The KLPRP Index (-17% YTD) has severely underperformed the FBMKLCI (+1.6% YTD) year-to-date. Valuations remain low with our universe’s RNAV discount (64.5%) approaching historical peak level (68.7%) and all are now trading below their book values. This could be a primer for potential M&As or even privatisation plays, although we have yet to hear of any such market whispers. While valuations appear compelling, there is no clear catalyst in sight and there are issues weighing down the sector. Earnings quality has deteriorated given several downward earnings revisions over the last few quarters, mainly driven by margin compression issues arising from inventory clearing efforts. Developers’ ROEs continued to weaken, which is more severe than the ROE trends of supporting sectors, namely construction (KLCON) and financials (KLFIN). The National Housing Policy 2.0 has been completed and is pending cabinet’s approval. Based on recent news flow on this policy, it indicates that the government is trying to balance between affordable housing needs and current oversupply situation from a primary and secondary market perspective; but we are curious how first-home-buyers’ hurdles with financing will be addressed considering the banking system’s current high exposure to real-estate. The landscape for developers will also remain challenging as we foresee less new launches since focus will be on inventory clearing, which means thinner margins, not to mention the pressure from the government to lower house prices due to SST exemptions and perhaps a more active secondary market. Although valuations are low, we see no near-term catalysts and expect most developers’ share prices to range-bound at current levels pending the Budget-2019 announcement (2-Nov) or if there are earlier announcements on housing policies or lending requirements. Reiterate NEUTRAL on Developers.

Weakness in property stock prices worsens as the KLPRP was down by 17% YTD vs. the FBMKLCI (+1.6% YTD). Big-boy players fared relatively better than small-mid cap ones with declines of -18% and -24% YTD, respectively. Over QTD-3QCY18, the KLPRP slid 4.4% although the FBMKLCI was up by 2.7%. The last reporting season was also lacklustre with evidence of further deterioration in earnings quality (refer to APPENDIX for 2QCY18 result review). It is clear the aversion to property stocks is still lingering.

Valuations remain low… will it trigger M&As? Our universe’s average RNAV discount has widened slightly to 64.5% from last quarter (63.3%), which is nearing the historical peak level of 68.7%. Majority of our universe is trading between -1.0SD to historical peak discount levels, save for SUNWAY and UOADEV, which are trading at the historical average to -1.0SD discount levels; note that SUNWAY and UOADEV have higher proportion of recurring income and/or diversified income, which explains their slightly more defensive share prices1. In terms of Fwd. PBV, all developers in our universe are now trading below book value with majority at trough or close to trough levels. For big land-bank owners, namely UEMS, IOIPG, and SPSETIA, their landbank costs are based on historical acquisition costs with bulk of acquisitions made many years ago, implying low land costs compared to prevailing market value – it also means that the company’s valuations imply no further development profit.

This may be a primer for potential M&As or even privatisation plays; but at this juncture, we have yet to hear any whispers on the matter. It is also our view that while small-mid cap players are also trading at very low PBVs, they are less likely to undertake any privatisation plays as their listing status is essential for their branding and positioning in the market; the assumption here is that their current listed entity is the only one listed i.e. no sister or mother listed companies. Based on our observations over the years, privatisations are likelier if there are other listed mother/sister companies while M&As tends to be strategic, likely involving GLC-driven ones. Most of our universe’s Fwd. PERs are slightly above historical averages to trough levels, though we highlight that Fwd. PER levels may not be representative as a comparison since earnings are retrospective for a developer while some have high earnings volatility, rendering PER valuations methods less meaningful.

Source: Kenanga Research - 5 Oct 2018