Given sluggish economic growth ahead, we expect property sales for the developers under our coverage to fall by another 5-10% in 2016. Industry house prices and transaction volumes are estimated to contract by ~3-5%. We also do not expect any material policy loosening in the upcoming Budget 2016. Our value picks are IOI Properties and Tambun. We also like Paramount for its resilient education exposure. MRCB should also benefit from strong news flow.

Sector valuations at -1SD level. Current sector valuations are heading towards crisis levels, with sector P/BV already dipped below -1SD and discount to RNAV nearing the -1SD level. Given our GDP growth forecast of 4.8% and 4.9% for 2015-2016, and the ongoing political and macro issues, the property sector is unlikely to turn positive in 4Q. Focus on developers with prospective land value and solid balance sheets. New property sales growth is not likely to be the story over the next 12 months. In our view, however, value for selective stocks has emerged. We expect IOI Properties to stage a rebound from its low of 0.55x P/BV, benchmarking against the floor valuations of UEM Sunrise. The former is backed by a solid pool of recurring income-generating investment properties and 11,000 acres of development landbank. We also like developers that own valuable landbank in a relatively healthier property region, eg Tambun Indah Land (Tambun), which has 500 acres in Mainland Penang. Based on its current market cap, the implied land value looks attractive at only MYR25 psf vs the current market price of MYR35-40 psf for land parcels there. Prolonged undervaluation of some companies may set off a new round of privatisation.

Unsold inventory set to rise. Given the aggressive launches in the past and slower growth in new sales ahead, we expect developers to accumulate more unsold inventory. Inventory/new sales ratio has been on the rise since 2012, and about 75% of the developers under our coverage have a ratio of >0.5. New launches are likely to be fewer as developers concentrate on winding down unsold inventory going forward. Anything to buy? While IOI Properties and Tambun are our value picks, we continue to like Paramount Corp (Paramount) given its strategic education exposure. Meanwhile, we also expect strong upcoming news flow on construction contracts and landbanking to drive Malaysian Resources Corp’s (MRCB) share price.

Some Values Have Emerged

Sector valuations close to -1SD level While the bad news on the macroeconomic and political fronts may continue to linger, our focus on the sector is now on stock valuations. The industry’s discount to RNAV is currently getting closer to the -1SD level – the pre-2013 General Election mark – while P/BV has just dipped to below -1SD. Barring a possibility of crisis (as our market assumption) – although re-rating catalysts have yet to emerge – in this sector update we identify value stocks that investors should take opportunity to accumulate given the current cheap valuations.

IOI Properties stands out Taking UEM Sunrise as a benchmark for floor valuations – given that it recently rebounded strongly by more than 40% from an all-time low of 0.55x P/BV – among the stocks under our coverage, we believe IOI Properties could stage a rebound too given its historical low valuations of 0.5-0.55x P/BV. While the earnings outlook may not look exciting for its property development division, IOI Properties is backed by a pool of solid assets. This includes 14,000 acres of landbank as well as MYR3.4bn worth of recurring income-generating property assets like IOI City Mall Putrajaya, IOI Mall Puchong, and several hotels and office blocks that underpin almost 20% of the company’s EBIT. This percentage is likely to grow as assets mature and more are built. The current valuation of a 59% discount to RNAV could be too low for a big-cap property stock in our view.

Tambun’s implied land value is cheap Given that most property stocks have been severely bashed down, we also select a group of developers with less than 30% net gearing to calculate the implied market value of their anchor landbank. Among the six companies that we chose, we think Tambun’s implied valuation at only MYR25 psf looks increasingly attractive as market value for land parcels in Mainland Penang has already appreciated to MYR35-40 psf and the company’s landbank is only 15 minutes away from the fast-growing Batu Kawan area. Strategic landbank is scarce, and the IKEA store, Penang Designer Village and Columbia Asia Medical Centre developments are moving on track. On the other hand, the implied landbank value for other developers only looks decent. Although UEM Sunrise’s implied land value is only at MYR8psf, Iskandar Malaysia’s near-term prospects are unexciting. This is given the upcoming supply glut in residential properties and, hence, the potential negative impact on property prices. Landbank is aplenty down south.

Not so favourable industry outlook Looking ahead, given our 4.8% and 4.9% GDP growth forecasts for 2015 and 2016 respectively, we expect the property sector to remain lacklustre. In our view, while some recovery can be expected, given the depressing year (2015), if the political and weakening currency issues are still unresolved, the market sentiment may continue to dampen the propensity to buy big-ticket items. For the developers under our coverage – and based on our sales projections – we expect another 5-10% drop in property sales next year after a nearly 20% fall in 2015. We have factored this decline into our FY15-17 earnings forecasts. Meanwhile, residential property transaction volumes for the overall industry has contracted by 3.3% while the value of residential property transacted fell by 7.4%, on an annualised basis for 1H15. We expect another 3-5% drop in both transaction volume and house prices next year.

Expect rising unsold inventory as an industry trend For the overall industry, fundamentals still appear to be weak as banks continue to curb mortgage financing. We also expect unsold inventory to pile up given developers’ aggressive launches in the past, as well as slowing demand for property. In Figure 10, while there is a lagged effect in inventory when compared with new sales (regardless of the timing impact), we believe the inventory to new sales ratio would still increase given the reasons mentioned. In the table below, we highlight the companies that have an inventory to new sales ratio of above 0.5x. Note that, while Paramount’s inventory to current asset ratio has gone up – given that its inventory to new sales ratio is still at below 0.5x – we are not overly concerned with its inventory trends. Only Tambun and Hua Yang appear to have relatively healthier inventory positions, considering also that both developers have not been aggressive in their launches over the past one year. Given the current situation, we reasonably believe that developers are likely to remain cautious with rolling out new projects as the focus over the near term should be on winding down unsold properties to reduce their holding costs and cash flow. More rebates or discounts can be expected to accelerate inventory sales.

Meaningful policy loosening is unlikely in Budget 2016 After the macroeconomic prudential measures that have been imposed by the Government and central bank, the house price index growth in Malaysia has eased to +4.1% YoY in 1Q15 after 8-9% growth in 2014. Sequentially, 1Q15 saw the first negative (QoQ) growth of 1.8% since 4Q08. While some investors may, therefore, look forward to some loosening of the cooling measures in the upcoming 2016 budget, we do not think Bank Negara Malaysia (Bank Negara) and the Government would embark on an easing mode just yet, as household leverage is still considerably high at 87.9%, one of the highest in the region. If anything, we believe the Government’s emphasis would be on affordable housing or introducing new incentives for first-time home buyers. Unfortunately, these may not be sufficient to revive the property sector, in our view. Considering that GDP growth is likely to slack, we do not think the household debt to GDP ratio would drop anytime soon. It should be the central bank’s effort to contain household leverage and to ensure Malaysian households are financially healthy to weather economic challenges, especially given that the global interest rate may be raised going forward.

Valuations and stock picks Compared with other sub-sectors, property is one of the worst-performing industries so far this year, having declined by 10.9% vs the FBM KLCI’s 6.6%. We keep our NEUTRAL sector rating unchanged, as we do not see any impending sector re-rating catalyst over the near term. However, values for selective stocks have emerged, such as IOI Properties and Tambun. We believe the current cheap valuations represent a good opportunity for investors to accumulate value stocks. We also continue to like Paramount, given its strategic exposure to the education division, which provides resilient earnings to the company. Meanwhile, we expect strong upcoming news flow on construction contracts and landbanking to drive MRCB’s share price.

Source: RHB Research - 22 Sep 2015