Review of 2009
Despite all the problems faced by the sector, including squeezed margins, poor sales for most developers, rising unemployment and the economic recession, the property sector was one of the best-performing sectors in 2009.
This was because property stocks came from a very low base, having been bashed down in 2008. In fact, property was the worst-performing sector in 2008 when the KL Property Index lost half its value.
Property share prices also enjoyed a big rebound because the sector is considered to be cyclical and high-beta, and would benefit from a rebound of the stock market and economy.
The sector, however, was dealt a temporary blow at end-October when the government announced a 5% real property gains tax (RPGT) effective Jan 1, 2010.
Property stocks under our coverage staged a rebound in 2009 but most of them did not enjoy as big a bounce as the property sector as a whole. This was because two of them — SP Setia and Mah Sing — enjoyed relatively resilient share prices in 2008 as PNB bought big stakes in the two companies on the open market and their valuations were not as beaten down as other property stocks.
Hunza Prop announced an EPS and RNAV-dilutive rights issue during the year, which threw a damper on its share price. KLCC Prop as a property investment company also did not enjoy a big recovery in share price as the stock is tightly held and its dividend yield is not high. E&O was the biggest winner in 2009, nearly tripling in price after crashing 84% in 2008. We initiated coverage on the stock in September.
Outlook for 2010
Property stocks reacted negatively to the RPGT announcement and have mostly been trading sideways since then. We view this as a good buying opportunity as the outlook for the sector is improving. Prospects for the two major determinants of the property sector — the economy and stock market — are certainly looking up.
Fundamentals 1: Economy to rebound from 4Q09
The economic recovery has started, evident from the clearer signs of improvement in both external and domestic demand conditions. Real gross domestic product (GDP) growth improved markedly to register a smaller contraction of 1.2% in 3Q09 from 5.1% in 1H09. We believe the economy will rebound to positive growth of 2% in 4Q09, taking the full-year GDP estimate to a contraction of 2.3% against a growth of 4.6% in 2008. Both consumer and business sentiments have turned the corner, which augurs well for private sector demand. This, along with the projected recovery in exports, will lift real GDP growth higher to 3.5% in 2010 and 5.5% in 2011.
The growth catalysts for 2010-11 will be (i) a firmer recovery of domestic demand as fiscal spending is stepped up and Ninth Malaysia Plan (9MP) projects are completed, and (ii) a turnaround of exports as the global economy recovers.
The recovery is expected to be broad-based, with private-sector demand taking charge as the public sector gradually unwinds its fiscal support. Private-sector demand is estimated to rise 4.3% in 2010 while public-sector expenditure is set to pull back 3.6%.
Exports should rebound 8%-10% after the collapse of global trade last year. Positive leads underpinning the export recovery are (i) the easing contraction of global trade, (ii) a moderate recovery for the major developed economies, and (iii) improved demand for consumer electronic goods.
Fundamentals 2: Stock market rallied 45% in 2009
Last year began all doom and gloom and the market continued its 2008 bear market slide in 1Q09. But the mood changed dramatically in April when the KLCI started rallying.
Although we turned bullish just before Datuk Seri Najib Razak became the country’s sixth prime minister on April 3, we too have been surprised by the strength and speed of the market resurgence. The KLCI’s 396-point or 45% upswing in 2009 effectively reversed 2008’s vicious downward spiral.
A virtuous cycle is now in play. Although the KLCI’s gain in 2009 was certainly impressive, Malaysia is lagging behind its regional peers. This is not a surprise considering that the KLCI was one of the better performers in 2008, falling less than its peers.
Being a closely watched barometer of confidence for Malaysians, a high KLCI is good news for the property market. In fact, we often notice a high correlation between the asking prices for high-end properties in Kuala Lumpur and the daily movements of the KLCI, especially during uptrends. We also observe a high correlation between the KLCI and the KL Property Index though the property index has a higher beta of around 1.4x.
The average bull market in Malaysia over the past five cycles lasted 21 months against 19 months for the property index. We are now into the ninth month of this bull market. Even if this bull market lasts only as long as the shortest bull market in the 1990s, that is 15 months, there could be another six months to go. As for the property index bull cycles, the shortest was the last one in 2006-7 which was shortlived at 11 months, having been interrupted by the US subprime crisis. We believe this property index upcycle should last longer and match that of the broader market in view of the 5% RPGT hiccup, which also prematurely and temporarily halted the uptrend.
Fundamentals 3: Affordability at all-time best
Due to moderate price appreciation, rising incomes and record low interest rates, affordability of residential properties in Malaysia is at its all-time best. In fact, average home prices in the country have lagged far behind income growth ever since the 1997-8 Asian financial crisis.
Affordability has never been better and banks continue to offer very attractive mortgage rates at around base lending rate minus 2% and in some cases, BLR minus 2.4%, which means interest rates charged are only slightly over 3%, not much higher than fixed deposit rates of 2%-2.5%. Although many people will argue that the national average home price is not reflective of prices in the Klang Valley or Penang, surprisingly it is high-end homes that have enjoyed the strongest demand and price appreciation in recent years.
RPGT opportunity
The re-imposition of RPGT has shaken investor confidence in property stocks. Although the government fine-tuned the tax on Dec 23 so as not to penalise non-speculators, the damage is already done. Worst hit is E&O due to its high beta and very liquid nature. Also, E&O is exposed mainly to high-end residential properties, which is viewed as the segment where speculation has been most prevalent. The KL Property Index has fallen 5% since the announcement of the 5% RPGT on Dec 23, underperforming the KLCI which has gained 1%. Before the government’s RPGT relaxation for properties held for at least five years, the property index was down 8% against a flat KLCI. Since the fine-tuning, the sector has rebounded 3% versus the KLCI’s smaller gain of 1%.
Overall, we believe investors have overreacted to the 5% RPGT. Although it was a shock to industry players and analysts including ourselves, we expect potential property buyers to shrug it off. SP Setia, the bellwether of the industry, in fact recorded its best monthly sales ever in November, right after the RPGT announcement.
The group sold a mind-boggling RM293 million worth of properties during the month, nearly 80% of which came from Klang Valley projects.
Interestingly, the high-end development in Setia Eco Park chalked up sales worth RM61 million. Bungalows priced at a record RM4 million to RM4.5 million there were snapped up. Indications from other developers with strong marketing prowess also show similar promising progress. Mah Sing’s Perdana Residence 2’s superlink homes opened for registration in early December and attracted queues before 7am. Phases 1 and 2 with GDV of RM142 million have since achieved bookings of around 80%. Mah Sing also indicated strong interest in its upcoming Cyberjaya project. This was a pleasant surprise to us as we were cautious about prospects this far south of Kuala Lumpur.
The condo market also remains robust as Sunrise’s MK28 condos priced at close to RM800 psf in Mont’ Kiara have achieved take-up of a third since they opened for booking in December. The pricing is at the higher end of the price range for that location but a significant sweetener is the 10/90 financing scheme where buyers pay no interest for five years.
Risks
The key risk to our bullish call on properties in 2010 is if a double-dip takes place and both the economy and stock market head south. Our economics team estimates that there is a 30% chance of a double-dip occurring, 20% probability of a V-shaped recovery and 50% likelihood of a square root-shaped recovery.
Nonetheless, we take comfort in the government’s goal of a relatively robust growth rate of 5% for 2010, higher than our estimate of 3.5%. Also, we remain positive about the outlook for the stock market this year with a KLCI target of 1,450 points.
Rising interest rates
There is some concern that if inflation rears its head, interest rates could start to rise and sap demand for properties. But we are less perturbed as the property market is more a function of confidence and sentiment — which are largely driven by the economy and stock market — and have in the past continued to do well even in a rising interest rate environment.
Commercial oversupply
We have yet to see a glut of commercial space and occupancy rates of prime office and retail space in the Klang Valley remain very high. However, rental rates for newly completed office buildings appear to be soft due to the weak economic environment in 2009 and substantial new commercial space will be coming on to the market over the next one to two years. Hotel occupancy rates weakened in 2009 even though tourist arrivals held their ground. We are less optimistic about the commercial property market and prefer exposure to residential development.
Policy flip-flops
Should the government again impose even higher RPGT or propose new policies that could dampen the property market, potential buyers would stay on the sidelines for an even longer period of time due to further confusion. We believe the chances of this happening are low as the authorities have seen the backlash from the 5% RPGT decision and ended up fine-tuning the policy. In fact, we would not be surprised if the government threw in more incentives to give the sector a boost as the prime minister recently said he wanted to see “the property sector grow from strength to strength”.
Valuation and recommendation
We like all developers as they will benefit from a broad-based rebound in demand. Although blue-chip developers such as S P Setia and Mah Sing registered outstanding sales in 2009, this was not the case for smaller developers with weaker marketing abilities. However, we believe developers across the board will enjoy a recovery in sales and earnings in 2010. We believe concerns over the 5% RPGT are overblown and provide investors with a window of opportunity to pick up property stocks on the cheap. The sector’s fundamentals are improving significantly. In fact, we believe that one of the reasons the government saw a need to curb excessive speculation via the RPGT is the sector’s strong prospects.
We upgrade the sector from trading buy to overweight and upgrade E&O, Hunza, Mah Sing, S P Setia and UM Land from trading buy to outperform. Valuations remain undemanding as property stocks are still trading at big discounts to RNAV. We continue to shun KLCC Prop as it has no exposure to property development. KLCC Prop stays an underperform. E&O remains our top pick as it continues to be the highest beta and most liquid property stock. S P Setia continues to be a core holding due to its size and status as sector bellwether.
Potential re-rating catalysts for the property sector include 1) a pick-up in launches and sales in 2010, and 2) a rebound in earnings for most developers as many suffered from a combination of high cost and weak sales in 2009.
We are raising our target price for S P Setia from RM5.05 to RM5.51 as we up the RNAV premium from 10% to 20% and for Mah Sing, from RM2.34 to RM2.60 as we narrow the discount to the 15x target market P/E from 20% to 10% as the company has been on a landbanking spree.
E&O’s target price has been nudged up from RM1.89 to RM1.90 after factoring in the recent disposal of the Lot 595 land in Kuala Lumpur for over RM2,000 psf, higher than our earlier estimate of RM1,800 psf. We have also raised our FY10 net profit forecast for the stock by 45% to incorporate the RM31 million gain from the sale. We make no changes to the earnings forecasts for all other property stocks.
This article appeared in The Edge Financial Daily, January 5, 2010.
