• Downgrade to NEUTRAL from Buy, with new MYR0.64 TP from MYR1.48, 12% upside. SP Setia’s high leverage and low profitability could have been the key reasons for share price underperformance. We think management’s de-gearing effort will take time as disposal of non-core land parcels and monetisation of developed land through JV are typically a long process. While we are turning more positive on the property sector, we are cautious on the company’s weak fundamentals. Our TP is based on an 80% discount to RNAV, with a 2% ESG premium.

• De-gearing remains the main focus. SP Setia’s net gearing stood at 0.57x in FY22, vs 0.61x in FY21, as a result of the successful completion of overseas projects last year. However, the termination of the land disposal to Scientex (SCI MK, BUY, TP: MYR3.91) worth MYR518m that was announced last month (due to non-fulfillment of conditions required by the Economic Planning Unit) suggests that sale of non-core landbank is challenging and it is a long drawn out process. Management is also in an effort to collaborate with some external parties to jointly develop industrial projects in Tanjung Kupang in Johor and Setia Alaman in Klang, in order to accelerate landbank monetisation. While CFO Annuar Marzuki has set a 0.5x net gearing target by year end, we think this would highly depend on the success of land sales and JVs. Note that both interest paid and preference dividends cost an annual cash outflow of >MYR500m.

• High operating costs affect overall profitability. In the meantime, we are also concerned over the company’s operating efficiency as EBIT margin has been trending down over the past 6-7 years, from around 25% to 18% last year. Although management has just started to streamline its project team, we note that SP Setia has almost 40 projects which are ongoing concurrently – the highest among all the developers under our coverage.

• Aggressive launches may pose inventory risk. Management has set a sales target of MYR4.2bn (MYR4.11bn achieved in FY22) with MYR6.17bn launches for this year. Although landed residential makes up 47%, followed by 24% from high-rise developments, we are cautious with the potential increase in unsold inventory, especially if some of the new launches are not being well taken up. We highlight that SP Setia still has MYR1.24bn worth of unsold units (at cost) as at FY22, from MYR1.05bn in FY21. The unsold units are mainly the high-rise projects in KL as well as Johor.

• Update on overseas developments. As UNO Melbourne is towards the tail-end of its development, management is looking for more land parcels in Australia to keep its presence on the international front. Meanwhile, senior living residence will be the next development phase in Battersea Power Station in the UK. However, the launching timeline is still undecided for now.

Source: RHB Research - 26 Apr 2023