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 2^nd 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.

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.

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.