We did a site visit to Regal International Group’s major developments in Kuching in end November, including the already completed Tropics I (almost fully sold out), and several projects under construction - 72 Residences (Tropics II), Orchard Suites/Mall, and Corporate Park. These are some of our post-visit thoughts.
Lack of near term catalysts as major projects are still some way off completion
While it remains to be seen if 72 Residences (Tropics II) and Tropics City (Tropics III) can follow in the successful footsteps of Tropics I in Kuching, the benefits of potential buoyant sales, even if realised, will only be realised towards 2017 as the projects’ construction complete. Another major project, Corporate Park, is also slated to complete in 2018. Sales for Corporate Park have yet to fully kick off and demand is uncertain. These three projects make up close to c.55% of our recalculated RNAV.
Long Term outlook and residential property saleability remain strong
Using the price-to-income ratio as a gauge of housing affordability in Sarawak, we make a comparison table of the affordability of housing in Sarawak versus other states in Malaysia. Empirical research by the United Nations Centre for Human Settlement and World Bank found that a median home price to median household income of 3 times was considered to be the global norm and signals a well-functioning housing market.
Sarawak’s median multiple stands at close to the acceptable ratio of 3 and according to housing statistics pulled from the Department of Statistics and National Property Information Centre Malaysia, Sarawak’s housing ranks as one of the most affordable compared to other states in Malaysia currently. This is despite a CAGR of c.8% for the Sarawak House Price Index since end 2009. Not surprisingly, Kuala Lumpur and Penang ranks as one of the most expensive in the country.
For a more meaningful comparison, historically, the median home price/median household income in the U.S. is around 2.6x, according to a study done by Zillow (an online real estate database company) published on Forbes. Using Singapore’s 5-room Housing Development Board (HDB) BTO flat as a gauge for the affordability of public housing in Singapore, our median multiple stands at 5.5, according to statistics from HDB.
Change in accounting treatment of revenue to reduce earnings volatility
Currently, Regal’s revenue and cost of sales for projects in East Malaysia (the bulk of their projects) are recognised using the complete contract method. This means that bulk of the revenue from a sold unit can only be recognised upon completion of construction and when the ownership of the unit transfers to its new owner. Changes to the accounting rules FRS 115 “Revenue from Contracts with Customers”, starting January 2017 mean that developers can switch to recognising revenue progressively, according to the progress of construction works, starting from 2017. This new initiative would be a fairer representation of the profitability of property developers and results in less lumpy earnings.
Current Valuation close to NTA value (net of goodwill). Downgrade to Neutral with lack of near term catalysts.
Regal’s last closing price of S$0.165 trades at close to its NTA value of c.S$0.175 (excluding RM39m goodwill), assuming an exchange rate of 1SGD:3RM.
With the change of analyst, we downgrade our call from BUY to NEUTRAL with a downwardly revised target price of S$0.24 from S$0.43. Our call and target price factor in a steeper 50% discount (original 30%) to Revalued Net Asset Value (RNAV) due to the gestation period for sales to materialize and construction to complete. Uncertain demand for Corporate Park and Airtrollis, as well as the illquid nature of the shares are also factors for the steeper discount to valuation. Lastly, the challenging outlook for the Group’s precision business, coupled with the lack of near term catalysts for the property business arm over the next year, leads us to a Neutral call for the company as we expect FY16 to be similarly loss-making (albeit showing an improvement from FY15) before things turn around thereafter. (Read Report)
Source : Phillip Securities Research