City Developments @ 6.01 (Property/ Singapore) 0 comments
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1.Weak sector outlook
2.SOTP valuation is below current price
I have been very bearish on property for quite a while, and this latest hotstocksnot coverage shows that I have not lost this pessimism over this sector yet.
My recent views over Singapore property are well-documented in my Trendspotting blog article in February titled "Continued weakness in Singapore residential housing". In it I outlined the liquidity situation, supply-demand dynamics and valuation comparison to historical prices and concluded that private residential demand plus prices will remain weak through the next 1-2 years. My views sector-wise have not changed. Though global liquidity conditions might have improved, my understanding is that local banks are only lending out based on 60% of home value, while unfavourable supply-demand conditions will not resolve themselves so fast. There is talk now that HDB prices will be next to fall; that removes a price support mechanism for mass market private residential housing, erstwhile the strongest of all private housing (together with old-money landed housing).
There are three acknowledged property giants in Singapore: Capitaland, City Developments and Keppel Land. Of these, City Developments is generally regarded as having the best acumen and being the most prudent. In particular, it is known for its prudent accounting policy, where it does not revalue (upwards) the valuation of the property landbank on its books, unlike most other property developers.
This is why alone among the big developers, City Developments is trading above its NTA/share. However, a rough SOTP (sum of the parts) valuation of its various segments shows that at the current price, there is little bargain to be had, especially when one surveys the post-Lehman wreckage on the market (even after the recent 25-30% market rally).
In the most recent FY, the Property Development division of CDL contributed ~55% of the profits, the Hotels division (through 54%-owned Millenium & Copthorne) accounted for ~30% and the balance was contributed by the Investment Properties division. These are the three main arms of CDL and my SOTP is based on a balance sheet assessment along these three lines.
First, the Property Development division, for which CDL is most well-known for. This is held at $2.9B on CDL's FY08 balance sheet. I would like to divide its development properties into two time periods based on their time of acquisition: pre-2006 and post-2006. A look at the URA price index below illustrates the reason for my division:
As one can see, private home prices started rising from a base since 2006, reaching its peak in early 2008. Hence my personal judgment would be that development properties acquired since 2006 will not make money for CDL; on the contrary they are likely to lose money, especially that acquired in 2007 when euphoria was at its peak.
An examination of balance sheets in FY05 and in FY08, plus a general overview of the development landbank acquisitions over '06 to '07, shows that the post-06 landbank are valued at around $1.5B on CDL's current books, with the remaining half being acquired pre-06. I'd mark down the value of the $1.5B post-06 landbank by 20%, while marking up the $1.5B pre-06 landbank by 50%. The post-06 landbank includes prime landbanks like Quayside Collection, Anderson 18, Futura, Lucky Tower; that is why I think CDL will make significant losses on this landbank. On the other hand, CDL is known to have an undervalued landbank acquired in earlier years: for example, as far back as 2003 I can find landbanks that still remain on CDL's FY08 books, properties like land parcels in Pasir Ris, Swiss Club Road, Tampines/Upper Changi Road. I am ready to assign a 50% profit margin on these landbanks.
The net result of this is to add $0.45B to the recorded value of the Development Properties segment on the books.
Now for the Hotels division. Here the work is made easier because Millenium Copthorne is listed in London. The stock is traded at 2.25 pounds over there, but NTA/share is 5.75 pounds. Hence price/book ratio is 0.4X or 60% discount to book. Bringing across the 60% discount to CDL's hotel properties (recorded as Property Plant & Eqpt item) on its book translates to a $1.35B discount to the book value of its Hotels division.
The discount to book is reasonable because the return to equity of the global hotel industry is going to be trading under cost of equity for some time, given the severe hits to business travel and discretionary spending worldwide. M&C, furthermore, is heavily exposed to the West, especially in the UK; it is therefore likely to be hit hard.
Lastly, the Investment Properties segment, of which office properties comprise the majority of this segment, This accounts for $2.3B on CDL's books. I resist the temptation to mark down the value of this segment, because of CDL's prudent policy of no property revaluation which means the valuation of these investment properties have not been blown up during the economic boom. Instead, I use the price/book valuation for a peer as the guide --- in this case I use local office property kingpin UIC. After stripping away substantial revaluation gains for UIC through 2005-07, the NTA of UIC should be ~$1.40, which means at current price of $1.09 UIC is trading at 0.8X price/book. For simplicity sake, I will leave CDL's Investment Properties segment's book value as it is ie. valuation at 1X book.
The net result of revaluing CDL's net asset value is to subtract (1.35-0.45)=$0.9B from its current book value of $5.4B, which means CDL's book is worth around $4.90/share according to general market valuations today. I put the last four words in italics because a large part of my SOTP valuation is dependent on comparative valuation with peers and market valuations of certain segments. Clearly when the economy recovers, the valuations will change. For example, when the travel industry recovers, the Hotels segment might no longer be valued at discount to book; it might indeed trade at a premium to book. My above analysis merely shows that in the context of today's market and peer valuations, CDL is NOT a bargain and hence should be eschewed for other more deserving investments.