Maintain NEUTRAL as the sector remain plagued with affordability, policy and oversupply issues. We feel the sector still lacks sustainable earnings visibility and growth to justify a re-rating in valuations. While sales numbers reported by developers have been strong, we believe it would be increasingly hard to drive sales in CY22 given: (i) absence of HOC discounts, and (ii) expected interest rate hikes on the back of a persistent oversupply situation. The high unsold housing units in circulation and declining HPI are indicators that developers will find it increasingly challenging to drive sales while maintaining margins. That said, we feel that certain developers’ share price has undershot fair valuations and now provides appealing risk-to-reward opportunity. Such names include UEMS (OP; TP: RM0.40), SUNWAY (OP; TP: RM2.05) and SIMEPROP (OP; TP: RM0.725).

CY21 sales ended strongly. Developers under our coverage registered extremely strong sales in the last reporting quarter. The broad rationale behind the strong sales is largely due to the low interest rates climate coupled with the Home Ownership Campaign (HOC) incentives being implemented. Cumulatively, CY21 sales of RM19.3b were even stronger than pre-Covid years in FY18 and FY19 (refer below) thanks to the sales growth from ECOWLD, SUNWAY IOIPG, MAHSING and UEMS.

Anticipating headwinds in FY22. Despite the strong sales registered, we are cautious over FY22 sales prospects. This is due to: (i) absence of HOC (which ended in Dec 2021) – which offers house buyers cash savings of RM6.35k to RM28.5k (2.1%- 2.9%) for properties worth RM300k-1m, (ii) expected interest rate hike as the economy recovers (in-house assumption imputes 2x 0.25% hike towards end-2022), (iii) property cooling measures implemented in Singapore (in Dec 2021) – which would restrain sales for SUNWAY, and (iv) growing residential units in circulation* creating a more competitive landscape. Therefore, we anticipate a 13% drop in overall YoY sales by developers under our coverage to RM16.75b. Meanwhile, we find sales targets provided by management remaining rather optimistic given the rising headwinds. While such sales targets are not impossible, we believe it would be at the expense of margins.

*Units in circulation comprise: i. overhangs and ii. unsold units under construction within the residential and serviced apartment market. These data obtained from NAPIC.

Property development’s OP margins have been stable. Screening through the margins for developers under our coverage, operating margins (before JVA, interest and tax) have generally improved YoY from the lows in FY20 as economic recovery kicks in. In fact, some developers have seen margins recovered to pre-Covid levels in FY21 despite facing multiple lockdowns in that year (ECOWLD, MAHSING, SIMEPROP, UOADEV). We observe that such stellar performance is attributable to developers’ cost controls mainly from: (i) lower admin cost likely due to the reduced workforce/employee salary post-pandemic, and (ii) lower sales and marketing expense from less expensive digital marketing initiatives (instead of conventional physical methods) to drive sales. Nonetheless, MRCB and UEMS’ margins suffered as they could not reduce cost as quickly as the drop in revenue. This is mainly due to: (i) their lack of fresh sales, (ii) low unbilled sales at the start of the period, and (iii) less nimble cost structure.

While the pandemic has allowed developers to lower their cost base in the admin and marketing fronts, we foresee margin pressure to mount in FY22. This will come from fixed priced contracts awarded in FY21 (and potentially for the rest of FY22) which would encapsulate higher building material costs and labour translating to lower developers’ margins. To counter such a situation, some developers have resorted to varying strategies to contain the hike in material costs. For instance, ECOWLD has pivoted to launch higher margin products i.e. landed bungalows/semi-dees within their matured townships which commands higher margins.

Unbilled sales healthy. Despite the multiple headwinds ahead for the sector, developers under our coverage have rather healthy unbilled sales given the strong sales registered in FY21. All developers under our coverage have revenue cover of >1 year with the exception of UOADEV which only have RM0.09b worth of unbilled sales owing to the lack of launches over the last two years.

Growing net gearing a concern (we treat RCPS/ICPS/Perps as debt in our net gearing calculations). Since FY18, we observe that net gearing and net debt of developers have been growing (refer table below). This trend could mean that developers are taking on additional debt to fund new launches instead of recycling cash from preceding launches/completed properties to fund the new developments. This could potentially result in higher completed properties (in developers’ balance sheet) in the medium-term and might not be sustainable over the longer run – especially in this climate with a challenging outlook. Should companies continue to strive for aggressive sales backed by higher launches by taking on additional debt, we opined that their net gearing will balloon and leading eventually to equity fund raising – a frowned upon exercise for a sector without a sustainable growth trajectory. Note that SPSETIA currently has the highest net gearing within our coverage at 0.96x (as of FY21).

Rising interest rates will not only impede end-demand but also impact cash flow and bottom-line. The anticipated rise in interest rates this year attributable to rising inflations would translate to higher interest costs to the developers. Based on simple calculations, by multiplying 50bps* on developers existing borrowings, the additional interests required to be paid by developers under our coverage are listed below. However, note that the higher interest may not be reflected in the income statements for certain developers such as IOIPG which builds investment properties as they capitalise such interest costs into their balance sheet – thus only their cash flow is affected.

Maintain NEUTRAL. Overall, the sector still remains fundamentally challenged from affordability, policy and oversupply standpoints. Despite the low valuations (in PBV terms), the entire sector still lacks sustainable earnings visibility and growth to justify a re-rating. That said, we feel that certain developers’ share price has undershot fair valuations and now provides appealing risk-to-reward opportunity. Such names include UEMS, SUNWAY and SIMEPROP.

Our positive angle for UEMS (OP; TP: RM0.40) comes from: (i) internally-led initiatives to improve bottom-line and (ii) potential M&A exercises spearheaded by its major shareholder Khazanah Nasional given its cheap Fwd. PBV of 0.2x.

For SUNWAY (OP; TP: RM2.05), the kicker comes more from its healthcare segment which provides strong growth potential in the coming years. Meanwhile, we believe SIMEPROP (OP; TP: RM0.725) has better earnings visibility compared to peers as it owns vast land banks in matured townships allowing them to focus on landed/industrial products during these challenging times and therefore be less affected by the high-rise oversupply issue.

Source: Kenanga Research - 5 Apr 2022