EARNINGS for Malaysian property sector suffered a -15.4% dip in 2020 chiefly due to disruptions in the construction process precipitated by the movement control orders (MCO) which were imposed to contain the COVID-19 outbreak in Malaysia.
Movement restriction led to more uncertainties such as more construction sites being shut down and the transportation of the building materials being disrupted.
The hampered construction process softened the revenue registered by property companies. Notably, the revenue recognition of the property companies is on progressive payment methods (based on stages of work completed).
Hence, the lagged construction process would drag the billing payment and thus the companies’ revenue, profit or even cash flow.
Further to that, many companies deferred new launches until a better pandemic situation is confirmed in order to maintain cash reserves.
Recovery mode in 2021 and 2022
In spite of having underwhelming performance in the near term due to the disruption caused by the resumption of the movement restriction, the prospect of the property sector remains encouraging in 2021 and 2022.
Here are a few factors backing the promising recovery of the industry:
- Less stop work disruptions for on-going projects
In 2020 and 2021, construction progress was affected by lockdowns which delayed project completion and revenue recognition.
In 2022, we opine that with the higher vaccination rate across the country, that there would be less stop work orders that would hamper construction work. As such, property companies should see rebound in earnings for 2022.
- Property market underpinned by encouraging housing initiatives and favourable interest rate environment
The Malaysian Government has introduced a myriad of initiatives to support housing activities amid the COVID-19 outbreak. Home Ownership Campaign (HOC) is a well-known initiative to provide stamp duty exemption in order to lower upfront costs for home buyers.
An extension is confirmed for HOC until end-2021 due to the resumption of the movement control order which is expected to bring a new round of upheaval on the property market.
Furthermore, as part of the Budget 2021 from 1 January 2021 to 31 December 2025, first-time home buyers can enjoy full stamp duty exemption for the memorandum of transfer documents (MOT) and sales and purchase agreement (SPA) for homes priced up to RM500,000.
On top of that, initiatives such as rent-to-own scheme for PR1MA homes, gigantic new units for lower-income communities surely play as stimulants to revive the housing activities.
Bank Negara Malaysia (BNM) is expected to remain the accommodative monetary policy stance and keep the benchmark Overnight Policy Rate (OPR) at the record low of 1.75% until at least 3Q 2022.
Under such a favourable interest rate environment, potential homebuyers would find it attractive to own a house as the housing loan rate positively correlates to the OPR. A lower OPR could lower the financing cost and loan repayment.
All-in-all, amid government-led housing initiatives and low interest rates, we expect property demand and take-up rate to remain supported until end-2021 which would help property firms convert some of the unsold inventory into sales.
We are expecting an earnings recovery going forward with earnings expected to recover by 16.6% in 2021 and 17.7% in 2022 (see Figure 1).
That said, without generous government incentives and cheap interest rates, uncertainties lie beyond 2023 as reality of oversupply resurfaces
Official National Property Information Centre (NAPIC) data illustrates the oversupply challenges within the property sector in Malaysia. As of end-2020, existing residential stocks amounted to 5.85 million.
The incoming supply of residential units is above 430,000 and a planned supply is approximately 430,000, resulting in a future supply simply going beyond 860,000 units.
Given that an average market demand of 197,756 units per year was recorded over the past five years, we see the product of existing stocks and future supply is nearly 34 times the five-year average demand (6.71 million/197,756 units) (see Figure 2).
A mounting increase in the sum of property overhang and unsold records would be a testament to the recent mismatch of the market demand and supply. Although much improved since 2018, the overhang situation remains at a serious level where the market demand is far from reaching the market equilibrium.
Turning around the mismatch of demand and supply would be virtually impossible at this juncture because property developers leverage on new property launches to drive the company development.
Such challenging market conditions couldn’t be solved entirely, but by easing, we see a gradual cutting in new launches coupled with the lower new planned supply.
Valuations appear super cheap amid weak investor sentiment due to continued oversupply concerns
In terms of valuations, based on the forward PB (price-to-book) ratio of 0.44 times, it is evident that the property sector is trading way below its book value and could suggest that it is undervalued. We believe the low valuation is attributable to the weak investor sentiment amid continued oversupply concerns as highlighted above.
Even though we are expecting an earnings recovery going forward with earnings expected to recover by 16.6% in 2021 and 17.7% in 2022, earnings could start to weaken beyond 2022 and is more uncertain without the generous government incentives and cheap interest rates (see Table 2).
Conclusion
We are “neutral” on the property sector despite short-term recovery as long term prospects remain uncertain; there could be diamonds in the rough but the hard part is to identify them.
We acknowledge the cheap valuations of the sector and at the same time are cognisant of the long-term uncertainties beyond 2023.
Super cheap valuations could attract certain investors who want to bet on privatisation or mergers and acquisitions (M&A). However, investors may need to be patient to see the upside potential materialise.
Therefore, we recommend investors who are searching for rough diamonds to pick companies with higher profitability track record, good project take up rates, strong cash flows and are holding quality assets.
iFAST Capital Sdn Bhd provides a comprehensive range of services such as assisting in dealing, investment administration, research support, IT services and backroom functions to financial planners.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
