THE KL Property Index (KLPI), which is basically a market capitalization index of all Bursa Malaysia listed property companies, recently hit a low of 765 pts.
Since hitting an all-time high of 1,524 pts in August of 2014, the KLPI has dropped an astonishing close to 50% of its value to its current level. In fact, the KLPI is now hovering at its lowest point since May of 2010 and clearly has emerged as one of the worse performing sectors in recent times.
Why is the sector in the doldrum? Are property companies suffering from the overhang and unsold properties? Have the dynamics of market changed so much or are people simply not interested in property stocks anymore, no matter how cheap they are?
Year-to-date, the KLPI is down 12.4% and of course some individual stocks are clear under-performers and chief among them are the large capitalized stocks like S P Setia, ECO WORLD Development Group (EW) and IOI Properties Group (IOIPG), which are down 43.3%, 28.6% and 26.6% as at Oct 10.
There are some 97 constituents in the KLPI and out of this, 14 companies can be deemed to be large property companies with market capitalization in excess of RM1bil each.
Today, Malaysia’s largest property company by market IOIPG with total market capitalisation of RM6.22bil while the largest company by total enterprise value (EV), i.e. net debt plus equity, is also IOIPG at almost RM16bil.
Out of these 14 large market capitalisation companies, with the exception of YNH Property, 13 are trading below their respective net asset value (NAV) and hence they are deemed to be more attractive in the current market environment. In addition, UOA Development is also not part of this analysis as it is a net cash company, despite trading at about 0.75x price to book (P/B) value.
From here, analysing the balance 12 companies, we observed that debt has now become an integral part of property companies today to the extent that net gearing (total debt less cash divided by shareholders funds) among these large companies today is at about 46.1% on average. The 12 companies have net gearing ranging from as low as 16.5% for Mah Sing Group (MSGB) to as high as 88.1% for IGB.
As debt has become prominent among property companies, the EV among property companies today is significantly represented by debt, and this among the 12 companies ranged between as low as 23.4% for MSGB and as high as 63.3% for EW. In actual fact, net debt today represents almost 50% of EV of these 12 companies.
With the KLPI down to the level it is today, the 12 property companies that trade below their respective NAVs have a range of P/B from a low of 0.33x for IOIPG to as high as 0.73x for Eco World International.
We can observe that there is a mild correlation between net gearing level and how market perceives a property company.
Chart 1 shows that in general, as net gearing rises, market’s valuation of a property company as measured by the P/B valuation matrix deteriorates, which explains that market in general does not like companies taking on added debt as it burdens a company’s financials to the extent a company’s operating profits are eaten up by expenses related to debt services.
Why are property companies increasingly in debt? The obvious answer is that the property market cycle is indeed not in favour of the developers and we are also seeing some of them holding large amount of inventory in the form of completed units that remained unsold.
The business of a property developer is simple. Unless the landbank of a property developer has been with the company for ages, most property developers do landbanking activities first to have the required capacity to develop and to remain in business. Hence, most of them, unless if they are cash rich or have been holding their respective landbank for a considerable period of time, carry out landbanking activities, and typically between 50-70% is financed with bank borrowings.
Having done the required planning, feasibility studies and approval, the developers will then launch their project to the market. Not long ago, whenever there are property launches, we will see investors and buyers making a beeline to book their next purchase and within hours or days, the project launch is fully sold out. Those were the days when the property market was just three words - buy, buy and buy.
These days, a property launch event is hardly a talked-about event and developers have to go to great lengths to attract buyers to their launch parties, let alone to close a sale. Worse, even after a launch, very rarely do we see or hear developers achieving 100% sale.
Most developers will achieve some sort of success, perhaps with about 50-90% of sales between the launch of a project to completion of a project, which is defined as at the time of vacant possession. While landbank is mostly funded by banks, the development of a project too is required to be funded via bridging facilities. A developer will use three sources of funds to ensure the construction of the launch project goes on smoothly right up to completion. One is his own working capital, second is the progress payments that are received from buyers and third the bridging facilities from their banks. It all looks nice on paper but the problem effectively starts when a developer is not fully sold, especially for high rise development.
A developer that is involved in high rise development may enter into serious cashflow issues if sales are weak. Assuming a developer foresees 20% gross profit margin for a high rise development. It is likely he may face cashflow issues if sales are 80% and below. Logically, every unit that the developer sells is a profit to the developer but cashflow wise, the development will face cash crunch as the developer’s profits in the form of actual cash is actually stuck at the 20% or more of the unsold units, even after completion, in the form of inventories. This is not so difficult for a developer who is a township developer involved mainly in landed properties as the developer could actually afford to launch in phases. But for a high rise development, not achieving near 100% sales can lead to serious cashflow issues or worse, an abandoned project if the developer has exhausted all the means to complete the high rise development.
With the KLPI at its near 10-year low, the winners among these top developers are developers who have cheap landbanks, developers who are involved in township development, especially among the affordable market segment and with relatively below average net gearing level. Table 1 shows the key financial statistics among the 12 property developers.
Trading at below 0.5x book value, this dozen property companies have indeed reached a valuation point that is rather inexpensive and perhaps warrant a good look for investors with appetite for risk, especially with a longer term horizon. Hence, despite the challenging market environment in the property sector, the negative sentiment on the sector is likely over-played and there is no reason for this twelve companies to trade at significant discount to their respective NAV or worse at multi-year lows.
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