We  upgrade  the  Malaysia  property  sector  to  OVERWEIGHT.  This  is underpinned  by:  i)  undemanding  sector  valuations,  ii)  catalysts  from upcoming  infrastructure  projects,  iii)  a  stronger  2014  GDP  growth outlook,  and  iv)  a  negative  real  interest  rate  environment.  We  also recommend switching  to larger-cap  property stocks from the small-cap ones. Our Top Picks are IJM Land and Sunway.

• Negatives  priced  in.  We  upgrade  the  sector  to  OVERWEIGHT  from Neutral.  We  believe  that  five  months  after  the  2014  Budget  was announced,  the  sector’s  valuations  have  largely  priced  in  the  negative impact of the Government’s cooling measures. It is now trading at a 33% discount to  RNAV, slightly higher than the  pre-election  level, and much lower than the recent peak of 13%.
• Switching  to  larger  caps.  Since  Jan  2013,  the  share  prices  of  the small-cap  property  stocks  within  the  Kuala  Lumpur  Property  Index (KLPRP)  have  appreciated  by  59%  vs  the  larger  caps’  26%.  As  small caps  have  rallied  sharply  over  the  past  one  year,  we  advise  that investors  take  up  positions  in  the  larger-cap  property  stocks,  as  these developers are typically those with much stronger balance sheets, better landbank  portfolios,  stronger  brand  names,  solid  management  and execution track records. They are now trading at attractive valuations .
• Infrastructure  projects  to  drive  growth.  The  high-speed  rail  (HSR),MRT Lines 2 & 3,  and  Kwasa Damansara projects  will be the additional re-rating  catalysts  for  the  sector,  especially  within  the  Klang  Valley. Penang’s growth will still be  primarily  driven by the  flow of  investments into  Batu  Kawan.  As  for  Iskandar  Malaysia,  although  demand  in  the physical market will take longer to  recover,  there  is  market speculation that  a new casino may  be built  in Johor. If  this  materialises, it  could give rise to spillover effects on that region’s property sector.
• Stronger  GDP  growth  supportive  of  demand  recovery.  Our expectation of a demand recovery in 2H14  is also driven  by  a  stronger 2014  GDP  growth  outlook  and  the  implementation  of  the  goods  and services  tax  (GST)  in  April  2015.  We  expect  demand  to surge  prior to GST  implementation  while  our  in-house  estimate  of  a  stronger  GDP growth of 5.4% this year (2013: 4.7%) is favourable to the sector.
• OVERWEIGHT.  Our Top Picks are IJM Land  and  Sunway. We still like Tambun Indah and Matrix Concepts for their thematic angle.

Ready For a Rebound
Where we’re at We upgrade the property sector to OVERWEIGHT from Neutral. Five months  after the  2014  Budget  announcement,  we  believe  the  sector’s  valuation  have  largely priced in the negative impact of the cooling measures  and is  currently  trading at  a 33%  discount  to  RNAV.  This  is  slightly  higher  than  the  pre-13th  General  Election level (ie prior to early May 2013) and is much lower compared with the recent peak of 13% as at end-May 2013 to early June 2013, ie a month after the election was held.

The slew of cooling measures has largely worked to “cool down” the property market, as evidenced by the slowdown in property sales since 2H13. As developers were not confident  in  rolling  out  new  projects  at  end-2013,  given  the  weak  demand,  new launches  were  meagre  during  this  period.  The  Iskandar  Malaysia  market  was  the worst affected. Based on our observations, presales by some of the developers there have been discouraging and demand has waned substantially since the 2014 Budget announcement.  Therefore,  we  believe  the  pricing  points  of  new  projects  slated  for launch  over  the  next  few  months,  including  Avira  by  E&O  (EAST  MK,  TRADING BUY, FV: MYR2.70)  and Citrine by Sunway  (SWB MK, BUY, FV: MYR3.33)  –  note that UEM Sunrise (UEMS  MK, TRADING BUY, FV: MYR2.73) has delayed its Almas project  –  will  be  very  crucial  in  regaining  buyer  confidence,  especially  when  these developments make their debut in the market.

Total property sales of the  nine  developers  under our coverage  rebounded  in 4Q13 from  3Q13,  which  we  believe  could  be  due  to  buyers  rushing  to  sign  sales  and purchase  agreements  (SPA)  before  the  lapse  of  the  developer  interest  bearing scheme (DIBS)  on  1 Jan 2014.  For 1Q14, we expect sales numbers to remain weak in general, given a lack of new launches and weak property demand.

Taking a re-look at larger caps

We believe investors should start positioning  for the larger-cap property stocks, after a  significant  run-up  in  the  small-cap  space.  Since  Jan  2013,  share  prices  of  the small-cap  property  component  stocks  with market caps  of less than MYR2bn within the KLPRP  have  appreciated by 59% vs  larger caps’ 26%  (measured by aggregate market cap). While the index has drifted downwards  since May/June  2013,  when the US Federal Reserve (US Fed)  was mulling  over the tapering of  quantitative easing (QE3),  the  small-cap  property  stocks  have  started  trending  upwards  from  4Q  last year, and more significantly in 1Q14. We believe this was largely due to their cheaper valuations  while, at the same time,  investors also avoided the larger caps  that  are typically  perceived  as  a  proxy  to  the  Malaysia  property  sector.  During  this  period, news  flow  on  a  few  selective  stocks  such  as  Eco  World  Development  (ECW  MK, NR), Malaysia Aica (MAI MK, NR) and Daiman Development (DD MK, NR)  –  either relating to the injection of assets or other developments  –  also helped to stir investor interest in the small-cap space.

Going into 2Q, we advise investors  to position for the larger-cap property stocks,  as these  developers  are  typically  those  with  much  stronger  balance   sheets,  more strategic  landbank  portfolios,  stronger  brand  names,  and  better  management  and execution  track  records.  Apart  from  the  attractive  valuations,  our  upgrade  is  also underpinned by: i) a stronger GDP growth  outlook for 2014, ii) catalytic infrastructure developments, and iii) a negative real interest rate environment.

Stronger GDP growth in 2014 supportive of demand recovery in 2H

Property transactions and sales typically track GDP growth closely (see Figure 4). As we expect the latter  to be stronger this year, we  believe  the Malaysia  property sector will  recover in 2H14. On the back of  our  2014 GDP growth forecast  of 5.4%  vs  4.7% in  2013,  we  estimate  stronger  residential  and commercial property sales  growth  of 10.7%  and  9.5%  this  year  compared  with  -2.8%  and  -1.5%  in  2013  (based  on annualised  1H13  numbers)  respectively.  The better economic outlook will be largely underpinned by stronger exports, driven by a stable economic recovery in the US and Europe, and a weaker MYR. RHBRI expects real exports to pick up pace to +4.5% in 2014 vs  -0.3% in 2013. Locally,  private consumption and  investment will also likely remain resilient this year, with estimated growth of +5.6% (2013: +7.6%) and +14.5% (2013: +13.6%) respectively.

Meanwhile,  the  implementation  of  the  GST  from  1  April  2015  is  expected  to  spur demand for big-ticket items, such as white goods and properties , as consumers rush to make purchases  to avoid paying  the  tax. In anticipation of a price increase of at least 6%  next year  due to this tax,  and the  likelihood of  the  incremental cost  being passed on by developers, we believe demand for properties will increase in 2H14.  By this  time,  consumers  will  have  largely  digested  the  impact  of  inflationary  pressure arising from the Government’s 2013 fuel, electricity and sugar subsidy cuts – a move that has given rise to a significant chain effect in the macro economy.

Property still a hedge against inflation
Property  is  always  seen  as  a  preferred  asset  class  to  hedge  against  inflation  and store  value.  Another  reason  we  think  demand  will  return  is  because  we  expect inflation to  inch  up going forward, more so after the GST is implemented. Already, Malaysia is in a  negative real interest rate environment.  Following  the  Government’s subsidy  rationalisation,  February  headline  inflation  rate  stood  at  +3.5%  y-o-y  from January’s  +3.4%, Dec 2013’s  +3.2% and  Nov 2013’s  +2.9%, compared  with  2.97% for a 3-month fixed deposit rate. The accelerating inflationary pressure found its roots in  a fuel price hike  in Sept  2013, which  continued to spill over  into  higher  prices of other products  and services. We expect  the situation to worsen due to a  power tariff hike that came into effect on 1 Jan 2014. Overall, we expect inflation to trend up to an average rate of  3.0-3.4% in 2014 from +2.1% in 2013,  and  to  3.5-4.0% in 2015, the highest since 2008.

The negative real interest rate environment is likely to persist.  Although the gap will narrow,  as  we  expect  Bank  Negara  Malaysia  (BNM)  to  only  raise  interest  rate  by 25bps in late 3Q14 to 3.25%, cash-rich individuals, corporations  and institutions will still  find  real  estate  more  appealing  for  capital  preservation.  On  the  other  hand, although  higher  interest rates  are  generally not favourable  to the property sector, we believe a gradual hike by a small quantum, ie  25 bps, will be manageable,  as  the current  average lending rate (ALR)  still stands at around 4.5-4.6%  vs  4.7-4.9% over the last two years. The current mortgage rate is about 4.2-4.3%.

A push from infrastructure catalysts

Infrastructure developments are typically a boost to the property sector. This year, we expect three key projects to be announced, namely: i) the HSR link, ii) MRT Lines 2 & 3, and iii) Kwasa Damansara development.

The objective of HSR link is to enhance the connectivity between Kuala Lumpur  and Singapore  by  cutting travel time  between  the two  cities to just  90 minutes  vs  the  2-3 hours currently.  Feasibility studies of the  HSR  are currently underway, and both  the Malaysian and Singaporean Governments are currently reviewing new landing points to  optimise  the  connectivity  to  other  transportation  networks.  According  to  Land Public Transport Commission (SPAD) CEO Mohd Nur Ismail Mohamed Kamal, the project  is now at its pre-tender Phase 2, which includes  a finalisation  of engagement with Singapore as well as a finalisation of project structure that will be the main input to the tender process.  We believe  once the alignments and locations of the stations are confirmed, developers will be busy taking position in their landbanking strategies. We see  the  same  impact  when  MRT  Lines  2  &  3  are  announced. We  believe  the spillover  from  both  the  HSR  and  MRT  projects  to  the  property  market  will  be  the greatest in the Klang Valley, while sentiment in the Iskandar Malaysia market will also likely  recover. We  expect  the  news  flow  from  both  projects  to  stream  in  from  mid-2014.

The much anticipated  2,330-acre  Kwasa Damansara development  in Sungai Buloh, Selangor,  is  making  some  progress.  The  latest  announcement  is  of  the  20  pre qualifiers for the development of  a 64-acre tract of land called Project MX-1.  The first phase comprises a mixed development  parcel  that will  be  integrated  with the MRT station  that  fronts  the  main  road.  Based  on  our  checks  with  industry  players,  the potential  GDV  of  the  64-acre  land,  with  a  plot  ratio  of  3.5x,  must  not be  less  than MYR7bn,  and  must be fully completed within 12 years.  Apart from  Kwasa Land SB holding  a  30%  stake  in  the  joint  venture  (JV),  developers  must  also  include  some profit  guarantee  terms  in  their  proposals.  These  20  prospective  developers  are required to submit their qualitative and quantitative plans by 27 May, according to a media report.  While taking part in this mega development will be exciting, given the terms and conditions, we believe developers will also need to balance  the risk-reward factors so that their balance sheets will not be weighed down.

Meanwhile, we remain positive on the outlook for  Penang mainland market, given the development  activities  in  Batu  Kawan,  which  has  seen  a  few  industrial  players operating or setting up their plants. With the entrance of IKEA, we expect  this area and Seberang Perai  Selatan  to experience a similar trend  to  what we saw in Taman Tun  Dr  Ismail/One  Utama/Mutiara  Damansara  in  the  Klang  Valley  when  the  first IKEA/Ikano outlet opened in 2003.

Proper  development  plans  are  already  in  place.  Education  institutions,  including GEMS International School in Pearl City, KDU  and University  of Hull  campuses, as well as a premier shopping outlet by PE Land and CB  Richard  Ellis  will be built  over the next 3-4 years. In the coming months, the Penang Development Corp is expected to award the tender for a golf course and  a theme park, with Eco World speculated to be  the  winner.  Currently,  Tambun  Indah  (TILB  MK,  BUY,  FV:  MYR2.20),  a  pure Penang mainland play, is already enjoying strong property sales.

While the Iskandar Malaysia market will still be rather challenging over the short term, on  ongoing concerns  over  oversupply as well as its high exposure to  foreigners, we believe  the  HSR  project  will  help  regain  market  confidence.  In  addition,  the  media reported earlier on a casino that may be built in Johor. If this is proven to be true, the development  could  have  some  spillover  effects  on  the  property  sector,  apart  from stimulating the tourism industry in the region.

Valuations
We  upgrade  the  Malaysia  property  sector  to  OVERWEIGHT  (from  Neutral).  Our upgrade is underpinned by:  i)  a  stronger GDP growth  outlook for 2014,  ii)  catalysts from  infrastructure  developments  such  as  the  MRT,  HSR  and  Kwasa  Damansara projects,  and  iii)  undemanding  valuations  as  the  negative  impact  of  the  cooling measures have been priced in. The negative interest rate environment will also make properties one of the preferred asset classes for capital preservation. We recommend that  investors switch to larger-cap property stocks, as they are  a  better  proxy to the property  sector,  especially  with  market  demand  expected  to  recover.  We  remain selective  on  the  smaller  caps  and  still  like  the  affordable  housing  players  such  as Tambun Indah and Matrix Concepts (MCH MK, BUY, FV: MYR5.00) for their thematic angle.  Among the larger caps,  we prefer IJM Land  (IJMLD MK,  BUY, FV: MYR3.70) and  Sunway.  We also urge investors to watch out for UEMS  and E&O.  The formerwill  be  one  of  the  prime  beneficiaries  when  the  HSR  or  casino  projects  are announced, while the latter is expected to obtain approval for  its Seri Tanjung Pinang 2 project in mid-2014. We also view E&O as a potential takeover target.

S

Source: RHB