Jul 22, 2011

Malaysia Property Sector

Malaysia Property Sector and Stocks  Highlights 
•  We reaffirm our Overweight stance, and BUY ratings on S P Setia, IJM Land and Ivory Properties. From the fundamental standpoint, we are unmoved by the recent sentiment-driven sell-down in property equities, triggered by market talk of potential policy tightening on residential demand. Among the concerns are the reintroduction of a graduated scale of real property gains tax (RPGT), mortgage loan approval criteria based on net salary and loan-to-value cap at 70% for the purchase of second home. The sell offs have also been due to a weak market. 
•  Thus far, there have not been any policy pronouncements on these fronts. And, our channel checks reveal mixed signals on the potential policy curbs. While we do not completely discount the rumoured policy tightening, our view is that any policy curbs, if they were to materialise, will not likely be severe enough to derail incremental residential demand formation given the significant multiplier effect of housing on economic growth. The authorities need to strike a delicate balance between ensuring the systemic stability of the banking system, consumer confidence and the development of the Iskandar Region where a vibrant housing market is a critical success factor. 
•  In any case, we believe that property equities have surely priced-in the policy risks by now. Consider this: sector stalwart S P Setia’s share price has already tumbled by some 15% off its high of RM4.40 in April 2011, compared with the 1.5% rise in the KLCI index over the same period. This is much more severe than the 3% correction in S P Setia’s share price when the government imposed the LTV of 70% for third homes.  
•  The valuation retracement – as reflected in the widening of discount to NAVs (S P Setia and IJM Land are trading at a 30% and 39% discount to our NAVs, respectively) – implies that the balance of risks is on the upside. This is because we are seeing a
sustained strength of the primary market where presales are holding up very well. Just last week, we witnessed the overwhelming market response to the launch of Mah Sing’s Icon City and Sunway City’s Velocity.  And, mature townships
continue to register robust presales of landed homes. 
•  Admittedly, the secondary market is seeing a slowdown in transactions. Rising physical completion may also put a cap on
asking prices. Nonetheless, our sense is that landlords have the holding power to sit on the completed homes. The secondary market may see a widening in bid and ask prices leading to slower transactions. But as long as presales prices are still inching up, secondary prices appear unlikely to soften significantly. 
•  We remain committed to our investment thesis of an extended residential pricing up-cycle, although price gains are likely to be more modest because of a higher base. The current pricing strength in the primary market also reflects rising replacement cost of land. More importantly for property equities, we believe that the NAV growth story is intact even in an environment of slower residential price gains. We put forth three reasons.
•  NAV-accretive land deals. This is the primary valuation driver given that well-executed land deals would accelerate NAV growth. S P Setia, IJM Land and Ivory Properties are the frontrunners for several land deals, we believe. With urban renewal gaining traction, developers would be able to capitalise on the ongoing privatisation of government land and staff quarters. This structural change in the land supply side is a significant positive. 
•  There may also be potential liberalisation of residential plot ratios in established urban areas where there is an acute shortage of land available for development, coupled with strong effective demand, we believe. As it is, we are already seeing generous plot ratios at select sites to defray the high land cost. Such a move, if it materialises, would accentuate NAV expansion stemming from higher gross development value.
•  Valuation kicker from the redevelopment of Sungai Buloh. The Sungai Buloh land has high immediate development potential. Kwasa Land – the development arm of the Employees Provident Fund – is expected to announce the tender for the first parcel by 1H2012. Work on the MRT lines and stations in the locality has commenced.
•  Earnings delivery is intact as developers – S P Setia and IJM Land – are sitting on record unbilled sales of RM3.5bil and RM1bil-RM1.5bil, respectively. Taken together with the scope for NAV growth, we believe that properties equities are cheap from both the earnings and assets perspectives. One negative though is the market risk in the near term: we expect the KLCI
to move sideways with consensus earnings expectations bottoming out in 3Q11. This should pave the way for the next leg up in early 4Q11 when we expect the KLCI to end the year at around 1,650 – with property equities leading the upturn as we approach the tender for the Sungai Buloh land in 1H2012.

Research by AMResearch