We downgrade the property sector to Neutral from Outperform as we switch our investment narrative to focus on the sector’s challenged fundamentals instead of a tactical rebound play based on depressed valuations previously. We do this because the effectiveness of a rebound play wanes over time and market will eventually gravitate its focus back to the sectors structurally challenged aspects i.e. affordability, oversupply, policies. While some may argue that the low interest rates environment will spur property purchases in subsequent years of recovery like the post-GFC era, we would argue otherwise. The sector context is no longer the same with current household leverage (through household debt/GDP ratio) being significantly higher than in 2009 – limiting debt headroom by consumers to fuel property sales. While developers under our coverage are trading at appealing PBV valuations of 0.2-0.4x, we note that these value buys will remain exactly that if there are no convincing signs of growth from the earnings and sales front. Any housing incentives currently will only act as a sentiment booster and will not dramatically shift the downward trajectory faced by the sector since 2014; unless concrete earning figures starts trickling in.

Downgrade to Neutral from Outperform as we switch our investment narrative to the sector’s challenged fundamentals instead of a tactical rebound play based on depressed valuations previously. Earlier, our tactical Outperform call was premised on the fact that the steep fall in share prices and valuations (in March) were bound to see a relief rebound. While we did witness a rebound; the effectiveness of a relief rebound wanes over time and market focus will gravitate back onto the sectors’ fundamentals which is still plagued with structural issues.

Lower interest rates and incentives will help support property sales, but unlikely to increase it. Tracing back to the GFC era when OPR rate was reduced drastically from (3.5% to 2.0%) in 2008/09, properties sale did not pick up immediately in the year itself (refer figure 1). Needless to say, the weak economic backdrop which shattered confidence and outlook greatly overshadowed the perks of the lower financing rate then. Synonymous to the previous crisis, developers under our universe have generally lowered number of launches and sales targets this time around (refer Table 1). None of them are optimistic enough to increase launches or targets despite the easing monetary and fiscal policies.

While the subsequent years (from 2010 to 2014) saw strong recovery as evident by the increasing property transaction values, we opine that the current backdrop coming out from the Covid-19 crisis is slightly different compared to the GFC era. Back when the GFC hit, household leverage (through household debt/GDP ratio in figure 2) was lower (at 64% in 2008), allowing households the means to gear up to purchase properties. However, going into this Covid-19 crisis, household leverage was 19ppt higher at 83% (as of 2019) which limits the debt headroom to drive significant property sales moving forward

Structural issues require concerted effort to address. The common issues plaguing the sector has been the same few, namely: (i) the lack of auto release mechanisms for unsold Bumi lots in certain states, (ii) compliance and capital contribution costs, (iii) high land conversion premiums, (iv) social housing obligations, and (v) foreign buyers’ threshold. These long standing issues require the cooperation between federal, state governments and the developers to be remedied. If a common ground can be found, all these would reduce the costs to buyers, translating to more affordable price points.

That being said, another deeply rooted structural issue would be the oversupply situation we are currently in. In our view, the oversupply situation stems from persistently high land prices coupled with developers’ constant pursuit of profitability and growth in a cyclical sector. In the path of seeking growth, developers compromise on the living quality of developments i.e. higher density and smaller units on a higher PSF pricing – leading to the overall lack of appeal of units which translate to low demand and in turn oversupply. Case in point, when cooling measures were introduced back in 2014, developers continue to press ahead with launches (refer Figure 3) leading to an unproportioned supply influx on the back of a weaker demand. Indirectly, the oversupply situation has caused the Malaysia HPI YoY growth (refer figure 4) to moderate throughout the years and will likely continue to experience low growths moving forward.

Low PBV suggests value buy, but concrete earnings growth needed to lure investors back in. Since hitting the peak in 2014, the KLPRP index has entered into a long-term downtrend trajectory. While valuations are indeed appealing at this juncture (0.2 – 0.4x PBV, the overall sector will require a long-term remedy to convince investors that sales and earnings moving forward could see a structural uptick. For the time being, the macro context of the sector suggests that meaningful growth is still lacking and sales and earnings of developers are still skewed towards the downside and the floor has yet to be seen. For the upcoming budget, we think that further incentives to the sector i.e. DIBS would temporarily boost affordability as well as market sentiment. However, until structural earnings growth trickle in, it might be tough to envision a direction turnaround in sector share prices. That said, we do see thematic trading opportunities such as HSR revival which could spur interest in specific counters. Post house-keeping, we have a blanket de-rating to our universe’s targeted PBVs to -1.5SD or below (some were pegged at -1.0SD) to reflect the lingering structural issues.

Sector risks include: (i) the domino effects in the event of financial obligation defaults by key property companies, (ii) impairment of receivables / inventories, (iii) falling property prices, and (iv) rising building material costs.
 

Source: Kenanga Research - 6 Oct 2020