We  downgrade  the  property  sector  to  NEUTRAL.  Our  stock  picks  are Sunway,  IJM  Land  and  Matrix  Concepts.  We  expect  2015  property transaction  volume  to  fall  by  3-5%  on  the  back  of  slower  economic growth and high loan rejection rate, while property prices to stay flat, as developers will  likely  have difficulties in  passing  on incremental costs. We estimate new sales to drop by 10-20% from -25% in 2014.

Expect 1H15 transaction volume to fall by 5-10%.  We expect overall residential and commercial property transaction volume to fall by 5-10% in 1H15 (vs +2.8% HoH in 1H14) and 3-5% for 2015. The decline should be  more  severe  in  2Q15 immediately  after  the  implementation  of  GST from 1 Apr 2015. Based on Singapore’s  experience, after the GST rate was raised to 7% from 5%  in July 2007, residential property transaction volume  contracted  by  41%  HoH  in  2H07.  We  expect  the  Malaysian market to experience a similar trend but with a milder fall.  

Sentiment  hit.  RHB  economics  team  has  cut  its  2015  GDP  growth forecast  to  5.0%  from  5.3%  (vs  5.8%  in  2014).  The  slower  economic growth  and  the  recent  sharp  drop  in  equity  prices  are  hitting  market sentiment. We expect this to dampen the demand for property next year.  

Average new  sales to  drop  by  10-20%.  We  believe  both buyers  and developers will  adopt a wait-and-see attitude, and hence launches and take ups will  likely  be slow.  As we expect property prices to be flat or up slightly  by 3-4%,  given lower volume, we estimate new property sales to fall by an average 10-20% in 2015 from -25% in 2014 and +41% in 2013. 

Less  exciting  earnings  growth  ahead.  To reflect  our  expectations  of the  property  market,  developers’  earnings  growth  in  FY16  should  be negative, or flattish at best. The Penang property market, however, could fare  slightly  better  as  the  weakening  MYR  should  benefit  both  exports and tourism, which are the key economic activities of the state.

Downgrade to NEUTRAL.  The sector is  now  trading at a 33% discount to RNAV, and we expect the discount to widen towards the mean level of about 40%. Overall, we raise our discount to RNAV by 5-15%. We prefer stocks with ongoing corporate exercise,  such as Sunway and IJM Land,as the  upside  is more promising,  and  both also offer an exposure to the construction sector, where  we have an OVERWEIGHT rating.  Affordable housing players should also fare better, due to the resilient demand. Our Top Picks are Sunway, IJM Land and Matrix Concepts.

Lack Of Catalysts In Sight

Property sector outperformed the market YTD
In  line  with  our  previous  sector  rating  (OVERWEIGHT),  the  property  sector  has outperformed  the  market  this  year.  YTD,  the  KL  Property  Index  (KLPRP)  has appreciated by 4%  vs  FBMKLCI’s -6%. Relative to the performance of other sectors, property  is  the  best-performing  sector  after  telecom  &  tech  and  mining  (O&G). However,  we  expect  the  operating  environment  to  be  more  challenging  going  into 2015 especially as GST kicks in. Current valuations for the sector have yet to price in the  sharper  decline  in  property  sales  next  year.  We  downgrade  the  sector  to NEUTRAL.

Expect 1H15 transaction volume to fall

We expect overall residential and commercial property transaction volume to fall by 5-10% in 1H15 (vs +2.8% HoH in 1H14) and 3-5% for 2015. While loan rejection rate should  remain  high  (currently  at  40-50%  quoted  by some media reports)  as  banks continue to tighten mortgage lending, the impact of GST will also kick in from 1 Apr 2015. The fall  should be  more severe in 2Q15, immediately after the implementation of  GST.  Based  on  the  empirical  evidence  in  Singapore,  regardless  of  whether  the impact is direct or indirect, the property transaction volume typically spikes before the GST rate goes up, followed by an immediate increase in prices and a drop in volume post rate hikes. In 2H07 after the GST rate in Singapore was raised to 7% from 5%, residential  property  transaction  volume  contracted  by  41%  HoH.  We  expect  the Malaysian market to experience a similar trend but with a milder fall next year.

The  implementation  of  GST  will  likely  affect  consumer  sentiment  and  raise inflationary pressure, which in turn will not help in encouraging  the  propensity  to buy properties. Although property prices may be held up slightly due to the tax impact,  we believe a large increase in prices is unlikely given that the  demand is expected to be weak, and  developers could face difficulties  to  even  mark up prices and  to pass on the  incremental  costs.  Coupled  with  the  expected  fall  in  transaction  volume,  this would, therefore, translate into lower property sales for developers going forward.   We believe  buyers  will  be  cautious  in  making  their  buying/investment  decisions  and developers will be careful with their launches, and hence they will likely adopt a wait and-see attitude. New launches and take ups will then slow down. As a result, for the stocks under our coverage, we estimate new property sales to fall by an average 10-20% in 2015 from -25% in 2014 and +41% in 2013.

Slower GDP growth and a sharp drop in equity prices hit sentiment

Apart from the  GST  impact,  we  also  expect  the  slower  GDP  growth to  drag  down property transaction volume next year, as  the  macroeconomic environment typically has  the  largest  impact  on  property  market.  The  RHB  economics  team  has  cut  its 2015 GDP growth forecast to 5.0% from 5.3%, a weaker growth compared with 5.8% estimated  for  2014.  The  downward  revision  is  primarily  due  to  the  “stall-speed” recovery in some major world economies such as the Eurozone, Japan and China and uneven growth for the  US and UK, which could affect the strength of Malaysia’s export growth. On the domestic front, falling oil & gas (O&G)  investments on the back of  plunging  oil  prices  and  slower  property  investments  will  likely  exacerbate  the slowdown in economic growth next year. In addition, there could also be downside risks of businesses and consumers over-reacting to  the implementation of the GST. Meanwhile, the recent sharp drop in equity prices (6% in less than two months since November)  should  affect investors’ buying sentiment and the fall in CPO and rubber prices should affect the rural households’ incomes and their purchasing power.

At the same time, the  Malaysian Institute of Economic Research’s  (MIER)  consumer sentiment index has dropped to below the threshold of 100, ie by 2.1 ppts to 98.0% in 3Q14, while its business conditions index also plunged by 17.0  ppts  to 95.9 in 3Q, well below the threshold of 100 points. 

All  these,  together  with  softening  commodity  prices  and  expectations  of  a  slower economic  growth  in  the  period  ahead  will  mean  property  transactions  could  likely continue to come in below expectations going forward.

Cooling  measures  and  inflationary  pressure  neutralise  “last-minute” buying

While  new  sales  have  started  to  recover  in  2Q,  the  momentum  for  3Q  new  sales appeared to have tapered off (SP Setia has yet to release  its  quarterly results). The “last-minute”  buying of  big-ticket  items  ahead  of  the  GST  implementation is  not  as evident  as  expected,  as  the  impact  of cooling measures  continues  to  work its  way through  coupled  with  rising  inflationary  pressure.  To  recall,  the  Government announced  a  14.9%  electricity tariff  hike  effective  from  1  Jan  2014  and  raised  the retail  prices  of  RON95  petrol  and  diesel  by  20  sen  each  to  MYR2.30/litre  and MYR2.20/litre  respectively, or 9.5%  –  10.0% effective 2 October. Although the prices have recently been adjusted downwards  in tandem with falling crude oil prices, the decline is only <2%.

Tightening policies unlikely to be loosened up 
The  tightening  measures  imposed  by  Bank  Negara  (such  as  lowering  the  loan -tovalue cap to 70% for third home mortgage onwards, and computation of household debt  based  on  net  income)  since  late  2010,  combined  with  the  slew  of  cooling measures announced in Budget 2014 by the  Government have successfully slowed property  sales,  in  line  with  the  desired  results  of  the  policy  makers.  Although  the developers have been lobbying to loosen up some policies, we think this is unlikely to happen as household debt to GDP ratio remains relatively unchanged at 86.7% as at end-June 2014 vs  86.8% in end 2013.  Affordability is still an issue as property prices have  yet  to  have  meaningful  adjustments,  although  their  growth  has  gradually tapered off.

Lower transaction volume will hurt earnings growth
Given  our  expectations  of  the  property  market,  we  believe  earnings  growth  for property  developers  will  be  rather  flattish,  especially  in  FY16.  In  our  forecast,  we have  factored  in  the  impact  of  slower  sales  and  hence  flat  or  negative  earnings growth in FY16. Thematic angles and news flow for Iskandar and Penang as well as the  Klang  Valley  seem  to  be  lethargic.  Disappointingly, the  announcement of  MRT Line 2 in end-October also did not generate any excitement on property stocks. Apart from the upcoming Penang transport master plan and high-speed rail projects, we do not foresee any major  news flow going forward. The Penang property market could be  more  favourable  as  the  weakening  MYR  should  benefit  exports  and  tourism, which are the key economic activities of the state.  Both manufacturing and services sectors account for more than 90% of Penang’s economy. Hence, affordable housing players such as Tambun Indah should still fare better.

Meanwhile,  the  Iskandar  market  will  remain  challenging  over  the  medium  term  as oversupply  of  housing,  exacerbated  by  the  incoming  units  to  be  built  by  foreign developers,  will  take  years  to  be  absorbed.  According  to  CBRE,  as  at  1Q14,  the existing supply of high-rise residential units in Iskandar stands at 31,082 units, while 28,874 units are under construction. This means that the existing supply will almost double  in  the  next  3-4  years.  Among  the  high-rise  residential  projects  that  will  be completed  over  the  next  3-4  years  include  Setia  Sky  88,  Tropex  Residences, Paragon Residences, Sky Suites @ Meldrum and The Peak (One Temenggong).

Key risk to our call

Stronger-than-expected  GDP  growth  may  derail  our  investment  thesis.  However, given the outlook of the economy, we think this is unlikely to happen.

Valuations
We  downgrade  our  sector  rating  to  NEUTRAL.  The  sector  (for  big  caps  only)  is currently  trading  at  33%  discount  to  RNAV,  and  we  expect  the  discount  to  widentowards the mean  of about 40%  as the market de-rates the sector. Overall, we raise our discount to RNAV by 5-15% to reflect the bleak outlook for  the  property sector. We maintain our BUY rating for stocks with ongoing corporate exercises, such as IJM Land and Sunway as the upside for these stocks is more promising. Both stocks also provide an exposure to the construction sector, on which we have an OVERWEIGHTrating.  We  keep  SP  Setia  as  a  BUY, as the  stock  has  a  potential  M&A  angle. We continue to like affordable housing players  such  as Tambun Indah,  Matrix Concepts and Hua Yang as the demand for the mid-range  housing segment  should be more resilient. Our Top Picks are Sunway, IJM Land and Matrix Concepts.

Source: RHB