The Edge, 31 March 2014 - Will property developers' earnings peak in 2014?

The Edge, 31 March 2014

Highlights

1. Most would agree that this is a challenging year for the reai estate industry. Property transactions In 1H2014 are likeiy to be subdued as the market adjusts to policy changes. We think some of the property deveiopers have been realistic and lowered their sales target for FY2014. This suggests that they are cognisant of the "high base" effect In FY2013 and impact from the property cooling measures announced at end-October 2013.

2. Property developers will report a good set of results in 2014. underpinned by huge unbilled sales built up over the last two to three years. When can we expect the earnings of property developers to peak based on what Is In the bag {unbilled sales)?

3. Our extrapolation of unbilled sales suggests that revenue recognition for most developers will peak in 2015, the exception being S P Setia due to projected strong revenue growth in FY2016 or FY2017 from the handover of Battersea Phase 1.

4.In a three-to-four-year horizon, 2014 could possibly be the best year in terms of profitability for most property developers. We are likely to see a decline in net profit in 2015, assuming 6% Goods and Services Tax (GST) takes effect from April 1. 2015, This is assuming that developers absorb the input tax for the majority of the construction materials and labour cost.

5.The KL Property Index is relatively resilient and in our view, there is room for the Index to move downwards in 2H2014 if property-tightening measures stay. Currently, the index is 11% from the peak (May 2013 at 1.519). We foresee smaller property developers facing a tough environment and the hope for them is a policy reversal or easing.

A challenging year but large unbilled sales help

The market is still adjusting to poUcy changes, hence IH2014 sales will be subdued.This suggests property developers are cognisant of the "high base" effect in FY2013 and impact from the property-tightening measures announced in Budget 2014 (on Oct 25, 2013). Most key developers have strong future progress billings to counter a possible slowdown over the near term

Sample size and assumptions

Based on the KL Property Index, there are more than 80 listed companies uith property exposure in Malaysia. It is not possible for us to analyse all of them. We have taken a sample size of developers. Our analysis solely takes into account the latest publicly available unbilled sales (most of them as at December 20l3).The extrapolation of earnings peak for developers is based on sales and unbilled sales data.

Earnings peak

Revenue (on income statement) from property development is recognised based on the "percentage of completion" method in respect of all units that have been sold in Malaysia. Based on our analysis, most property developers* revenue will peak in 2015 on a three-to-four-year horizon. Inevitably, we can expect a decline in revenue thereafter The exception is S P Setia due to projected strong growth in P"Y2016 or FY2017 from the handover of Battersea Phase 1 (completion method of accounting).

Overall cost of doing business has also increased and will be further exacerbated by 6% GST, which is scheduled to be implemented on April 1,2015, if developers absorb the input tax of 6% for the majority of the materials and labour cost, we can expect margin compression and lower profits. Hence, our conclusion that 2014 could possibly be the peak net profit year for most property developers. In Glomac's latest 3QFY14 results (announced on March 19), the company stated that, "Going forward, the property market is challenging with higher land premium conversion rates and construction costs".

KL Property Index to trend downwards by 2H2014?

Looking at the historical trend of the KL Property Index over the last decade, the index is still relatively high-Its peak was at the end of May 2013 at l,5l9┬╗Presently, the index is 11% from the peak and there is room for the index to move downwards as we head towards 2H2014 if property cooling measures stay and there are no changes to the GST implementation timeline.