Sunday 22 June 2014

High unbilled sales no guarantee of good future profits

The surging property market over the last few years will finally start to slow, as developers, investors and the general public brace themselves for the effects of GST (goods and services tax), on top of other property cooling measures. 

This week, we discuss the potential impact and possible spill over effects of GST to property developers, which is set to affect their top and bottom lines sooner than expected although scheduled to kick in starting April 2015.

Gross margins impacted by introduction of GST

As residential property is exempted from GST, the increase in input tax cannot be claimed by the property developers or passed on to the house buyers for properties already launched and sold.

Having locked in their future sale value, these developers would have to absorb the rising costs when they commence building activities.

We are starting to see the effects of compressed margins even before April 2015. Already, SP Setia in its latest quarterly results has reported lower profit margins as a result of them recognising the financial impact of GST for projects already launched. The remaining effects of GST will unravel in future financial periods, in accordance to future work in progress.

Slight fall in gross margins has a pronounced effect on net margins

A fall in revenue will cascade to the gross profit margins, which will cause a further drop in net margins after fixed costs and taxes.

The simple financial model example below (Table 1) tells the story. With the imposition of GST, a drop in gross profit of 14% translates to a drop of 43% in net profit, assuming operating costs remain constant.

The above financial model has not even factored in the possibility of the property developers being at the mercy of contractors who are bound to hike up their charges due to their higher contribution and input costs.

This effect will be more prominent as we enter into the 2nd half of 2014, as more developers would already start factoring in the GST cost once they can reliably estimate the additional cost to be incurred.

High unbilled sales does not secure future margins

Though most key developers have strong future progress billings to possibly sustain cash flow throughout the next year, sales recognised in the upcoming years will be exposed to rising cost pressures, with falling profit margins.

Read the full analysis in The Edge this week.

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