Friday, November 22, 2013

Sunway - The Five Pillars of Sustainability… (Kenanga)

Sunway Berhad -
Price: RM2.74
Target Price: RM3.08
The Five Pillars of Sustainability…

Initiating Coverage on SUNWAY with an OUTPERFORM recommendation and a TP of RM3.08 based on our SoP valuation, which provides a total return of 14%. The TP valuation is at a 25% discount to the property sector which is inline with our industry average of 27%. We like SUNWAY for: (i) its cheap landbanks, (ii) low sales base compared to other large cap developers, (iii) has the second largest exposure to Iskandar region where we have a bullish outlook, (iv) the third largest market capitalisation developer with strong branding and experience and a full value chain from construction, property development to investment properties, (v) one of the top contractors with an outstanding order book of RM3.9b, (vi) company’s plan to spin off more assets to SUNREIT, the third largest retail-based MREIT in town by market cap, in three-years time, and (vii) undemanding valuation of 10.7x-8.7x and 1.0x-0.9x for its FY13-15E PER and PBV vs. the industry average of 14.6x-12.4x and 1.4x, respectively.


Huge property pipeline with strong branding. The group has garnered global recognition from its flagship development in the 800-acre land in Sunway Resort City. It has a total GDV of RM55b and effective GDV of RM32b, which is still relatively huge vs. its market cap of RM4.6b, while also implying that it has the second largest GDV compared to MAHSING (RM25b) and IJMLAND (RM39b). Sunway’s land cost is very low being only 3%-6% of its GDV, which would mean higher than average development margins. It will also enjoy low sales base effect (FY14-15E sales of RM1.5b-RM2.5b), offering more room for growth compared to its big-cap peers.

One of the top-notch contractors with an outstanding order book of RM3.9b. The management targets to replenish RM1.5b worth of contracts per annum. Although this division is not as lucrative as the other divisions, it would help to maximize the synergy within the group, especially as regards to its property development arm with the key advantage of transfer pricing and hence maximizing profits within the group. Coupled with its technical knowhow, being the first in Malaysia to introduce Virtual Design and Construction (see overleaf for further details), it allows the company to secure all types of private and government projects because of the advantage in cost and time control. As for the next 10 years, its orderbook replenishment prospects will be driven by the remaining ETP and 10MP projects.

More asset unlocking activities. SUNWAY has been expanding its commercial asset base to create steady income streams for both SUNWAY and SUNREIT. Currently, there are ten properties under SUNREIT with an estimated asset value of RM5b while SUNWAY also directly holds a few of the education-related properties, malls, hotel and theme parks. Meanwhile, the company is in the midst of expanding Sunway Pyramid and developing the three reit-able assets namely The Pinnacle, Sunway VeloCity Shopping Mall and Sunway University New Academic Block with a combined NLA of 2.2m sq ft. These assets are potentials for future injection into SUNREIT to unlock the value of the asset at the group level in the next three- to four-year time.

Forecasting FY13E, FY14E, and 15E core earnings of RM440m, RM495m and RM543m respectively, driven by: (i) FY13E-15E construction order book replenishments of RM1.5b-RM2.0b, (ii) FY13E-15E property sales of RM1.3b-RM2.5b, and (iii) recurring income from investment properties, REIT, trading & manufacturing and quarry. The risks to our estimates are weaker property demand, construction order book replenishments, negative regulations and project financing issues.

1. Investment Merit

Initiate coverage on Sunway Berhad (SUNWAY) with OUTPERFORM and TP of RM3.08 based on our SoP

valuation, which still offers an attractive return of 14%. We like SUNWAY for: (i) its cheap landbanks, (ii) low sales base compared to other large cap developers, (iii) has the second largest exposure to Iskandar region where we have a bullish outlook, (iv) the third largest market capitalisation developer with strong branding and experience and a full value chain from construction, property development to investment properties, (v) one of the top contractors with an outstanding order book of RM3.9b, (vi) company’s plan to spin off more assets to SUNREIT, the third largest retail-based MREIT in town by market cap, in three-years time, and (vii) undemanding valuation of 10.7x-8.7x and 1.0x-0.9x for its FY13-15E PER and PBV vs. the industry average of 14.6x-12.4x and 1.4x, respectively.

Property Development

Third largest Market Cap developer. SUNWAY is one of the most visible listed developers in Malaysia, followed by UEM Sunrise and SP Setia. Its sheer size provides good shares trading liquidity, which meets many institutional funds’ mandates. This enables the group to embark on large and longer-term developments such as in Nusajaya and the region given the capital intensiveness of infrastructure required.

Owner of prime landbanks in matured areas. SUNWAY has 3,834 acres of landbank which carries a total GDV of RM55b and effective GDV of RM33b. Most of its landbank are located in Johor (55%) followed by Klang Valley (20%), China (10%) and Singapore (10%). Landbanks in prime areas are harder to come by these days as land cost has escalated tremendously given the run-up in property values over the last few years. In Klang Valley, SUNWAY has landbanks in Sunway Resort City (Sunway South Quay: effective GDV of RM2.2b), Taman Maluri (Sunway Velocity: effective GDV: RM2.4b) and Kota Damansara (Sunway Damansara with effective GDV of RM1.0b, which is near the MRT station and Tropicana Garden), to name a few. These projects can reap high sales within a short period of time as these are matured developments with good connectivity, which naturally attract upgraders in the area. Penang is also one of the star property performers in Malaysia due to the scarcity of landbanks in Penang Island and rapid industrial growth in the mainland. SUNWAY has some RM1.8b GDV worth of GDV in Penang over 120-acre landbank, of which more than half is located in the Penang Island. Thus, the projects should fare well, assuming mid to high end pricing given the robust Penang island property demand.

Strong earnings visibility of more than ten years. SUNWAY has a total remaining effective GDV of RM32b, which is relatively substantial vs. its market cap of RM4.7b as compared to other developers. We believe it could last the company a good ten years assuming revenue growth of about 20% p.a. This provides significantly longer-term growth prospects than the other bigger developers which are already operating on a ‘high base’ in terms of topline/sales and have earnings visibilities of only up to 6-7 years assuming similar aggressive topline growth.

Higher sales growth momentum given its low base effect. SUNWAY’s internal FY13E target is RM1.3b sales based on new launches worth GDV of RM1.5b, which is on par with FY12 launches of RM1.3b and lower than FY11 launches of RM2.4b. The lower launch value in FY13E is because there was more overseas projects in FY11-12 with higher GDV as compared to the local projects. Meanwhile, FY13 launches are lower than its peers such as UEM SUNRISE (RM3.0b), SPSETIA (Malaysia sales of c. RM4.6b) and IJMLAND (RM2.2b). We are also estimating FY13E property sales of RM1.37b based on the guided new launches of RM1.5b and other on-going projects from FY12; sales will be driven by projects like Sunway South Quay, Sunway Velocity, Bukit Lenang and etc. As for FY14, we are projecting RM1.5b sales based on new launches with GDV of RM2.0b, which represent YoY growth of 23% and 34% respectively. The strong growth will continue to be driven by the on-going projects as mentioned above as well as new project launches such as Medini, Mount Sophia in Singapore and etc.

Sunway’s GDV still have ample upsides. We believe the GDV assumptions are conservative given the remaining GDV of RM55b (effective GDV of RM32b) which implies a GDV extraction rate of RM14.5m/ac, which is still at the lower spectrum of other bigger developers assumptions of RM16m/ac-RM538m/ac. Same goes for GDV/Mkt Cap; SUNWAY is still relatively better with the ratio of 11.7x as compared to the industry average ratio of 11.4x.

Second largest Iskandar exposure amongst the big-cap developers. In terms of total GDV, SUNWAY has 40% exposure to Iskandar and we are still relatively bullish on developers with sizable exposures in the area. We believe the region will continue to be the main engine of growth for developers as the pace of property demand has grown exponentially there due to strong G2G tie-ups between Singapore and Malaysia. A few property measures were put in place by the Johor state government and the Budget-2014, but we believe these are meant to rein escalating property prices which if left unchecked, will be unsustainable in the long run.

Banking on its lower entry costs… SUNWAY’s current projects in Johor are largely on a joint-venture basis. It has 1858-acre land while the land costs are relatively low; at Pendas (RM12psf) and Medini (RM14psf) as compared to the recent transacted land values of RM35-134psf in the areas, i.e. lower holding costs for the group, and Sunway’s land cost is very low being only 3%-6% of its GDV, which would mean higher than average development margins. This is especially so when its stake in the Medini’s JV will eventually climb from the current level of 46% (previously 38%) to 60% (it is allowed to increase the stake within 54 months after the lease purchase agreement date). It also provides them more pricing flexibility in combating the recent cooling measures put in place.

…and strategic JV partners. It is evident that SUNWAY has benefited from its JV partner, Khazanah Nasional Bhd, Malaysia’s investment arm, and expect this relationship to generate more positive synergies. While Medini land cost is fully settled by means of its JV with Khazanah, its Pendas land payment terms are attractive as it is staggered and deferred over a period of 120 months. This means less strain on its cashflow and land holding cost while it can match income to cost once launches take place. We believe Khazanah has opted for SUNWAY due to their Sunway Resort City experience while SUNWAY is one of the few large developers with in-house infrastructure capabilities and proven track records. Bandar Sunway is reaping the fruits of their labour, especially through spinning off its investment properties to REIT.

Best of both worlds. With the combination of both Medini and Pendas land, it has c.1,800 acres (68% for the integrated township development and 32% for open spaces for parks, greenery), implying a low-density development on the back of a 1.0x plot ratio. This will likely attract foreigners from high-density cities like Singapore. Given the low density, we still expect decent margins given that GDV to land cost is low at 3%-6%. These two projects provide flexibility in earnings drivers because the company would be able to cover a good mix of products and cater for different groups of buyers, i.e. foreigners or high-end markets and locally driven affordable market.

Johor landbanks have strong connectivity! Notably, its landbanks are located next to the Second-Link Highway towards the Tuas direction. Additionally, there is a strong possibility that the Coastal Highway may cut through these landbanks which will link the landbanks directly to the city center and potentially, UEMSUNRISE’s Gerbang Nusajaya. This will be a major driving force of demand for residentials in the area.

Landed residentials will always be in demand. Notably, most of their landbanks in Johor are largely earmarked for landed residentials, which will continue to see sustainable demand, particularly those in prime locations or those with strong connectivity. It will also serve as a decent hedge against inflation in light of rising land and replacement costs, particularly if they are foreign buyers (e.g. Singaporeans) or Malaysians working in Singapore, as well as, locals. This is mainly due to the scarcity of landed properties in Singapore, which are mainly the primary preserve for Singapore citizen and the pricing there are multiple folds as compared to Malaysia. Apart from UEM Sunrise, SUNWAY is one of the few developers owning sizable land in Medini and Pendas with total land area of 1,770 acres and GDV of RM30b. These projects should enjoy strong demand and capital upsides given the lower land costs, as well as, the opportunity of replicating another award-winning world-class township here. It also has another 88-acre land in Plentong, Johor namely Bukit Lenang, which is about 15 minutes’ drive to Johor Bahru and CIQ complex; it is largely catered for high-end market with selling prices of >RM1m/unit.

Flexible target markets in Johor. This is because the Medini area is not restricted by Bumi quotas and low-cost housing requirements whereas the Pendas area still conforms to the usual requirements; this means Medini has fewer restrictions and expects quicker take-up rates and better margins. We also understand that Medini is unlikely to be affected by the new foreign buyers’ threshold of RM1m/unit meaning their strata residentials will increase in popularity since this may be the only area unaffected by that measure; meanwhile, their landed residential products will likely be priced above RM1m/unit. Pendas will be targeted at local buyers and believe it will be priced lower than their Medini project whose target markets are largely locals or Malaysians working in Singapore. (Refer to Risks section for more details on impact from Budget-2014 measures). The first phase of Medini will likely be launched in Dec 2013. It will be an integrated development which comprises of serviced apartment and offices attached above c.40 units of retail lots with total GDV ranging between RM400m and RM500m. Since Medini may likely be exempted from the foreign buyers' floor price of RM1m/unit and retail lots are in strong demand given the lack of supply, we believe the take-up rates should fare well. Launches of landed properties will likely kick-off in 1H14. Meanwhile, the management has yet to decide on the development of Pendas - the land still remains brownfield at this juncture.

Attractive valuation points. Although they are the third largest developer by market cap, SUNWAY’s FY13E-14E PER or PBV valuations are still relatively cheaper than its peers. The company is currently trading at FY14E Fwd PER and PBV of 9.8x and 0.9x, which is attractive vis-à-vis most developers with >RM1b market capitalisation like UEMSUNRISE, SPSETIA, IJMLAND, etc., which are averaging at 12.4x Fwd PERs and 1.4x Fwd PBV. Although the group has other businesses like construction and property investment, its largest core earnings driver is still property which contributed 58% to the core earnings in FY12. Additionally, its GDV to Market Cap ratio of 11.7x is the highest among the Johor based developers compared to UEMSUNRISE (8.4x), CRESCENDO (10.0x) and SCIENTEX (3.7x). Its dividend yield is also comparable to its peer average as well.

World-class brand name with overseas exposures. SUNWAY has garnered global recognition from its flagship development over the 800-acre land in Sunway Integrated Resort City, which comprises of world-class facilities that attract 40m visitors every year. Meanwhile, this is further enhanced by the overseas property developments. The company has more than RM4.7b GDV in the developed and developing countries such as Singapore, Australia, China and India. However, almost all of its overseas projects are joint-ventures, either with local parties or reputable player such as Hoi Hup Realty (based in Singapore), SSTEC (the master developer of the Tianjin Eco-City, which is a 50:50 JV between a Chinese Consortium led by Tianjin TEDA investment holding Co., Ltd and a Singapore Consortium led by the Keppel Group). Hence, it has mitigated a significant amount of execution or cross-country risks, which have been a proven formula as its major projects have achieved 100% take-up rate shortly after launch.

Monetizing local landbanks. The management emphasizes that their focus will mainly be on monetizing the local landbank in the near to medium term, i.e. ongoing projects in Klang Valley and the new projects in Johor. New overseas project is Mount Sophia in Singapore for the meantime, with effective GDV of RM641m while ongoing projects will be Novena in Singapore (effective GDV of RM713m). Hence, we do not expect any major overseas contribution these next few years which would also likely avoid the impact from the recent volatile fluctuation of currency rate.

Property Investment

A diversified REIT which leans on retail. Property investment division includes the management of retail and

commercial assets either directly by subsidiaries of SUNWAY or through 34.4% owned SUNREIT worth c.RM5b in total asset value. From SUNREIT, we expect a steady cash dividend stream of RM78.4m-RM79.5m over FY13E-14E to SUNWAY from its stake of 34.4%, which would be handy for their property development working capital needs, such as infrastructure and earthworks for Medini and Pendas. The majority of these assets are located within Sunway Integrated Resort City, a successful integrated township mix which attracts 36m visitors annually, containing 15k student population and a large catchment of 500k population from the township as well as nearby Subang Jaya. The well-diversified portfolio comprises malls, office buildings and education campuses located at key residential areas such as Bandar Sunway, Kota Damansara and Pusat Bandar Seberang Jaya, as well as, penetrating city centre areas such as Jalan Putra (next to PWTC) and Taman Maluri, Cheras. We have coverage of SUNREIT with MARKET PERFORM call and TP of RM1.36.

Second largest core earnings contributor to the group and yet more to come. The property investment division is the second largest core earnings contributor after property development, which contributed c.51% to the core profits in FY12, excluding the revaluation gains. In FY12 alone, SUNWAY enjoyed RM97.8m of disposal gains from sale of Sunway Medical Center. This was the result of continuous efforts of developing quality and sustainable products and townships. Its crown jewels are mainly its retail malls which SUNWAY has put in a lot of Asset Enhancement Initiatives to enhance the popularity of the malls by bringing in new tenants with established or innovative brands. Moreover, the group will continue to develop more products with recurring revenue such as the upcoming mall at Sunway Velocity, office building – The Pinnacle and new academic block at Bandar Sunway, which would add on another 2.2m sf on top of the existing NLA of 3.7m sf.

An avenue of unlocking its property investment assets. SUNWAY has been expanding its commercial asset base to create steady income streams for both SUNWAY, as well as, SUNREIT. Currently, there are ten properties under SUNREIT with an estimated asset value of RM5b while SUNWAY also directly holds some education-related properties, malls, hotel and theme parks. Meanwhile, the company is in the midst of expanding Sunway Pyramid by adding an additional 20,000sf of NLA for Oasis Boulevard 5, and Sunway Pyramid 3 with NLA of 220k sf which will be completed by end-CY14 (70,000sf of lettable retail space and the remaining is a four-star integrated hotel). It is also developing the three REIT-able assets namely The Pinnacle, Sunway VeloCity Shopping Mall and Sunway University New Academic Block with a combined NLA of 2.2m sqft. Meanwhile, SUNWAY (excluding SUNREIT assets) has c.RM3.0b worth of investment properties in its books that are Reit-able. However, the key criteria for assets being injected into SUNREIT are: (i) acquisitions must be yield accretive post unit base dilutions from raising new funding, (ii) have organic growth opportunities, and (iii) relatively stable income over long periods. Furthermore, SUNREIT has the first right of refusal to acquire properties from SUNWAY. Indicated assets that will be injected into the REIT are as follows:

Construction

SUNWAY is one of the top-notch outliers among the contractors as the division is able to capitalize on other divisions, such as its building material division, to maximize the synergy within the company. Moreover, its property development subsidiary will provide recurring streams of jobs to the division. Although the internal projects are eliminated at intercompany levels, the company has the competitive advantage of reduced transfer pricing over its peers which will help maximize the profits of the group, especially the property development division. SUNWAY has a good track record in this segment with a diversified pool of clientele in the government and private sector. For example, the company manages to secure an adequate amount of infrastructure order book from the government and the booming Johor projects given its tieup with Khazanah. Over the years, SUNWAY has completed a number of iconic projects, including the KLCC, Sunway Pyramid Shopping Mall, Legoland in Johor and Rihan Heights in Abu Dhabi.

Technical know-how. SUNWAY also capitalizes on its technical know-how to secure more projects. They can offer lower bid prices but yet reap slightly better margins as compared to peers. The company achieves this by introducing the widely used system in western countries namely Virtual Design and Construction (VDC). Currently, SUNWAY is the first and only contractor which has this 5D technology in Malaysia that includes: (i) the 3D Building Information Modelling (BIM), (ii) the 4D project planning, scheduling and calculating progress in physical development and timeline, and (iii) the 5D automated quantities take-off, accurate cost estimation and real time cost control.

Sizeable outstanding order book of RM3.9b. Its outstanding order book now stands at RM3.9b, out of the total contract value of RM6.1b; 71% are external jobs and the remaining goes to the subsidiaries. We estimate this sizeable order book will last for c.2 years. The company aims to maintain this orderbook size with a replenishment rate of about RM2.0b p.a. including approximately 20% of internal orders, which is how it has met its target YTD. Hence, we have faith in SUNWAY that it will be able to keep the ball-rolling to achieve its role as a revenue engine as this division is the highest revenue contributor to group.



More infrastructure opportunities to go! Although the construction division is not as lucrative versus the property development division in terms of margins, it would provide the company strong cashflows to undertake projects with a long gestation period in its property development/investment division. Given its skill set and competitive advantage, SUNWAY has managed to secure all types of private and government projects in the past year, which has increased its visibility significant when compared to other construction big boys. Hence, we foresee more opportunities of order book replenishment coming from the remaining ETP and 10MP projects such as the railway infrastructure as SUNWAY is one of the main contenders for the MRT project. We understand that the Government will continue to expand and upgrade the country’s railway tracks which include MRT2 and MRT3, KL-Singapore High Speed Railway, Southern Double Track Gemas-JB, KVDT upgrades, LRT3 extensions, East Coast Region Railway, Johor-Singapore RTS and KL Monorail extension with more than RM100b worth of contracts.

Tendering for more buildings works. Management also highlighted that the company will also continue to tender for more building works in Malaysia. Currently, SUNWAY is tendering for the proposed Malaysian Anti-Corruption Commission building in Putrajaya, which is believed to worth more than RM500m. We also gather there will be more extension works to be done at KLCC. Hence, we believe that SUNWAY has high chances of winning this bid due to its track record of completing few of the KLCC construction works.

2. Outlook & Risks

Property Development

More landbanking? The company will continue its overseas ventures through JVs, such as the recent award of a parcel of land in Mount Sophia, Singapore, which is a JV project with Hoi Hup Realty Pte Ltd from Singapore. Nevertheless, it also emphasized that the focus in the coming years will mainly be the domestic front. Due to the scarcity of prime land, the company will continue its effort to explore more pocket landbank in the existing region if pricing is reasonable either in Klang Valley, Penang and etc.

Hike in RPGT and abolishment of DIBS may weaken sales temporarily, but we expect this to be short-lived. In the Budget 2014, RPGT had been raised from 15% for the first 2 years from purchase date and 10% for the 3rd – 5th year to 30% for the first 3 years from purchase date and 20% and 15% for the 4th and 5th year respectively. However, SUNWAY’s projects are mainly high-rise residential and commercial titled properties and thus, the impact will be less severe as it takes 4-5 years to complete construction. We think that investors may have to consider holdings on for a slightly longer term, although one should bear in mind that the low interest rate environment is still conducive for buyers while the man on the street typically opts for properties as a hedge to inflation as they lack other viable investment alternatives.

Overall, we think that the RPGT hikes will have the least effect on new launches, i.e. developers, and will weed our speculators in the secondary market, particular those trying to take advantage of the discounted prices in the secondary market compared to the primary market. Meanwhile, the Government has also proposed to abolish DIBS scheme in the recent Budget 2014. We believe there may be some sales pressure on developers such as SUNWAY with >90% exposure to DIBS in the short term. Nonetheless, we do expect demand to resume in light of inflationary factors (e.g. GST, subsidy rationalization) thereafter, particularly as the banking liquidity to the sector is still favorable whilst we expect SUNWAY to come out with more innovative marketing schemes to sell their projects. We also reckon this has already been largely pricedin pre-Budget-2014 announcements. Nevertheless, we believe developers with high exposure to DIBS will likely offer higher rebates and will come out with more innovative incentives for buyers in the absence of DIBS. We do not deny there may be a slight slow down in demand for developers with high exposures to DIBS although we do expect demand to resume prior implementation of upcoming inflationary factors (e.g. GST, subsidy rationalisation).

High exposure to Iskandar Johor could mean short-term pains, but medium to longer term prospects remains intact. Currently, 40% of SUNWAY’s landbank is in Johor, which means major sales should be coming from Johor next year. Given the recent raising of foreign buyers’ floor prices to RM1m/unit from RM500m/unit and 2% levy on foreigners who buy properties in the state effective from 1st May 2014 onwards, it would affect those smaller units (typically high rises) in Johor. Nevertheless, SUNWAY’s on-going project at Bukit Lenang is selling above RM1m/unit and the company’s plan for next year will mainly focus on its Medini land instead of Pendas. In terms of levy on foreign buyers, we view it positively given: (i) the actual levy is lower than the earlier expectations of 4%-5%, which was guided by the State Executive Councillor for Housing and Local Government, and (ii) the actual levy is lower than the recent idea by Penang government to impose 3% levy on foreign property buyers. The Penang levy is unofficial as yet and is being considered at the moment; however, if it does come into effect, Johor properties would be slightly more attractive. The current levy for foreigners in Johor is RM10k/unit as compared to a 2% levy on a property worth RM2m which is only RM40k in absolute terms and at these pricing levels, we believe the differential will not be significant to such high-end buyers. In short, SUNWAY is unlikely to be affected due to: (i) most of its products are above a million ringgit, (ii) Medini will unlikely be affected by the new floor prices for foreign buyers, which means the demand in Medini will likely surge as these are the only areas that foreigners can buy properties below RM1m/unit. The recent Budget-2014 proposed measures (e.g. 30% RPGT for foreigners for the first 5 year holding period) may be a deterrent in the short run to foreign buyers. However, we believe this sentiment will not be long-lived; we expect house prices in Malaysia to continue appreciating due to increasing land costs and higher replacement costs arising from subsidy rationalizations and implementation of the 6% GST on 1-Apr-2015. This will be more so the case in Johor, especially given the prospects of economic drivers likes Pengerang’s Oil & Gas activities and the Singapore-Johor Rail Transit System (RTS).

Notably, Singapore’s property cooling measures are far more severe than Johor given high stamp duties and holding costs (refer to our Property Sector report, 28/10/13). We also believe locals and Malaysians working in Singapore will take this opportunity to accumulate properties in Johor. The measures put in place in Malaysia/Johor will ensure more stable prices which will ensure more sustainable demand over a longer period of time. Despite the proposed measurements, we anticipate that SUNWAY will benefit from its Medini projects as Medini is a special economic zone and will likely be exempted from the new floor prices for foreign buyers. Hence, we believe SUNWAY will still benefit from: (i) continuous interest in Iskandar Malaysia properties, (ii) the Johor-Singapore RTS outcome, whose feasibility study should be known by Nov to Dec 2013, (iii) Medini Iskandar’s listing by 1H14 and IWH’s listing next year, (iv) more G2G agreements with Singapore, (v) increasing FDIs e.g. O&G plays in Pengerang and Tanjung Piai, and (vi) Greater Klang Valley to benefit from the KL-Singapore high-speed rail train news, TRX, Circle-Line MRT and RRI land awards.

Panic buying before GST implementation which will more than neutralize negative measures. We also highlighted in our recent property sector report (dated 28/10/13) that if GST is implemented in April-2015, we anticipate pre-implementation ‘panic buying’ in 2014, assuming no major changes in the banking sector liquidity towards the sector. Similar experiences form other countries such as Canada and New Zealand had seen such trends in anticipation of future cost push inflations on property prices. This will also be beneficial to SUNWAY’s 2014 sales, as its financing terms, quality and goodies could be attractive than many developers in town. Hence, we also expect SUNWAY to front-load their launches in 2014 on the back of higher demand which will be a big booster to future earnings.

Macro economic and sector risks. This includes overall property down-cycles, tightening of banking liquidity, sharp interest rate hikes, negative real estate policies, global economic slow-downs, etc. economic uncertainties or a global slowdown contagion effect may slow down demand significantly. This will have negative implications on cash flow for developers doing medium to long term integrated projects. The group will be particularly sensitive to any changes in the Iskandar landscape, which is dependent on the G2G relationship between Singapore and Malaysia.



Constructions

Our construction analyst maintains an OVERWEIGHT call on the construction sector given: (i) the anticipation of the increasing news flows in the near term i.e. Cabinet approving the RM25b KVMRT Line 2, conclusion of the RM6.0b WCE highway’s financing, feasibility study completion on High-Speed Rail, Langat 2 treatment plant tender, award of PPP/PFI projects, (ii) development of the M&A activities i.e. Selangor water assets, highways infrastructure, (iii) commitment from the Government to implement the “high impact but low import content” projects despite potential review of some mega projects due to weak fiscal position, and (iv) undemanding valuation of big caps contractors. Value for money projects – MRT – likely to benefit SUNWAY. Due to its fiscal position, the Government focuses mainly on the “value-for-money spending initiatives” in the Budget 2014. Hence, we believe the Government will continue the MRT project which in turn would potentially benefit SUNWAY as the company has been prequalified for MRT elevated tracks, stations & depot packages to secure further MRT contracts.

Delays in awarding of construction contracts. We are aware that the government may delay some of the projects due to the urgency to address the country’s fiscal position (i.e. narrowing surplus of current account, rising national debts, fiscal deficit position). Nonetheless, our economist is of the view that the government will not delay some of the high-impact projects, which will yield high multiplier effects such as KVMRT. In fact, the government has recently pointed that the KVMRT project will not be postponed.

Potential of cost overruns. The current landscape can be precarious for contractors as we have plenty of inflationary factors, which are on the way e.g. GST and subsidy rationalization. The contracts are expected to be fixed while building materials are not. However, SUNWAY’s in-house building material division would be one of its key advantages over the competitors as the company can preserve more due to lower transfer of pricing.

Property Investment

Lack of catalysts. The asset acquisition environment has been extremely quiet over 2013. We believe this is highly due to the low cap rate environment of 5%-6% (vs. 7%-8% previously) which is a mismatch against MREITs asset NPI yields. We understand that SUNREIT has been eyeing acquisitions even from third parties of up to RM7.0b over the next 3-4 years, but nothing is firmed up as yet. Nevertheless, SUNWAY does not have any asset injection plan at the moment as the reit-able assets are still at an immature stage and SUNWAY will reconsider injection nearer to 2016-2017.

Retail organic growth under threat? We believe there may be weaknesses with future organic growth rates for retail MREITs (6%-9% p.a.) such as CMMT and SUNREIT. Retailers are facing stiff competition, which has resulted in higher A&P costs, limiting their ability to keep-up with rising rents brought about by the series of REIT-ing activities and IPOs over the last few years. We will be monitoring the situation closely as we have yet to factor this impact into our earnings. As for office spaces, we do expect flattish organic growth due to the supply glut in the Klang Valley while industrial spaces are unlikely to capture any short-term upswing in rates as leases are longer termed (5-10 years). However, Sunway REIT can look forward to new income streams from the delivery of Sunway Putra Mall, which is slated to be completed by Feb 2015, and we expect RM7.5m-RM51.5 of additional total revenue for FY15-FY16E, which represents 1.8%-10.0% of the REITs to total gross revenue, which has already been built into our estimates.

More sensitive to consumer sentiment. As retail spaces are its largest component of the property investment segment (61%), the potential growth will be highly correlated to their retail tenants’ business, which in turn depends on the consumer sentiment. Generally, retail segments would be the hardest hit by inflationary pressures arising from the subsidy rationalisation program and GST implementation. However, while the government continues its effort to attract tourists, this would help to cushion the slowdown in sales from the domestic front. As shown in the consumer sentiment chart, the index has peaked in 1Q13 and dropped in the 2Q13.

3. Financial Analysis

Steady and Productive. Historically, SUNWAY has proven track records way before the merger of SunCity and Sunway Holdings with 5-year Core NP CAGR of 14%. Excluding one-off items, the group was able to maintain stable ROE ranging between 8% and 11% in the past four years which were relatively better than construction based developers like IJM Corp record of 6% to 8%. In 1H13, SUNWAY registered revenue growth of 18.1% YoY and earnings of 19.2% YoY buoyed mainly by the stronger performance from the property development and construction divisions. The better performance was mainly due to stronger sales achieved from the recent launched projects and higher progress billings from local projects such as Sunway South Quay, Sunway Damansara and Sunway Velocity as well as higher contribution from Singapore projects.

We project core net profit growth of 10%-12% p.a. for FY13-15E, mainly driven by the property development and property investment division with total contribution of 82%-83% of operating profits. In terms of revenue, construction will account for c.39% of revenue, the highest contribution among the divisions.

i) On the property development front, we are targeting strong FY14E sales growth of 23% YoY to RM1.5b despite a negative growth of 29% for FY13E (RM1.3b). The sales decline in FY13E is mainly due to lower launches in FY12-13 as compared to FY11. We have estimated new launches of RM1.5b, RM2.1b and RM2.4b for FY13E-15E with a conservative average take-up rate of 40%-50%. FY14E-15E will continue to be driven by on-going projects (e.g. Sunway Damansara, Sunway South Quay and Sunway Velocity) and new projects from Johor. Unbilled sales of RM2.2b provides close to three years visibility for the development division.

ii) With regards to its investment properties division, we have not imputed for any new asset at this juncture. However, our assumptions are as follows: (i) Retail and office: 5% and 1% organic growth assumptions, respectively, (ii) Hospitality: we have assumed a 3.0% in the annual room rate with the occupancy rates increasing incrementally by 1% each year.

iii) In terms of construction, we have imputed in orderbook replenishment of RM1.5b p.a. which led to c.RM2.7b orderbook for both FY14-15E.

Returning to a comfortable zone after rights issue. To recap, SUNWAY has just completed its 1:3 rights issue on 13 August 2013 with issue price of RM1.70. There were additional 430.9m new shares and c.RM733m cash from the exercise. This has pared down net gearing from 0.54x to 0.29x or below our comfortable net gearing ceiling of 0.5x-0.6x. We reckon that it would not have any significant debt repayments due in the near term. As a result, we expect FY13E-15E net gearing to hover around 0.2x-0.3x. Meanwhile, the company recently proposed the issuance of commercial papers/ medium-term notes of up to RM2.0b in nominal value. These proceeds will mainly be used to repay all amounts outstanding under the existing commercial paper/medium-term note programme of up to RM500m and to finance investment activities, capital expenditure, working capital, repayment existing/future borrowings and other corporate purposes. We reckon that the impact of the amount is insignificant and net gearing for FY14E (assuming the proposal will be done in next year) would likely increase from 0.24x to 0.25x.

5. Valuation/Recommendation

A good time to enter? Since property stocks have peaked in May 2013, after the post-GE rally, SUNWAY’s share price has declined 19.3% to the YTD lowest at RM2.92 while the KLPRP has only fallen by 12.2% to the YTD lowest at 1,335.3 in June. Although both KLPRP and SUNWAY prices have edged-up slightly by 1.6%-1.3% from their YTD lowest points, we believe there is more room for recovery. It is also trading at near trough valuations in terms of Fwd PER and PBV.

Initiating coverage on SUNWAY with an OUTPERFORM and TP of RM3.08. Our TP is derived from our SOP valuation, which implies a total return of 14% including a 7.0 sen DPS. Our TP implies FY13E-15E PBV of 1.1x-1.0x and PER of 13.6x-12.2x which are still lower than the industry average of 14.6x-12.4x and 1.4x respectively. The stock is currently trading at FY13E-15E PER and PBV of 10.7x-8.7x and 1.0x-0.9x respectively which we find undemanding as compared to the other big players. This is mainly because SUNWAY’s PBV is relatively lower than most of its peers ranging between 1.1x-1.7x while its PER is close to IJM Land’s levels even though SUNWAY’s market capitalisation is slightly bigger than IJM Land.

Our TP is based on:

i) The property development division is based on a 25% discount to our RNAV which is inline with our sector’s weighted average discount of 27%. Our RNAV is derived from a 10% WACC to DCF future development profits based on net margins of 19%.

ii) Assumed a 12x FY14E PER to construction division, which is on par with mid to big cap construction peers ranging from 12x-15x.

iii) Assumed zero surpluses on its holdings investment property valuations.

iv) Net return from SUNREIT based on our in-house target price of RM1.36 which is derived from the FY14E NDPU of 6.9sen based on a targeted net yield of 5.1%.

v) Assumed an 8x FY14E PER to the quarry, building material, trading and manufacturing divisions, which is on par with small-mid cap manufacturers.

vi) 289m of warrants and 155m of ESOS are accounted for our FD RNAV per share for the dilution impact at the price of RM2.50 per share and RM0.95 per share respectively. We also assume 1% interest saving from the warrants.



Source/Extract/Excerpts/来源/转贴/摘录: Kenanga-Research,
Publish date: 21/11/13

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