• Maintain NEUTRAL. We prefer township developer Matrix Concepts (MCH) and asset owner IOI Properties (IOIPG) as their earnings are expected to be more resilient. As the heightening inflationary pressure will likely last longer, the rising building material costs, labour shortage issue as well as higher interest rates would hit developers with many new projects and/or high borrowings more materially.

• Expect 2022 property sales growth to be flat. Overall, we expect property sales to be around the same level as last year. Despite the rolling lockdowns, property sales rebounded strongly in 2H21, spurred also by the Home Ownership Campaign (HOC). For 2022, although the property market should benefit from the re-opening of the economy, the uncertainties brought about by the inflationary pressure, swing in the MYR, and the potential recession risk in the western countries could hit demand recovery.

• 3-5 ppt margin erosion due to rising costs. Although the spike in building material and labour costs were much higher, the overall impact to developers would be rather gradual as some contracts have been locked in earlier. New projects will likely see a thinner margin due to the inability to fully pass on the incremental construction costs to house buyers. Indeed, developers already saw declining margin over the past 4-5 years due to discounts and rebates offered to unwind unsold inventory, and this (margin) trend is expected to continue.

• Cost pressure will likely persist until year end. While it is hard to predict the price direction of many commodities, based on the prevailing inflationary impact on the broader economy, we think the cost pressure will last at least until end 2022. In addition, we do not think the labour shortage issue can be resolved over the near term, as various sectors are also competing for the supply of labour, once it is available.

• Expect impact of higher interest rate to be gradual. While we think the rising interest rate should affect demand for property, impact will likely be gradual as current mortgage rate is still relatively moderate compared to the rate five years ago. On the other hand, the higher interest rate may affect developers with high gearing, as the additional borrowing costs may further dampen development margin, and hence, earnings.

• Prefer township developers and asset owners due to earnings resilience. Township developers and asset owners should fare better given the current market environment. Developers with ongoing township developments (eg MCH and TILB) should see more resilient sales, smoother construction progress, and lesser impact on margin. On the other hand, income stream for asset owners (eg IOI Properties (IOIPG) and UOA Development (UOAD)) should strengthen more significantly this year as the economy and international borders reopen.

Source: RHB Research - 29 Jun 2022