We  maintain  our  OVERWEIGHT  rating  on  the  property  sector.  We believe  concerns  over  an  interest  rate  hike  should  have  largely  been priced  in.  We  expect  a  stronger  GDP  growth  in  2014  and  the  frontloading of big-ticket items to  drive  a  stronger demand recovery in 2H. Mega  infrastructure  projects  will  be  the  wild  card  to  boost  the  sector further. Our Top Picks are Sunway, Tambun Indah and Matrix Concepts.

• Concerns  on  interest  rate  hike  largely  priced  in.  Since  our  sector upgrade  in  end-March,  the  Kuala  Lumpur  Property  index  has appreciated  by  7.4%.  The  rally  was  stronger  in  April,  but  it  fizzled  out when worries over an interest rate hike emerged in May. We believe the impact  has  already  been  priced  in,  and  a  25bps  hike  either  in  July  or September  should be manageable  for the property market, as  this  may raise monthly mortgage installment by only about 3%.
• Front-loading  has  not  happened  as  yet.  We  expect  a  stronger demand recovery in 2H. While the rush to buy properties has yet to be seen, we believe marginal property buyers and investors are likely to buy properties towards late  2014 to avoid  paying the 6% goods and services tax (GST)  which will take effect from  1  April 2015.  Meanwhile,  we  havestarted seeing an uptick in banking system property loan approvals since late 1Q14, pointing to a gradual recovery in property sales in 2Q.  
• Waiting  for  mega  infrastructure projects.  We expect more news flow on  the  highly-anticipated infrasructure projects  in 2H, such  as the MRT Line  2  &  3  and  high  speed  rail  link. We  believe  the  positive  impact  of both  projects  would  be  more  significant  in  the  Klang  Valley  region,  asbetter  connectivity  and  the  relatively  cheap  property  prices  in  Kuala Lumpur  will  likely  lure  more  Singaporeans  over,  given  the  ease  of travelling.
• Penang growth story still appealing.  We continue to like the Penang growth story and anticipate more news flow in the upcoming months In line  with  our  expectations,  the  JV  deal  between  Penang  Development Corp and Temasek to develop a business process outsourcing hub as well as  the  endorsement for  Seri Tanjung Pinang  2  (STP2)  masterplan were  announced  in  2Q.  The  tenders  for  the  proposed  golf  course  and theme  park  projects  are  expected  to  be  awarded  in  2H,  which  could prompt  another  round  of  RNAV  re-rating  for  the  Penang  mainland players. Tambun Indah is the key beneficiary.
• Maintain  OVERWEIGHT.  Our  Top  Picks  are  Sunway,  Tambun  Indah and Matrix Concepts.  Following the privatisation of IJM Land, the M&A angle could potentially spice up the sector. SP Setia is a likely candidate.

Look For Values
Current valuations
Since we upgraded the sector to  OVERWEIGHT  (from Neutral) on 27  March, the KL Property index has appreciated  by  7.4%.  The  re-rating was stronger in April, but it fizzled out when worries over an interest rate hike  emerged in May. Our Top Pick IJM Land  has performed well  after  IJM Corp  (IJM MK, BUY, FV: MYR7.90)  proposed to take it private  last month.  The  property  sector is currently trading at  a  32% discount to RNAV, still below the most recent peak at  a  20% discount to RNAV, during the post-13th general elections rally.

Impact of rate hike should be manageable
RHB  economics  team  expects  a  25bps  increase  in  overnight  policy  rate  (OPR)  in 2H14, either in July or September. In our view, the expected quantum of the rate hike should  be manageable for the property market,  as this may potentially raise monthly mortgage installment  by only  3%. The mortgage rate will  likely  continue to hover at 4.1-4.3%.

New property sales to pick up gradually from 2Q

In line with our expectations, new property sales slowed significantly by almost 50% q-o-q and 45% y-o-y in 1Q14, largely due to  the effect of cooling measures  and  therush  to  close  sales  in  4Q13  before  the  lapse  of  the  developers’  interest  bearingscheme  (DIBS)  in  1 Jan 2014.  The lack of new launches by developers  amid  weak market  sentiment  led  to  lacklustre  property  sales  in  1Q14.  Similarly,  the  growth  in house  prices  has  also  eased  since  2H13.  Malaysia’s  house  price  index  (HPI)  has only grown 8% this year compared  with 11-12% in mid-2013, and key regions such as Kuala Lumpur, Selangor and Johor have  all  seen the same declining trend.  The sluggish  property  stock  performance  in  4Q13-1Q14  has  largely  reflected  the  weak physical property market.
Coming  out  from  the  trough,  we  expect  sales  to  pick  up  gradually  from  2Q,  partly helped by  a slowdown in  property price growth  that may lift affordability  somewhat. Numbers should be stronger in 3Q. A few developers under our coverage are already seeing better  sales in April and May, including Tambun Indah  and Matrix Concepts. Apart from these, new launches such as UOA Development’s Sentul Point and South Bank,  IJM  Land’s  Rimbayu  Phase  3,  Eastern  &  Oriental  (E&O)’s  Avira,  Sunway’s Eastwood and Wellesley, Eco World  (ECW MK, NR)’s  Eco Majestic, Eco Business Park,  Eco  Spring  and  Eco  Summer  were  also  well-received,  largely  due  to  theproduct  types,  locations,  as  well  as  more  aggressive  marketing  efforts   to  regain buyers’ confidence.

Loan approvals start to tick up 

Loan approval rates for residential and non-residential properties are finally showing a sustainable recovery of above 51% and 46%  respectively  since January this year. This reinforces our expectations  that the sector’s  new sales are starting to recover from  2Q.  The  approval  rates  had  been  sliding  following  Bank  Negara  Malaysia (BNM)’s  announcement  of  prudent  lending  guidelines  that  took  effect  from  1  Jan 2012. Going forward,  we expect  loan  approval rates  to  continue to  improve as the rounds of policy tightening  measures should have largely wiped out the speculatorsand over-leveraged buyers over this 2-year period. Based on our recent checks, in anticipation of the  rate hike, some commercial banks are now offering more lucrative mortgage  packages  such  as a  base lending  rate  (BLR) minus  2.45-2.50%  to  draw more borrowers. This is positive to the property sector.

Stronger GDP growth and mega infrastructure projects are the sector’s key drivers 

Property transactions  and sales  typically  track  GDP growth  very closely.  In view of our economist’s forecast  of  a stronger real  GDP growth of 5.4% for 2014 vs  4.7% in 2013,  we  believe  the  better  economic  outlook  will  likely  flow  through  to  property demand. 1Q14  GDP growth was already  encouraging  at 6.2% y-o-y, faster  than the 5.1%  pace  in  4Q13.  The  stronger-than-expected  growth  was  mainly  driven  by  astrong  performance  in  the  construction  and  manufacturing  sectors  as  well  assustained recovery in exports (+18.7% and +16.3% in April and May respectively).

The re-rating for the Klang Valley and Iskandar property markets will likely come from the development of infrastructure projects. The  expected announcement of  the MRT Line  2  &  3,  being  the  line  connecting  Bandar  Baru  Selayang  to  Putrajaya   and  the circle line looping around the KL city centre, as well as the high speed rail (HSR) link from KL to Singapore in 2H will likely keep the momentum going. According to recent media reports, both Singaporean and Malaysian authorities have been meeting once every  month  on  the  HSR  project.  Both  Governments  have  entered  phase  two  of negotiations  on  the  project  to  decide  on  issues  such  as  technical  surveys,  socialeconomic  analyses  on  the  stations  and  the  environmental  impact.  The  Singapore authority  is  currently  studying  the  location  of  the  final  stop,  either  in  Tuas  West, Jurong East or the city centre. In our view, once  both projects  are announced, the Klang Valley property market,  especially  KL city centre,  will  likely  benefit the most, followed by the Iskandar region. The better connectivity and relatively cheap property prices between city to city will likely lure more Singaporeans over given the ease of travelling.  With  that,  we  are  likely  to  see  the  return  of  foreign  buyers  into  the  KL property market.  Meanwhile, given the two proposed stops (out of five)  in Seremban and Batu Pahat for the HSR link, Matrix Concepts could be a beneficiary in view of its landbank exposure. Currently, it has over 2,000  acres of land in Seremban and Labu areas,  and  its  Taman  Seri  Impian  project  in  Kluang  is  only  37km  away  from  Batu Pahat.  

On another front, Kwasa Land SB, the master developer for  the 2,330-acre Kwasa Damansara township, will likely see more parcels to be tendered out. The first 64.07-acre  parcel  Project  MX-1  was  recently  awarded  to  Malaysian  Resources  Corp (MRCB).  In  the  pipeline,  Kwasa  Land  is  expected  to  invite  the  bumiputera  (local bumiputera  developers  with  equity  holding  of  >70%  and  paid-up  share  capital  or shareholders’ fund  of  at least MYR1m and above)  and Tier 2 developers (medium scale  developers  with  paid-up  share  capital  or  shareholders’  fund  of  at  least MYR300m and above) for the bumiputera  and residential developments in 3Q and 4Q respectively.

Still prefer Penang property stocks

We still find the “Penang story” appealing, given the upcoming news flow after a slew of good news in 2Q. In May, a JV between Temasek and Penang Development Corp was announced to jointly develop Penang International Technology Park (PITP) and Business Process Outsourcing Prime (BPO Prime) on a 207-acre site in Batu Kawan, worth a GDV of MYR11.3bn. As the project is expected to create 30k new jobs, the spillover  effect  to  the  local  housing  market  is  expected  to  be  substantial.  Other catalytic  projects such  as  the  establishment  of  an  IKEA  mall,  a  premier  outlet  and education  institutions  in  Batu  Kawan  are  already  driving  strong  property  sales  at Tambun  Indah’s  Pearl  City  which  is  15  minutes  away.  In  June,  E&O  received  the endorsement  for  its  STP2  masterplan  from  the  Penang  state  government,  and  the reclamation works can be started in 4Q14. In the pipeline, we expect the tenders for the proposed golf course and theme park projects in Batu Kawan to be awarded in 3Q, and the Penang mainland players should then see another round of RNAV re rating as new land parcels will likely  be transacted at higher  prices. Property prices could  also  hit  record  highs  when big players, who enter at higher land costs, launch 
their  maiden  projects  on  the  mainland.  Tambun  Indah  should  be  the  largest beneficiary,  given its low land costs and decent product pricing. Other players with Penang mainland/Batu Kawan exposure include Global Oriental (GOB MK, NR) and Malton (MALT MK, NR).

GST impact on the physical market and developers’ P&Ls
We expect a stronger demand recovery in 2H, ahead of the implementation of  the GST.  As  Malaysia  is  adopting  a  GST  structure  that  is  different  from  those implemented  in  Singapore,  Japan  and  Australia,  we  lack  emp irical  evidence  to support  our  argument.  However,  as  an  indication  of  the  impact  of  taxes  on  theconsumption pattern, Japan’s  retail trade spiked 11%  y-o-y  in March this year, just before the consumption tax was raised to 8% from 5% in April. Hence, demand  for big-ticket items, which include properties, should pick up ahead of the   effective date of the  GST implementation in anticipation of higher prices. According to most of the property  developers  under  our  coverage,  the  GST  rate  of  6%  is  expected  to  pushproperty prices up by 4-10%.

The rush to buy properties has yet to be seen  for now. This could be attributed to  a lack  of  public  education  in  regards to  the  GST  impact  on  the  property  market and consumption. Nevertheless, we believe marginal property buyers and investors are likely to buy properties only towards late  2014 to avoid paying the tax. Demand for commercial properties, which are standard-rated for  the  GST, will likely surge more as  the  direct  impact  to  end-buyers  will  be  the  additional  6%  tax;  whereas  priceincrease for residential properties will be indirect as the segment is exempted from the  GST (but developers will likely pass on the incremental construction costs to end buyers, which are estimated at below 6% or so). Some  investors  are  also  concerned  with  the  potential  GST  impact  on  developers’ margin, especially after SP Setia  released its latest  weak quarterly results. Note thatdevelopers  with  sizeable  high-rise  integrated/mixed  developments  will  be  more vulnerable to the so-called “cost overrun”,  as the development period for this type of projects is usually longer and will cross the GST implementation date of 1 April 2015. While  SP  Setia  may  have  its  specific  reason  to  incur  the  significant  amount  of “provision” for GST financial impact in  its  2QFY14 results,  based on our checks with other major developers, we believe the sector earnings should be largely intact. This is  as  most  developers  constantly  review  their  budgeted  costs  of  construction  for every  project,  and  hence  the  financial  impact  of  the  GST  should  have  beenprogressively built in. Only a small number of projects may see some negative impact(due to various reasons), and hence the “provision” of the financial impact will have to be  incurred.  Meanwhile,  we  also  expect  developers  to  accelerate  the  construction progress  for  projects  currently  in  advanced  stages,  so  that  the  properties  can  be completed just before 1 April 2015 to avoid the tax impact on their P&Ls.

Key risks to our call

1.  Unexpected  market  risks  due  to  external  factors  that  could  affect  the  broad equity market.
2.  A larger-than-expected interest rate hike of 50-100bps in 2H14.

Valuations
We  maintain our OVERWEIGHT  rating for the sector. Despite the short rally in April, the sector is still trading at undemanding valuations. Key drivers for the sector are still the: i) better macroeconomic outlook given  a stronger GDP growth forecast for 2014, ii)  front-loading  of  properties  ahead  of  the  GST  implementation,  and  iii)  potential boost from mega infrastructure projects.  Meanwhile, apart from an  interest rate hike, we do not expect any significant  policy risk, as  house price growth  has eased after the massive round of cooling measures.

Stock selections are getting increasingly challenging as our Top Pick, IJM Land, is being taken private by IJM Corp, thus leaving fewer quality property stocks with the right angle to pick. As such, we advise investors to stick with the  winners such as Sunway for large-cap exposure and as a new proxy to the Malaysian property sector.The sum-of-parts for Sunway’s property and construction divisions are still relatively undervalued  compared  to  its  peers,  such  as  IJM  Corp  and  WCT  (WCTHG  MK, NEUTRAL, FV: MYR2.31), which have similar business divisions but are trading at higher  P/E  valuations  of 13-16x.  E&O, meanwhile, will continue to realise its RNAV as reclamation works for its STP2 start. Among the smaller caps, we still like Tambun Indah  and  Matrix  Concepts,  which  are  affordable  housing  players  with  respective thematic  angles.  Potential  M&A/privatisation  exercises  may  possibly  spice  up  the sector as well, with SP Setia as the likely candidate.

Source: RHB