noname

Investment Research

Company Report

SP Setia Berhad
Date: 6 August 2012

Property downcycle risk

The property sector in Malaysia experienced very rapid growth especially in the last two years of 2010 and 2012. SPSB has been a direct beneficiary of this development as it took this opportunity to constantly increase the selling price of its existing projects in addition to launching new high-end projects. Consequently, SPSB has been registering new record sales every year. However, we believe the property sector is now at precipice of a downcycle as property prices are now overstretched. As such, we believe SPSB will find it difficult to maintain its sales momentum moving forward. Based on RNAV, we derived a fair value of RM3.10 for SPSB. We have also assigned an Average conviction rating to SPSB. Overall, we have a SELL on SPSB.

Sell
Fair value Previous FV Share price Yield Capital gain Total return Conviction Stock code Market cap RM3.10 N/A RM3.60 +2.7% -14% -11% Average SPSB MK RM7,203m

Robin HU
robin@nonameresearch.com

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Global ambitions, local developments

Global ambitions
Expanding segmentally and geographically. SPSB has progressed rapidly since its first foray into property almost a decade and a half ago. SPSB started out as construction company in 1974 and was listed in 1993 It refocused into property in 1997 with only two projects; one in Puchong and another in Johor However, in the last five years, SPSB has been expanding segmentally and geographically Segmentally, SPSB expanded into retail development in 2008 and high end condo in 2009 with Setia Sky Residences Geographically, SPSB expanded overseas into Vietnam in 2007, Australia in 2011, Singapore in 2012 and more recently into UK with the Battersea project

But, GDV still currently driven by local projects

88% of RM52bn GDV still local. Despite its global ambitions, at present 88% of SPSB GDV is still expected to come from local property development. Out of a total property GDV of RM52bn1, 88% or RM44bn is expected to come from Malaysia while 12% or RM8bn is expected to come from overseas Remaining landbank currently stands at 4,239 acres with 86% of that in Malaysia

Figure 1: SPSB GDV by geography

International, 12% Eastern, 3% Northern, 4%

Central, 62% Southern, 18%

Source: SPSB, as at May2012

As of May 2012, Battersea GDV not included

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More than half of GDV coming from Klang Valley. Klang Valley continues to be the key region for SPSB with RM33bn or 63% of total GDV. Johor is second at RM9bn or 17% of total GDV. Collectively, Klang Valley and Johor are expected to contribute 80% of SPSB GDV. As such, property sales performance in these two regions will have the biggest influence on SPSB bottomline. Specifically, it is important to analyse whether property prices are still reasonable or have increased too aggressively in Klang Valley considering that more than half of SPSB RM52bn GDV comes from this region.
Table 1: SPSB GDV and landbank Active projects 12 7 6 25 Landbank (acres) 4,513 4,536 167 636 9,852 Remaining (acres) 2,422 1,178 64 575 4,239 Remaining GDV (RM bn) 33 9 2 8 52

Central (Klang Valley) Southern (Johor) Northern (Penang) Others Total

Source: SPSB, as at May 2012

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Too Much Too Soon

Price has increased too rapidly
The rapid increase in Shah Alam sales. In March 2002, SPSB acquired 3,930 acres of land in Shah Alam for RM597m from See Hoy Chan Plantations Sdn Bhd. The original GDV of this development was RM5bn with development over 25 years Subsequently, 700 acres was sold and the remaining 3,200 acres was allocated to Setia Alam, Setia Eco Park and Setia City Setia Alam (2,300 acres) was positioned as a mass market township while Setia Eco Park (800 acres) consists mainly of bungalows and semi-d and Setia City (158 acres) was marked for commercial development

Post the financial crisis in 2008, sales in Setia Alam and Setia Eco Park have increased significantly Setia Alam annual sales increased 2.5x from RM333m in 2007 to RM841m in 2011 Setia Eco Park annual sales increased 2x from RM168m in 2007 to RM346m in 2011

Here, comparison is made between 2007 and 2011 as (1) sales in 2008 and 2009 were impacted by the global recession (2) there was a marked increase in sales in 2010 onwards (2009 for Setia Eco Park).
Figure 2: Property sales from Setia Alam and Setia Eco Park
900 841 450

800
700 600

770

400
350 300

396
343 346

RM m

405 333 223 232

RM m

500
400 300

250
200 150 111

267

282

169

176

168

160

200
100 -

100
50 -

2004

2005

2006

2007
Setia Alam

2008

2009

2010

2011

2004

2005

2006

2007

2008

2009

2010

2011

Setia Eco Park

Source: SPSB

Sales driven by price not volume

Sustained 20% increase per annum in Shah Alam. From the figures below, it is apparent that property prices have increased very rapidly in Setia Alam and Setia Eco Park. Prices for a 20x70 double storey terrace house in Setia Alam has increased by an annual rate of circa 20% to RM668,000 per unit in 2011. In fact, new launches experienced a 15% to 30% price increase in 2009 on the back of a 10%-30% increase in launch price in 2008

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Prices for a 41x85 double storey semi-d in Setia Eco Park has increased by an annual rate of circa 20% to RM1.95m per unit in 2011. Prices for new launch increased by 33% in 2008 with average transacted price increasing from RM1.06m to RM1.36m

Figure 3: Selected property price in Setia Alam and Setia Eco Park
800 700 600 2500

668

2000

1950

RM '000

400 300 200 100 0

RM '000

500

1500
1000

500
0

2005

2006

2007

2008

2009

2010

2011

2005

2006

2007

2008

2009

2010

2011

20x70 double storey terrace house, Setia Alam

41x85 double storey semi-d, Setia Eco Park

Source: SPSB

Such rapid increase in price is also seen in other projects. For example, the maiden launch of Phase 1A (Boheme, launched Jun 2009) of Setia Sky Residence was at RM680psf. This was revised up 12% to RM760psf for Phase 1B (Alia, launched Nov 2009) and up another 38% to RM1,050psf for Phase 2 (Celeste, currently open for sale). Consequently, GDV continued to be revised upwards. In lieu of the continued buying despite higher price, SPSB has continuously revised upwards its GDV expectations. For example, the Setia Alam project, which had an original GDV of RM5bn when it was first mooted in 2002, has since been revised significantly upwards almost 5x to RM23bn in 2012.
Table 2: GDV revision of selected SPSB projects RM bn Setia Alam Setia Eco Park Setia City Total
Source: SPSB as at 31 May 2012

Initial GDV 2002 5.0 5.0

Revised GDV 2012 8.0 5.0 10.1 23.1

Remaining GDV 4.3 3.0 10.0 17.3

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SPSB property projects in Johor has also been revised upwards albeit at a smaller 1.4x from RM11.5bn to RM16.2bn. Nevertheless, it is still a 40% upwards revision.
Table 3: GDV revision of selected SPSB projects RM bn Bukit Indah Setia Indah Setia Tropika Setia Eco Gardens Setia Eco Cascadia Setia Business Park II Setia Sky 88 (not launched) Total Johor
Source: SPSB as at 31 May 2012

Initial GDV 2.8 1.7 2.0 2.0 1.5 1.0 0.5 11.5

Revised GDV 2012 4.7 1.8 3.2 3.5 1.5 1.0 0.5 16.2

Remaining GDV 1.7 0.2 1.9 2.9 1.4 0.9 0.5 9.5

Expectation continues to run high

Isnt RM1,250 psf a bit high? SPSB first high end condominium, Setia Sky which is located right in the city center, was launched at RM680 psf in mid 2009. Three years later, SPSB continues to push the price barrier, launching KL Eco City at a staggering RM1,250 psf. This effectively means that a small 650 psf unit will cost RM800k while a typical 1,200 sq ft unit will cost RM1.5m. There is a limit to how much the market, both the buy-to-stay purchasers and buyto-flip speculators, can absorb before the pricing becomes overstretched. In our view, the RM1,250 psf price point comes with significant downside risk. Firstly, we can see no fundamental reason for the price to double from RM680 psf to RM1,250 psf in three years other than speculative purposes. Secondly, how much more upside could there be from a RM1,250 psf price point? A 10% increase will bring it to RM1,375 psf and another 10% increase will bring it to above RM1,500 psf. At this point, even a 650 psf unit will cost a million.

Time to be cautious, time for a reality check

Rapid rise in price not supported by fundamentals. It is worth spending a moment to reflect on the aforementioned rapid rise in price. A two storey terraced house in Setia Alam was sold for RM218,000 in 2004 while in comparison a similar house in the township was launched at RM668,000 in 2011. This represents an annualised increase of 17% per annum. In Setia Eco Park, semi-d that were first launched in 2005 at around RM600,000 now command prices above RM2 million, an annualised increase of 22% per annum.

Such outsized increase in sales was driven not by change in fundamental demand factors (e.g. demography, income growth) but by temporary factors instead (e.g. lower interest rates, removal of capital gains tax, developer interest absorption

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scheme). These temporary factors are reversible and will result in years of above average sales and years of below average sales for SPSB. As SPSB itself noted, there has been an exponential value creation in less than 10 years. The exponential part is correct but the value creation part we find less agreeable as it is unlikely that any true value has been created. A speculative mirage is closer to the truth. A sustained price increase of 17%-22% per annum over 6 years should have rung some alarm bells. If this was the stock market, this would have been immediately been labelled as a bubble.

nonameresearch.com | 6 August 2012

Financial Review
A surge in revenue in last two years. There has been a significant growth in revenue in 2010 and 2011. In contrast to typical revenue of circa RM1bn-RM1.5bn, revenue increased 24% to RM1.7bn and 28% to RM2.3bn in 2010 and 2011 respectively. Correspondingly, net income grew 47% (distorted by low base in 2009) and 26% to RM252m and RM317m.
Figure 4: Revenue and net income 2004-2011

Source: SPSB

As property development is SPSB key segment, similar surge in property revenue is observed in 2010 and 2011 with revenue growing 22% and 31% to RM1.5bn and RM1.9bn respectively. Property GP margin is also normalising off the low of 23% recorded in 2009.
Figure 5: Property development revenue and margin 2004-2011

Source: SPSB

Nevertheless, due to the staggered nature of revenue recognition, the key metric to note is really property sales. In this regard, property sales have grown even more than revenue in 2010 and 2011 at 40% and 42% respectively. The surge in sales was driven both by markedly higher sales in existing mature development in Setia Alam and also sales from new development both local and overseas. In particular, sales in Setia Alam has increased from RM282m in 2008 to RM770m and RM841m in 2010 and 2011. Sales in 2011 was also helped by additional

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RM369m sales from KL Eco City and RM167m sales from Fulton Lane, Australia bringing the total sales to a record high of RM3.3bn in 2011.
Figure 6: Property sales 2004-2011
3,500 3,000 3,290

Overseas Penang 6% 10%

2,500

2,310
1,650 1,000 1,200 1,400 1,200 1,400

RM m

2,000 1,500 1,000

500 2004 2005 2006 2007 2008

Klang valley 55%

Johor 29%
2009 2010 2011

Property sales

Source: SPSB

Such high sales number is not sustainable. In our view, such high sales numbers are not sustainable. While we believe SPSB will achieve its sales target for 2012, we also believe that too high an expectation has been built into SPSB property sales. As highlighted in the previous section, the sudden growth in sales in 2010 and 2011 was driven primarily by higher price instead of volume.

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Valuation and Conclusion

Valuation method and key assumption
Based on RNAV, we derived a diluted fair value of RM3.10 for SPSB. At current price of RM3.60, this represents a potential total return of -11% comprising 2.7% dividend yield and 14% capital loss. We expect medium term property sales to be closer to historical trend than the recent marked increase in sales. In particular, we view the RM3bn sales in 2011 to be unsustainable In all probability, 2012 full year sales will be higher than RM4bn but this will likely be the apogee for property sales and thus we expect sales to decline from 2013 onwards Property margin in line with historical

Key risks
Property bubble. Our view is that the Malaysian property sector (in particular the Klang Valley condominiums, semi-d and bungalows) is overly bubbly. Incessant double digit growth in house prices have heightened the risk of a correction. A slumping market will drag SPSB down indiscriminately as well. Exposure to high end. SPSB slant towards high end properties in its portfolio provides little comfort. Based on our estimate, roughly 50% of SPSB properties are price RM500k-RM1m, 25% are priced > RM1m and only 25%<RM500k. Hence, almost 75% of SPSB portfolio is priced above the average house price. Interest rate and administrative shocks. From the macro perspective, the current low interest rate environment provides little comfort. Because the current interest rate is already at all time low, we think it is more likely for the interest rate to increase rather than decrease. A higher interest rate will make property more unaffordable and may very well be the de-rating catalyst that the property market seems to be in need of. Administrative shocks may come in the form of higher capital gains tax or higher LTV.

Conclusion
The property sector in Malaysia experienced very rapid growth especially in the last two years of 2010 and 2012. SPSB has been a direct beneficiary of this development as it took this opportunity to constantly increase the selling price of its existing projects in addition to launching new high-end projects. Consequently, SPSB has been registering new record sales every year. However, we believe the property sector is now at precipice of a downcycle as property prices are now overstretched. As such, we believe SPSB will find it difficult to maintain its sales momentum moving forward. Based on RNAV, we derived a fair value of RM3.10 for SPSB. We have also assigned an Average conviction rating to SPSB. Overall, we have a SELL on SPSB.

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nonameresearch.com | 6 August 2012

Historical Statistics
Revenue and Net Income (FYE-Oct)
2,500 2,000 1,500 1,154 1,000 500 2007 2008 2009 2010 2011 317 1,471 1,408 2,232 1,746

Payout Ratio (FYE-Oct)

90% 80% 70% 57% 45% 78% 67% 55%

60% 50% 40%

30%

RM m

260

213

171

252

20% 10% 0% 2007 2008 2009 2010 2011

Revenue

Net income

Payout ratio

Net Income Margin (FYE-Oct)

25% 20% 15% 10% 5% 0% 2007 2008 2009 2010 2011 23%

EPS and DPS (FYE-Oct)

20.0 18.6

18.0
16.0

15.2 12.5
8.6

14.8

15% 12%

14%

14.0
14% 12.0

sen

10.0
8.0

9.8

10.0

10.2 6.7
6.7

6.0
4.0

2.0
2007 2008 2009 2010 2011

Net income margin

EPS

DPS

Property Sales (FYE-Oct)

3,500 3,000 3,290

Property Margin (FYE-Oct)

45% 40% 38% 32% 26% 30% 23% 35% 30% 25% 20% 15% 10% 5% 0%

2,500

2,310
1,650 1,000 1,200 1,400 1,200 1,400

27%

26%

29%

RM m

2,000 1,500 1,000

500 2004 2005 2006 2007 2008

2009

2010

2011

2004

2005

2006

2007

2008

2009

2010

2011

Property sales

Property margin

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nonameresearch.com | 6 August 2012 Rating structure The rating structure consists of two main elements; fair value and conviction rating. The fair value reflects the security intrinsic value and is derived based on fundamental analysis. The conviction rating reflects uncertainty associated with the security fair value and is derived based on broad factors such as underlying business risks, contingent events and other variables. Both the fair value and conviction rating are then used to form a view of the security potential total return. A Buy call implies a potential total return of 10% or more, a Sell call implies a potential total loss of 10% or more while all other circumstances result in a Neutral call.

Disclaimer This report is for information purposes only and is prepared from data and sources believed to be correct and reliable at the time of issue. The data and sources have not been independently verified and as such, no representation, express or implied, is made with respect to the accuracy, completeness or reliability of the information or opinions in this report. The information and opinions in this report are not and should not be construed as an offer, recommendation or solicitation to buy or sell any securities referred to herein. Investors are advised to make their own independent evaluation of the information contained in this research report, consider their own individual investment objectives, financial situation and particular needs and consult their own professional and financial advisers as to the legal, business, financial, tax and other aspects before participating in any transaction.

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