SINGAPORE (Aug 20): Concerns about whether local developers and banks can weather the recent cooling measures were laid to rest during results briefings by the local banks. Only DBS Group Holdings revised its loan growth expectations down marginally. DBS has a 31% market share of local housing loans.

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Most of the housing loans in Singapore are made to owner-occupiers, and loan-to-value ratios are modest. This was borne out by the latest Monetary Authority of Singapore’s statistics (see table), which shows that the average LTV ratio is 51.5%, down 140 basis points q-o-q. Although the new housing loans limit granted for investment property is up q-o-q, it is still lower than in 4Q2017, an indication of limited or no speculation in the market.

URA continues to caution on supply, though. As at end-2Q2018, there were 45,003 uncompleted private residential units in the pipeline with planning approvals. Of this, 26,943 units remained unsold as at end-2Q2018, up from 23,514 units in the previous quarter.

The ability of developers to buy, develop and sell — that is, speed to market — affects their profitability. With the latest round of property cooling measures announced last month, landbank size and cost are the main factors that affect the valuation of developers. The downside risk to developers is likely to be already reflected in their share prices.

Price-to-value divergence

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Charts 1 to 6 compare the value of the companies to their growth, where change in share price is measured against revenue, net income, operating cash flow and free cash flow. Ideally, the growth in value of the company should be higher than the growth in price to represent undervaluation. Chip Eng Seng, Roxy-Pacific Holdings, Oxley Holdings and GuocoLand are all overvalued using this metric. UOL Group and Wing Tai Holdings appear undervalued, suggesting that there is potential for price appreciation for these two stocks. UOL and Wing Tai are also undervalued based on other factors, such as price to book (see Chart 7). Moreover, UOL is backed by veteran banker Wee Cho Yaw, whose family is the major shareholder of United Overseas Bank. It is also viewed as having a relatively low-cost landbank.

Earnings yield and book value

Property stocks are usually valued based on their price-to-book ratios and their discounts to revalued net asset value (RNAV). However, earnings also play a part. The earnings yield shows the percentage of each dollar invested in the stock that was earned by the company, and is the inverse of the price-to-earnings ratio. The PER of the developers is fair, at 13.6 times. This translates into an earnings yield of 7.4%, which is well above the benchmark risk-free rate (government bonds or fixed deposit rates). Generally, a PER of less than 10 indicates undervaluation, and for the six property stocks, Oxley and GuocoLand fit this bill.

Property stocks usually trade at discounts to their book value during volatile market phases, and a select few trade at premiums during bull market phases.

In some cases, property companies boost their shareholder equity by revaluing their assets. In FY2016 and, to a lesser extent, FY2017, Ho Bee Land revalued its investment properties significantly, which boosted its reserves. In 1HFY2018, it continued to revalue its properties upwards. On Aug 10, the company announced that it had revalued a 999-year property on Bukit Timah Road and as a result recognised a fair-value gain of $28.3 million. The reason given for revaluation was the sale of a 30-year lease on the property.

The developers appear overvalued when viewed through the prism of EV/Ebitda (enterprise value to earnings before interest, taxes, depreciation and amortisation). The benchmark for a company to be undervalued using this ratio is below 12.5 times. GuocoLand has the lowest EV/Ebitda (see Chart 7).

Unsold units weigh on returns

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Because property development is a capital-intensive business, companies in the sector are not likely to use their assets and equity efficiently. Interestingly, the low return on assets for some developers is largely due to unsold units of development properties (see Chart 8).

Furthermore, developers that hold on to unsold units have a price to pay in the form of additional buyer’s stamp duty. The Inland Revenue Authority of Singapore says the acquisition of sites before July 6 by developers is subject to 15% ABSD, which may be remitted upfront subject to conditions. These include commencing the residential development within two years from the acquisition date and completing and selling all the units within five years from the acquisition date. Wing Tai is famously known for holding out for higher prices for its Nouvel Ardmore development, where only a handful of units have been sold.

Increasingly, developers are looking for recurring income from investment properties for stability, as development profits are often volatile and lumpy. For instance, Oxley has acquired a portfolio of investment properties and UOL owns commercial properties and a hotel business. For 1HFY2018, investment property and hotels contributed 21% and 26% respectively to UOL’s revenue.

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Investors always keep an eye on margins. The higher the margins, the stronger the durable economic competitive advantage and economic moat these developers have against their competitors. All six companies seem to have strong gross margins, but only some are able to maintain their margins when it comes net income margins. Roxy-Pacific, Oxley, UOL and GuocoLand are able to do this, with Oxley being the best at retaining most of its gross margins as net income margins (see Chart 9).

All six property developers have strong liquidity positions, as measured by their current ratio and interest coverage ratio. This should put to rest concerns that small- and mid-cap developers may face challenges following the recent cooling measures. They are all quite robust.

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The benchmarks of 1 for current ratio and 1.5 for interest coverage ratio were achieved by all the companies, with the exception of Wing Tai (see Chart 10). The latter has negative Ebit and Ebitda. This is not a concern, as Wing Tai has strong major shareholders, and has other levers to pull such as monetising its unsold properties.

The developers, in particular the smaller ones, tend to be relatively highly geared, at above 100%. Only Wing Tai and UOL have a gearing of below 0.5 times (50%). UOL, with a gearing of just 0.23 times, has the capacity to take on more debt to grow its earnings, should it wish to do so.

Chip Eng Seng, Roxy-Pacific, Oxley, Wing Tai and UOL have enough cash and current assets to cover their contracted outflows, including interest expense. All five have strong cash and liquidity positions. GuocoLand does not have enough cash and current assets to cover contracted outflows and interest expense because it has a number of short-term loans that could mature. However, its major shareholder Quek Leng Chan is one of Malaysia’s richest men.

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The margin of safety analysis (Chart 11) looks at how safe it is to invest in a company, given the worst-case scenario (winding up/liquidation of the company’s assets). If the net tangible assets per share is higher than the prevailing share price, shareholders can expect to receive a premium or excess return in the event that the company goes into liquidation. The developers seem to have a comfortable margin of safety, with the exception of Roxy-Pacific and Oxley, which are trading marginally above their book values.

Dividends, rising share prices and total shareholder returns are important to investors. Growth helps, but so do dividends. The average dividend yield for property developers is 3.26%, which is a fairly adequate return when benchmarked against the risk-free rate. Chip Eng Seng’s dividend yield is the highest at 4.92.

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The developers have to weigh growth against shareholder returns. The dividend payout ratio shows how much of earnings they choose to return to shareholders. Interestingly, Wing Tai and Chip Eng Seng have paid out more than 100% of their earnings as dividends to their shareholders, but they have relatively safe liquidity positions. However, high payout ratios reduce funds that could be used for expansion (see Chart 12).

Who ranks best in business quality?

To determine the quality of the developers’ businesses, it is important to look at how well they have performed over a period of time — in this case, 10 years. The metrics used to determine the quality are 10 years of positive operating cash flow and free cash flow and 10 years of net profits and dividend payouts. For Oxley, the last seven years is used. Ten points are awarded for each metric and the score (with a maximum of 40) is converted into percentage. The benchmark of a good-quality business is more than 80%.

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Based on the score, only UOL and Wing Tai can be considered good-quality businesses (see Chart 13). They have performed consistently over the past decade.

Undoubtedly, despite downgrades following the July 6 measures, analysts see UOL as a “buy”. Maybank Kim Eng points out that UOL’s competitive land costs and ­manageable inventory levels puts it in good stead to weather residential headwinds. Competitive land rates for Amber 45, The Tre Ver and Silat Avenue, which collectively account for more than 90% of its unsold stock, imply that UOL has a bigger margin of safety than its peers, Maybank KE says.

For 1HFY2018, UOL reported a 73% y-o-y surge in revenue to $1,296.5 million, a 9% increase in net profit to $209.5 million and a 1% rise in net asset value per share to $11.14. Maybank KE has an RNAV of $11.75 and a valuation of $8.80 for the stock, based on a 25% discount to RNAV, or a 27% upside from the current level of $6.93.

Property measures and looming supply dampen outlook

According to URA’s 2Q2018 data, housing supply in the pipeline comprises 20,000 units from government land sales and en-bloc sale sites that are awaiting planning approval. These are from awarded GLS and en-bloc sale sites, as well as confirmed list GLS sites that have yet to be awarded. In addition, 24,000 units are unsold from projects with planning approval. On top of that, more than 30,000 existing private housing units remain vacant. These figures exclude executive condominiums (ECs).

Although the total figure of 74,000 units sounds alarming, they are likely to be developed over a period of years. Of course, among units pending planning approval, including those in the en-bloc bucket, not all may receive it. There could also be delays along the way for units with planning approval.

Based on the expected completion dates reported by developers, 7,130 units (including ECs) will be completed in 2H2018. Another 9,510 units (including ECs) will be completed in 2019. Vacancy rates of completed private residential properties at end-2Q2018 in the Core Central Region, Rest of Central Region and Outside Central Region were 10.9%, 7.7% and 5.0% respectively, compared with 11.6%, 8.3% and 4.9% in the previous quarter.

Total demand for units, including new sales, sub-sales and resales, was 3,828 in FY2015, 4,868 in FY2016 and 7,602 in FY2017. For 1H2018, 3,875 units were sold. Inevitably, an oversupply is building. This, coupled with the recent cooling measures — including an increase in additional buyer’s stamp duty by five percentage points for all individuals buying their second, third or subsequent properties and the lowering of the loan-to-value limit by five percentage points for all housing loans — is likely to dampen demand and price levels, analysts say.

Small- and mid-cap developers safe despite looming oversupply

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