KLPRP underperforms FBMKLCI over 3QCY17. Since our sector downgrade to NEUTRAL back on 6 July 2017, the KLPRP index has declined by 2.7% over 3QCY17, which was more severe than FBMKLCI (-0.5%)*. Back then, we felt that investors may have exhausted the beta-play angle, which we had positioned over 2QCY17, particularly with negative global headwinds from potential QE tightening, as well as, training their attention on headline sales and earnings delivery. The 2QCY17 reporting season was uninspiring with no major surprises while headline sales were mostly broadly within, but on the weaker side given that most new launches are skewed to 2H17 (refer to Appendix for 2QCY17 reporting season details). We also note that YTD, big-cap developers’ (>RM3b market cap) averages have done better than small-mid cap ones (refer to Appendix for charts).

Most developers under our coverage are banking on a stronger 2H17 due to timing of launches, which were mainly skewed post mid-2017. We still believe developers have better odds of meeting their sales targets this year compared to the last two years, because: (i) developers have adjusted and are now rolling out more affordable products and promotional schemes, (ii) active efforts to clear of inventory or WIPs, (iii) more genuine buyers are surfacing in light of increasing attractive property deals, and (iv) loan indicators have affirmed that the sector has truly found a bottom. We also note that there are more land banking deals materializing indicating that land prices have stabilized.

8M17 Property Loans indicators continue to be positive with Property Loans Applied and Approved at +10.8% and +11.6% YoY, respectively, led mainly by Residential segment as it makes up >75% of the property segment.

However, developers continue to lament. Over the last two years, our universe of developers has adjusted to the current market condition by offering more ‘affordable housing’ products in urban areas with pricings mainly ranging from RM400k- 700k/unit. However, REHDA’s recent 1H17 developers survey indicated that 73% of the respondents are facing buyers with end-financing problems, of which (i) 52% saw potential buyers being rejected by banks for those purchasing properties below RM500k/unit, (ii) 22% bank rejection for those between RM500k-700k/unit, (iii) 26% bank rejection for properties above RM700k/unit. The survey also indicated that developers have also been assisting buyers with the 10% down-payment and are discounting selling prices to boost sales and we reckon this is largely applicable to inventories or unsold units from projects, which are nearing completion. Admittedly, the ground survey does indicate that buyers’ ability to secure lending has improved compared to last year, although it is far from the ‘good old days’, and that banks are not fully factoring rebates/discount/freebies into property prices used for the loan application. The main impasse is obtaining the ideal margin of financing, of which even some first-time home buyers struggled to secure to full 90%.

So who is benefitting from better property loan indicators? Unfortunately, at the time of this report, the JPPH/NAPIC 2QCY17 property data was not yet publicly available and thus, we were unable to analyse which housing or property price segments have been benefitting from the improved banking sector data.

Our universe of developers may not be feeling the full impact of the improved lending environment as lending may have been channelled to the government housing schemes (e.g. PR1MA, MyFirstHome Scheme); recall that in Budget 2017 announcement, a new special ‘step-up’ end-financing scheme for PR1MA (up to 90%-100% end financing) was implemented on 1 Jan 2017, which is a collaboration between the government, BNM, EPF and the four major local banks (Maybank, CIMB, RHB, AMBANK). We also see a wave of competition of affordable homes from state housing initiatives (e.g. Rumah WIP, Rumah SelangorKu) and private developers (e.g. Binastra, Aset Kayamas, Skyworld, Maxim) while we note that projects with rapid takeup rates tend to be those priced between RM300-500k/unit with built-ups of 600-850sf and located in KL or near TOD stations.

So will we see loosening of monetary policies to the sector? We doubt so. The ratio of Property Loans Approved to Applied remains stable at 39% but is still a historical low while there has been a marginal improvement in the ratio of Property Loans Approved to Total Loans Approved to 36% (CY16: 35%), indicating that banks are still relatively cautious of exposure to this segment due to already high exposure. Note that in terms of outstanding loans, the banking system exposure to the purchase of property (residential and non-residential) is now at a peak of 58% (1H17) while LDR remains high at 90.3% (Aug-17). As a result, we do not foresee any significant loosening monetary policies and expect interest rates to be kept unchanged this year.

While we can say the worst is over and that the sector has found a bottom, we are far from an overdrive mode and the current level of property transactions may be the new norm.

Earnings and sales trajectory remains unexciting with looming margin issues. Our universe’s total FY18-19E earnings growth is only at -2% to +3% while FY18-19E sales trajectory remains unexciting at +4% each. We also anticipate near-term headwinds like margin compressions arising from: (i) late delivery penalties or LADs, (ii) promotional costs include discounts and rebates, (iii) rising building material cost, especially from steel, (iv) change of product mix to lower margin ones as our universe of developers are rolling out more affordable housing projects compared to the past. While we have built in these negatives into our estimates during the last reporting season, there is no guarantee that the full impact has been imputed as this depends on how earnings will pan out next year.

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Expecting range-bound valuations over 4QCY17. Currently, our universe RNAV discount is at 52.3% which is just slightly below its historical average of 50.6%, and we expect our universe’s RNAV discounts to oscillate around the historical mean pending confirmation on whether developers can: (i) achieve their full-year headlines sales targets, and (ii) guide for healthier growth rates for 2018. Most Klang Valley-based developers’ RNAV/SoP discounts are pegged at mean to +1.0SD levels while Johor-based developers are at -0.25SD to historical peak levels which we think is fair for a sector that has bottomed while significant sector catalysts have yet to materialize.

Source: Kenanga Research - 5 Oct 2017