our previous Top Picks (IOIPG, SUNSURIA) have done well since our recommendations. However, the previous reporting season was unexciting while 1QCY17 headline sales were mostly ‘broadly within’ with a weaker bias as timing of launches are largely skewed towards latter quarters. Since the sector’s share prices have done well YTD, we think the risk-reward ratio has become less appealing as investors will be training their attention to the upcoming 1HCY17 reporting season. While sector indicators do lend strength to the argument that a bottom has been found, the question of the momentum of the sector growth remains elusive while we think there is some threat to developer’s market share arising from government housing schemes. Valuations are at crossroads with our universe’s average RNAV discounts trading at historical average levels. We strongly believe that the sector’s RNAV discount levels can only re-rate beyond average historical levels if there are more positive headline sales surprises or when positive property policies are introduced (fiscal, banking sector related). Budget- 2018 could offer the sector some positives, although we are taking a more muted view at this juncture due to the pending General Election. Other catalysts that could excite the market are potential M&As (e.g. SIME’s spin-off of their property arm, ECOWLD acquisitions). We have mostly MARKET PERFORM calls and our Top Pick is A&M (OP; TP: RM3.00) for a deep value play. For now, we recommend that investors remain nimble on the sector for stocks, which have done well YTD; otherwise, investors may have to take a longer-term view on value plays, bearing in mind that near-term volatility may ensue over the traditionally weak 3rd quarter for the broad market.

KLPRP outperforms FBMKLCI. The KLPRP Index (+13.8% YTD) has outperformed the FBMKLCI’s (+8.4% YTD). Big-cap (>RM3b market cap) players’ average YTD returns were at 13.7% while small-mid cap player’s average did better at 16.7%. Recall that our tactical upgrade to OW last quarter was premised on sentiment superseding fundamentals as the sector has yet to see a physical overdrive in sales. However, back then, we felt that developers’ risks have been mainly priced in while being a laggard over the last two years. Our studies revealed that: (i) if FBMKLCI is positive in a particular year, the KLPRP beta improves above 1.0, (ii) KLPRP tends to outperform the FBMKLCI every 1-2 years regardless of the physical market, i.e. the KLPRP could do better than the broad market over 2017-18 (refer to Property SU, 21/3/2017). We note that 1QCY17 reporting season saw earnings being relatively less exciting and with minimal earnings revisions vs. the last quarter. Meanwhile, 1QCY17 headline sales appear to mostly ‘broadly within’ (mainly on a weaker bias) due to timing of launches, which are mainly skewed towards 2Q-3QCY17, while we also downgraded more calls to MARKET PERFORM. (Refer to APPENDIX for 1QCY17 reporting details and detailed YTD return charts).

Our Top Picks has done well. Last quarter, we selected the following Top Picks; (i) IOIPG as a beta play being a big-cap laggard with strong earnings momentum, (ii) SUNSURIA as our alpha play on its sales and earnings normalization resulting in the highest growth amongst our coverage with potential maiden dividends. IOIPG and SUNSURIA had registered return of 10.9% and 6.5%, respectively, since our Top Pick recommendations.

Time to deliver. Since the sector’s share price performance has done well YTD, we think the risk-reward ratio has become less appealing as investors will be training their attention to the upcoming 1HCY17 reporting season. Recall that over CY15-16, about 40%-50% of developers trimmed their sales target during 3QCY17.

Assuring sector indicators. Positively, residential loans applied and approved data continue to show improvements (nonresidential loans applied is improving but approvals remains on a negative trend) while other banking indicators for the sector remains relatively stable. 1QCY17 Malaysia Property Transacted Values was up by 8% YoY while Malaysia Residential Transacted Values was up by only 1% YoY, which we view as an improvement from the declining trends observed over FY15-16. Meanwhile, our universe average unbilled sales visibility remains steady at 1.1 years while average 1-year forward net gearing is healthy at 0.22x (refer to Appendix for details).

Changes in risk-reward ratio. These factors do lend strength to the argument that the sector has bottomed, although the question of the momentum of sector growth remains elusive; hence, we still maintain our Malaysia Residential Transaction projection (refer to Appendix). We still believe there will be less headlines sales risk compared to last year but we reckon there is still risk of some developers tweaking their targets. Thus, meeting sales targets may result in no major share price reactions while disappointments may result in sell-downs.

Competition from government housing schemes. We are also concerned that government housing schemes (e.g. PR1MA, Rumah Selangor-ku, Rumah WIP, etc), which are not significant drivers for our core coverage, may compete for market share in the mass market space. Notably, many of these government housings are priced between RM300-400k/unit in Klang Valley, while we note that many developers under our coverage are mostly doing above RM400k/unit in Klang Valley.

RECOMMENDATIONS

Downgrade to NEUTRAL from OVERWEIGHT as the sector has done well YTD with risk-reward turning downside bias as investors train their attention to headline sales delivery. We may review our sector call with an upward bias if: (i) 2QCY17 reporting season yields surprises in terms of headline sales, (ii) there is sharp share price retracements on the back of stable fundamentals, and (iii) positive policies from Budget-2018. For now, we recommend that investors remain nimble on the sector for stocks which has done well YTD; otherwise, investors may have to take a longer-term view on value plays, bearing in mind that near-term volatility may ensue over the traditionally weak 3rd quarter for the broad market.

Mostly MARKET PERFORM calls. We have kept most of our recommendations unchanged save for: (i) UEMS which we downgraded to MARKET PERFORM with a lower TP due to competition arising from emergence of more big-cap alternatives, besides IOIPG, which have higher Klang Valley-based projects (e.g. SETIA-I&P, SIME Properties) vs. UEMS’ high Johor exposure, (ii) HUAYANG which we trimmed our TP further to reflect heightened earnings risk arising from competing government housing schemes as the group is selling products in similar price range. Out of the 15 developers under our coverage, 67% are MARKET PERFORM calls while the remaining are OUTPERFORM calls vs. last quarter when 61% of our universe were OUTPERFORM recommendations.

Our TOP PICK is A&M (OP; TP: RM3.00) for 3QCY17 as a long-term deep value play and strong growth from low earnings base. We like A&M for several reasons; (i) low land cost of <10% of GDV mostly in Selangor, (ii) beneficiary of Pulau Carey port development play which could materialize by year-end, (iii) strong balance sheet with net cash position, and (iv) FY17-18E earnings growth of 33-30% which is higher than our universe of developers’ average growth of 11%-19%. However, we highlight that we expect weak 1H17 results performance as bulk of its planned launches are geared towards 2H17. Our Target Price of RM3.00 implies a 57% discount to its SoP per share of RM7.00.

Source: Kenanga Research - 6 Jul 2017