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.

Friday, 20 June 2014

Citrine – A sensible value proposition

Project launches in Medini have always drawn much attention amongst investors in view of its economic zone status and positioning as the Central Business District of Iskandar Malaysia.
  
As a result, recent months have seen many “investment type” properties launched at exorbitant prices riding this speculative wave.   

We believe Citrine@The Lakeview, to be launched soon by Sunway Group at RM700-RM800 psf is sensibly priced for a fully integrated development with well-articulated Unique Selling Points.  

Highrise Residential Launches in Medini in 2013

Project Name
Launch Price (psf)
Meridin
average RM730
Affiniti Residences
RM850 - RM1,000
Paradiso Nuovo
fr RM850
D'Pristine
RM700-RM850
Iskandar Residences
fr RM700
















Citrine comprises 167 units of designer offices, 328 units of apartments as well as 51 units of boutique retail which will not be sold.  Designer offices have built ups ranging from 746sf to 1671sf and the built ups for the apartments are from 618sf to 1571sf. 

The product mix is sensible and market-driven, taking into account the potential needs of the neighbouring developments including the RM60mil Canadian International School (to be built) and the newly completed Pinewood Iskandar Malaysia Studios. 

The planned complementary facilities such as international school, hotels, medical facilities, malls and theme park within Sunway Iskandar will improve sustainability and livability in the long run.   

Read more in The Edge this week.

Saturday, 14 June 2014

Corporate earnings improve marginally; facing headwinds going forward

The top 30 companies in Bursa Malaysia registered strong profit growth, as measured by earnings per share, of 18.2% in the first quarter of 2014. However, looking beyond the bottom line figure reveals profits boosted by one-off gains amid sluggish revenue growth.

The sluggish revenue growth is surprising given that the Malaysian economy chalked up an impressive y-o-y gross domestic product (GDP) growth of 6.2% in 1Q2014. GDP grew 5.1% in the last quarter of 2013. GDP is defined as the sum of all goods and services produced in an economy.

Let us first look at how Malaysian corporates fared in the first quarter. 

Overall, corporates performed slightly better in the first quarter of 2014 even after stripping out the one-off gains. Revenue growth turned positive after being in negative territory since December 2012. Profit and sales growth was also marginally higher.



The FBMKLCI is a market capitalisation-weighted index of the top 30 companies in Bursa Malaysia. As such, it is often seen as a good proxy and bellwether for Corporate Malaysia.

FBMKLCI companies registered strong profit growth of 18.2% y-o-y. Compared to the previous quarter, profits grew by 10.7%. This good set of results seems to be consistent with the impressive GDP growth registered by the economy in Q1.

However, things look less impressive once we strip out exceptional items from the bottom line.

In the case of the first quarter results of FBMKLCI companies, an abnormally large exceptional item was recognised by IOI Corporation Bhd. This in turn skewed the profit figures of the FBMKLCI upwards.

On the revenue side, growth has turned slightly positive with a 0.8% increase, marking the first time since 1Q2014 that revenue has not contracted.

The uptick in revenue and improvement in cost-side management contributed to an increase in profit margins in the first quarter.

At the moment, the operating profit margins of the FBMKLCI are about 19.6%, which is a 2.4% improvement compared to a year earlier.

However, revenue growth is still weak and companies cannot rely on keeping costs down to maintain profit growth. This is because inflationary pressure will eventually result in an increased cost base.

This will likely happen down the road due to the implementation of the goods and services tax (GST) in April 2015 and the possibility of further cuts to fuel subsidies. Bank Negara Malaysia has indicated that inflation will likely be between 3% and 4% in 2014.

So why has revenue and earnings growth been sluggish despite the strong economic performance in the first quarter?

Read more in The Edge this week. 

Sunday, 8 June 2014

Bursa Malaysia may see more fund raising activity

Companies with funding needs may increasingly look to the stock market if Malaysia’s low interest rate regime comes to an end. And there are growing expectations that Bank Negara Malaysia (BNM) will raise the Overnight Policy Rate (OPR) by to 3.25% from 3% when its Monetary Policy Committee next meets in July. 

Currently, the main sources of funding for companies are banks and the bond market. With interest rates on an uptrend, these two fund raising venues may become less attractive. The stock market, on the other hand, could see more fund raising exercises.

BNM’s latest statistics show that business loan applications have dropped by 10.6% in April from the previous year. Growth has actually been on a downtrend since January 2014.










While the pace of private debt securities (PDS) issuance has picked up in 2014 compared to the same period in 2013, this trend is unlikely to continue in the coming months. This is because companies issuing PDS would likely have to pay a premium to the current cost of borrowing to reflect the widely-anticipated OPR hike in July.












With bank loans and PDS being adversely affected by interest rates, a shift towards the stock market for capital raising seems natural especially when the FBM KLCI is trading near its all-time high of 1889.47 and investors are generally in a confident mood. 

Read more in The Edge this week.

Friday, 6 June 2014

Long overdue, analysts finally cut sales forecast for property developers

This week, The Edge carries a report on the sales performance of several property developers in Malaysia.

In the reporting period ended March 2014, close to half of the listed property developers under analysts’ coverage reported weaker than expected sales or earnings.  We had expected such moves.   

Meanwhile, property developers have largely maintained their FY2014 new sales target. It is going to be a tall order to meet new sales forecasts for some of these companies.

In the latest quarterly results, we can see slower demand for higher-priced properties and rising cost pressures. However, demand for affordable homes remains resilient.

Most of the larger listed property developers have relatively solid balance sheets (average net gearing of less than 20%) and hence, are able to hold back launches but this might not be the case for smaller property developers.

Companies in net cash position include UOA Development, Matrix Concepts (Matrix) and Daiman Development (Daiman). Matrix Concepts and Daiman focus on affordable and mid-range landed homes (terrace and cluster homes). This segment is clearly more resilient relative to high-rise homes.

Read the full report in The Edge.