This article first appeared in The Edge Malaysia Weekly, on October 26 - November 1, 2015.

THE fat around the valuations of property sector stocks is being trimmed this year, thanks to a softening real estate market — a result of the central bank pulling the plug on easy credit by imposing stringent lending rules for mortgages and the government’s introduction of cooling measures to discourage speculation.

Despite trading at steep discounts of around 40% to the revalued net asset value, the sector’s stocks are not tempting investors to buy.

The KL Property Index (KLPRP) has lost 5.89% year to date, closing at 1,209.98 points last Friday. For the first time in three years, the KLPRP is expected to underperform Bursa Malaysia’s benchmark index.

According to Areca Capital Sdn Bhd CEO Danny Wong, one reason for the lack of investor appetite for property stocks, even in the face of low valuations, is the weak sentiment surrounding the local economy and uncertain global growth prospects.

“Prices have bounced back but I don’t have property stocks which I want to buy right now.

“Valuations may be low, but everything else is very uncertain. Somehow, property stocks are the first to be thrown out by investors in an economic downturn … and they are also the first to rebound and recover,” the fund manager adds.

Against the generally tepid outlook among analysts, however, AM Research Sdn Bhd managing director Benny Chew holds a contrarian view with an “overweight” rating on the property sector.

To Chew, property stock prices have almost, if not already, reached,  the trough and it is time to start hunting for undervalued gems that have good landbank. He believes most share prices have already factored in the slowdown in new launches

“First, valuations have come off significantly. The average discount to net asset value for the property sector is at 40% to 50%. We think that the sector has bottomed out,” he tells The Edge.

Chew opines that share prices have already factored in a slowdown in pre-sales.

“The important thing is for inventory liquidation to start kicking in. As pre-sales slow, property developers will start to clear their inventories. As sales momentum from that kicks in and assets are being converted into cash, we expect the discount to net asset value for property stocks to narrow,” he says.

Chew does not expect land values to drop over the next 12 months. “This means that net asset values for property firms should hold up. You have even seen some companies start landbanking again,” he adds.

He favours Mah Sing Group Bhd and Titijaya Land Bhd for their earnings potential and strong asset base.

But other analysts are not as optimistic, or rather, more cautious.

Lacklustre sentiment aside, analysts claim the current low valuations are a reflection of the soft domestic property market. Statistics, which show slowing sales and consumer demand for properties, are keeping investors on the sidelines.

Based on Malaysia’s Economic Report 2015/2016, residential property transactions have declined 2.6% while total value fell 9.7% to RM36.4 billion in 1H2015.

Bank Negara Malaysia’s latest statistics show ongoing weakness in mortgage demand in August 2015. Loan growth for residential property may still be buoyant, but it is driven by a loan stockpile from previous years that is currently being drawn down. Even that growth has moderated from a peak of 13.9% year on year in August 2014 to 12.2% in August 2015. The expectations among industry players are for residential property loan growth to slip further, continuing an 18-month loan growth contraction streak.  

Property developers, too, are bracing themselves for an uninspiring sales outlook.

Last week, Sunway Bhd (fundamental: 1.50; valuation: 2.40) announced that it will follow in the footsteps of its rivals in revising downward its FY2015 property sales target 41% to RM1 billion from RM1.7 billion. Tropicana Corp Bhd (fundamental: 1; valuation: 1.50), S P Setia Bhd (fundamental: 1.90; valuation: 2) and Mah Sing (fundamental: 2.80; valuation: 2.40) have already made downward sales revisions of 30%, 13% and 32%, respectively.

This means that developers are now concentrating on clearing inventories and ramping up take-up rates and delivery of ongoing projects rather than pushing new launches. Unbilled sales from these projects will give property firms earnings visibility for the next 1.5 to 2 years, says Quah He Wei of AllianceDBS Research, who has a “neutral” rating on the sector.

More importantly, these patterns serve as an indication of tapering future earnings for property developers.

Quah adds, “There is no doubt that things are slowing down, so you have to be very selective with property stocks now. Go for companies that can sell houses, where sales are resilient, and those that are exposed to affordable housing projects,” he advises.

Quah’s top stock pick is MKH Bhd (fundamental: 0.80; valuation: 2), liked for its focus on developing landed properties in the Kajang and Semenyih area and focus on genuine homebuyers.

For the sector’s fundamentals to change, Alan Lim, an analyst with MIDF Research, says the property sector needs to see a boost from a “positive turn of events” such as the reintroduction of the developer interest bearing scheme or the lowering of Real Property Gains Tax.

In the meantime, Lim takes the view that the investors should distinguish between companies with strong balance sheets and a robust sales performance from those which do not as valuations are low across the sector.

“Investors can look at how much the stock price has declined versus how much sales have fallen. If sales performance is not deteriorating as fast as the share price, then there should still be value in the stock.

“Companies with strong balance sheets have holding power over their assets. They do not have to rush launches in order to repay bank borrowings. In that sense, they can preserve asset value. But, earnings come down to sales at the end of the day” he adds.

Lim, who has a “neutral” call on the property sector, prefers S P Setia  with a “buy” rating and target price of RM3.60 and Glomac Bhd (fundamental: 1.20; valuation: 2.40) with a target price of RM1.06.

“We like S P Setia because it can benefit from the higher foreign exchange rate of the pound sterling from its exposure to the Battersea Power Station project. Its upcoming fourth quarter results should be strong after the Fulton Lane recognition. The dividend yield at 4.4% is higher than the peer average of 4.2%,” he says.

Kenanga Research, meanwhile, advocates a more defensive bet in UOA Development Bhd (fundamental: 3; valuation: 2.40) with an  “outperform” call and target price of RM2.10. The company has a strong net cash position and strong dividend yield of 6.8%, while its product positioning is in the affordable range in the Klang Valley.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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