Saturday 2 November 2013

Post Budget Impact and Opportunities for the Property Sector

There is a window of opportunity from now until the end of the year in the secondary property market as higher Real Property Gains Tax (RPGT) rates will only take effect on 1 January 2014. The likelihood is that we are going to see an increase in sales volume in the secondary market but at lower prices, especially for those projects with Developer Interest Bearing Scheme (DIBS). 

Higher RPGT will have a negative impact but since the computation of the tax is based on the date the sale and purchase agreement (SPA) is signed, the impact might not be as severe if one is willing to wait slightly longer to dispose of a property. Typically, high rise residential projects take 36-42 months to complete. The impact will be greater on the landed residential segment as it takes about 2 years to complete but this segment is also a less speculative market.  

With the removal of DIBS, we are going to see fewer property transactions over the short term but we understand that banks have also been more cautious and gradually reduced their DIBS loan exposure over time. Hence, the impact would be less severe than initially thought. 

We think the increase in the minimum price of property that can be purchased by foreigners from RM500,000 to RM1 million could have a more significant effect as many developers have a large planned supply or units under construction to cater for both foreign and local buyers in the RM500,000 to RM1 million price range. Also, there is a higher proportion of speculative buyers in this price segment.   

The 6% Goods and Services Tax (GST) that takes effect from 1 April 2015 does not apply to residential properties but it does to commercial and industrial properties. In recent years, we have seen quite a number of mixed development projects under commercial land titles because they are more profitable. Most developers were building a large number of small units due to affordability. Residential land titles are regulated by density but commercial land titles are guided by gross floor area (GFA). Hence, there is generally no cap on the number of residential units. So residential developments under commercial land titles may not be able to claim GST paid for construction. This means that developers will face margin compression if they do not pass on the higher cost to buyers. However, the ability to pass on the higher cost will depend on demand conditions.

Next year, we can expect lower transaction volumes, lower prices due to lower demand, margin compression and lower profits for developers in a 2-3 year horizon. We think the market has priced in some of the negative news but clearly not all as few expected the severity of the measures announced. While stock prices are still resilient, we think it’s the calm before the storm. Most are still in a state of denial.   

More details on this article are published in The Edge this weekend.

Friday 1 November 2013

Making US$1billion, the quick and easy way

The Edge team this week put together the most comprehensive story to-date of Asiasons, Blumont and Lion Gold.  What happened, why and some probable rationale for the spectacular rise and collapse of the stock prices of these three Singapore-listed companies with major Malaysian personalities as directors and shareholders.

The stock prices rose even as the values of their investments were falling.  Further intrigued by a series of stock placements and short-selling of shares.

Then there is Black Elk, a highly problematic oil and gas company operating in the Gulf of Mexico and its owner, Platinum, a US hedge fund.  What have they got to do with the three companies above?

Thursday 31 October 2013

A boost for media freedom

Freedom of speech and freedom of choice are fundamental human rights that should be enjoyed by every man.  In a democratic society, we also expect media independence and press freedom. Freedom of the press means freedom of communication and expression through mediums including various electronic media and published materials. Logically, this includes the right to a permit to print.

Indeed, freedom of the press is also about property rights. These properties are printing presses, auditoriums, billboards, radio equipment, computer networks and so on. “Property rights” is a necessary condition for market economies to work.

Yesterday’s Court of Appeal decision rejecting the government's appeal against the High Court ruling that publishing a newspaper is a right, not a privilege, is commendable.  The consistent decision delivered by both the High Court and Court of Appeal is a move in the right direction.

Intervening in the application for a publishing permit on the basis of limiting competition is a flawed argument.  Monopolistic behaviour will only breed inefficiencies and deprive the public from the freedom of choice, and in this context, the access to more print options. It is also inconsistent with the new Competition Act. 

Media owners should be given the right to compete on a level playing field. Let the newspaper fend for its own survival. It is time to stop protecting status quo and embrace a more inclusive economic and social policy for the sake of the country.

Friday 25 October 2013

Property gets a beating, and operating expenditure is under-budgeted

As I mentioned in last week’s article, I expected the property sector to be hammered. Complaints of rising prices and affordability triggered by more foreign buying and the need to address social inclusion has resulted in very severe measures just announced in the budget.

The removal of DIBS (interest paid by the developer during the construction phrase) has removed a major “warrant” price for new launches. By just paying a small deposit, say 10%, buyers were free from any subsequent payments until completion, some 2 to 4 years away.

While raising the RPGT for everyone has the effect of reducing speculation, the perpetual and higher RPGT on foreign buyers will take a heavy toll on demand too. This is especially so when it is also combined with raising the minimum price for foreign buyers to RM1 million from RM500,000 previously.

There are many properties priced to sell at just above the RM500,000 threshold. These are small units, like the SOHO and small apartments, ranging in size of between 500 and 1,000 sf and priced at around RM700 to RM1,000 psf. This was the fast moving market segment.

We know the prices of new launches are at about a 10% to 20% premium to a comparable property in the secondary market. And new launches sell quickly in comparison too.

The new measures will change the game. The “warrant” premium is substantially gone. As such, we expect in the short-term, transaction volume will fall substantially. Prices will fall too, perhaps by as much as 10% to 20%.

On the overall budget, the Government is expecting its deficit to fall to 3.5% of GDP. I believe the operating expenditure is under-budgeted. Emoluments are expected to rise by just over 3%. We have not seen such a small increment in recent years. Also, subsidies are forecasted to fall by some 20% or over RM7 billion. What subsidies will be cut, besides sugar?

It is most likely that we will see supplementary budgets in the months ahead.

The budget is contractionary overall. This is positive for the long-term. The announced 6% GST from 2015 is also in the right direction, especially since it is accompanied by reduction in personal and corporate tax rates.
The splattering of small handouts, I suppose, is populist to gain the support of the poorer communities and a way to offset rising cost of living.

I expect the stockmarket to be adversely affected but the Ringgit will take the news positively… with some skepticism.

Buying water and selling stationeries

Water problems have long dogged Selangor, with the issue compounded by politics. With the General Election over, there will be less political posturing in Selangor. With that, there will be renewed commitment by both the Federal and State Governments to work towards resolving the issue of treated water in the state.

Between 2011 and 2012, incidence of water shortages in Selangor increased by 79%. Syabas is reportedly running on a reserve margin of just 1% with water consumption growing at 3-4% per year. This will adversely affect future economic activities in the Klang Valley, which accounts for 38% of the country’s GDP.

It is also clear that the governing party in Selangor, which sits as the opposition in the federal parliament, needs to show it is able to run the state effectively, generate new jobs and bring in new investments. A recent public criticism by the leader of the Opposition, of the Chief Minister of Selangor, a senior member of his own political party, is telling.

While the Chief Minister has managed Selangor well in the past term, resolving the water issue is critical for the future of industries and consumers in the state. With this in mind, there may be opportunities for investors in the sector once the restructuring takes place.

Credit Suisse recently issued an excellent report on the Bursa Malaysia-listed companies with exposure to the water sector.  I know the analysts Danny Goh and Rachel Tan well and therefore, the quality of their work. There is no need to reinvent the wheels.

Here is a quick summary table of the financials of three companies in the sector, for those who may not be able to secure a copy:

Company                    Price                P/E (x)                               P/BV (x)
                                    (RM)                2012    2013    2014
Gamuda                      4.89                 20.3     19.8     14.4                2.8
Puncak                        3.25                 5.6       4.9         4.2                 0.8      
KPS                             2.00                16.8      n/a         n/a                 0.9

The Selangor State government has offered RM9.65 billion to buy all the four water concessionaires in February 2013. It was not successful as Puncak Niaga rejected the offer, while the others accepted. To succeed, a better offer will have to be made to Puncak Niaga. Despite the recent rally, Puncak Niaga’s shares are currently still trading on single digit multiples and below book value.  

To be fair, the water restructuring play has made its rounds many times in the past three years, only to peter out as talks ended in a stalemate. However, with the general election over and the danger of dry taps a growing reality, there is palpable sense that a definitive solution will soon be found.

Turning from water to stationery, I feel compelled to return to China Stationery Ltd, which I wrote in this column on 5 Oct 2013. There are troubling facts that are inconsistent and not logical, at least to me.

Below is an extract of the last two years financial information

China Stationery Ltd
Extracts of Financial Statements
                                                               RMB’000                         RMB’000
                                                            31 Dec 2012                 31 Dec 2011
Cash and Bank Balances                   1,889,491                      1,327,077
Borrowings                                               54,400                             49,100
Amount due to a shareholder                        38                              71,746
Revenue                                               1,980,628                     1,774,710
Cost of Sales                                      (1,110,626)                      (979,207)
Gross Profit                                              870,002                        795,503
Gross Margin in %                                      43.9%                             44.8%
Interest Expense                                          8,261                           41,908
Interest Income                                            7,014                             5,200
Interest rate on borrowings                         15.2%                           34.7%
Interest rate on deposits                               0.37%                          0.39%

It raises many questions, such as:

1) What stationeries are sold by China Stationery Ltd that generate an astronomical 44% gross margin? The company makes plastic stationery, plastic tape printer and ink.
2) Why does the company borrow when it has so much cash?
3) In 2012, the company paid back RMB 71.7 million to its shareholder. Is this the controlling shareholder?
4) Why is the total effective cost of borrowing between 15% and 35%?
5) Why was the company paying a hefty 57% interest rate, with RMB 38.9 million interest on a RMB 68.5 million convertible bond in 2011?
6) Why are the bank deposits of some RMB 1.9 billion earning only 0.4% interest when the 1 year deposit rate in China is over 3%?

In our previous report, we also indicated that the major shareholder, Lead Champion, has sold down from 71.85% to 23.43% since the beginning of this year.

China Stationery Ltd is a Bermuda registered company. Its principal place of business is in Fujian Province, China. It is listed in Malaysia. Its independent auditor is in Singapore.

The stock price may look “cheap” now. The cash available per share, accordingly to the financial statements, is four times more than the stock price. But I believe it may get “cheaper” soon. 

This article will be published in The Edge this weekend.