Chip Eng Seng - DBS Research 2017-10-19: Too (Chip) To Ignore

Chip Eng Seng - DBS Vickers 2017-10-19: Too (Chip) To Ignore CHIP ENG SENG CORPORATION LTD C29.SI

Chip Eng Seng - Too (Chip) To Ignore

  • Initiating coverage with BUY and SOTP-based TP of S$1.18; attractive prospective yield of 4.4%.
  • Chip Eng Seng (CES) is a property development and construction play trading at a substantial 52% discount to RNAV and 0.7x P/NAV.
  • Locked-in > S$1 bn in presales, with further upside from ongoing tenders and recently replenished land bank.

Growing investment and hotel portfolio offers stability.

  • Integrated real estate developer with strong capability to leverage on the upcoming property upturn. Founded in the 1960s as a construction company, Singapore-based Chip Eng Seng Corporation (CES) has expanded its scope and scale over the past five decades, and has gradually diversified into property development, investments and hospitality businesses. 
  • In recent years, the group has been selectively acquiring projects in Singapore and overseas, which is ripe for the picking in FY17-18F.
  • Over S$1 bn pre-sales to be recognised in coming years with upcoming launches to underpin NAV growth. 
  • Most of the group’s residential projects are substantially sold and together with an estimated construction net order book of S$538.4m (as at end- 2Q17), CES has locked in at least S$1 bn in sales - which will be recognised progressively, underpinning strong earnings visibility in the coming years. 
  • In addition, the award of a recent tenders at Woodleigh and Changi should boost the group’s earnings and NAV in the medium term.

Potential unlocking of undervalued hotel portfolio. 

  • The group has also built up a sizable hotel and commercial portfolio. The jewel is Park Hotel Alexandra, which is recorded in its books at an estimated S$210m (S$475k/key) but potential realisable value, if sold, could be as high as S$376m (S$850k/key), which means a further 27Scts upside to current NAV. 
  • While the hotel provides stable recurring cash flows to the group, substantial value could be unlocked given the robust demand for hotel assets in Singapore.


Initiate with BUY and SOTP-based TP of S$1.18. 

  • CES currently trades at a substantial 52% discount to our RNAV of S$1.88 and at just 0.7x P/NAV. Assuming a conservative 45% discount (vs larger peers’ 10%) to RNAV and valuing its construction business at peers’ average of 8x FY18F PE, we arrive at a SOTP-based TP of S$1.18. 
  • A prospective 4.4% yield is also on offer.

Key Risks to Our View

  1. Execution risk,
  2. Weaker demand,
  3. Competition,
  4. Equity fund raising risk.

Company Background 

Established, home grown construction and property development play. 

  • Founded in the 1960s, Singapore-based Chip Eng Seng Corporation (CES) has expanded its scope and scale over the past five decades – from a building subcontractor for conventional landed properties (such as bungalows and shophouses) to a main contractor for large scale private and public housing projects today.
  • Registered with the Building Construction Authority (BCA) as a Grade A1 contractor - the highest available grade - for both civil engineering and general building works, CES is able to cast its net wider for Singapore public sector projects (compared to peers in the A2 category and below) as its project tenders are not limited by contract value.

Proven track record in Property Development and Construction. 

  • CES has established a strong track record in both its property development and construction divisions, particularly in public sector construction projects where it has over 30 years of experience. The group won its first HDB project as a main contractor in 1982 and has taken on over S$1.8 bn worth of public housing construction projects over the last decade.
  • A key milestone for the group was its lead role in the construction of the iconic Pinnacle@Duxton - the first 50- storey public residential development in Singapore, which features two sky bridges linking seven towers and sky parks offering panoramic views of the city.
  • Expanding into the real estate value chain through development and building a commercial portfolio. With an established track record in construction, CES gradually diversified into property investment and development of residential, commercial and industrial projects in the 1990s, and the hospitality business in 2015.
  • The group’s property development arm, CEL Development, was incorporated in 2000. While the current portfolio mainly includes mid-market and high-end prime properties, the group’s expertise spans the diverse residential, commercial and industrial segments. Examples of completed projects since 2014 include the likes of Fulcrum, Nine Residences, Junction Nine, to name a few.
  • While Singapore remains the key market (88.6% of FY16 sales), the group has been investing overseas to diversify its earnings and built up a portfolio of development and commercial properties in Australia, Malaysia, Maldives (recently) and soon, New Zealand. In particular, revenue contributions from Australia has grown substantially from 0.7% in FY13 to 9.5% in FY16 and will continue to remain a key revenue driver going forward.

Burgeoning hospitality and commercial portfolio. 

  • CES first forayed into the Hospitality business in May 2015, operating its maiden Park Hotel Alexandra in partnership with Park Hotel Group to much success. They subsequently entered into a joint venture agreement in Oct 2016 to acquire a second hospitality asset, Grand Park Kodhipparu in Maldives for US$65m– which commenced operations in June 2017. CES holds a 70% stake in this 120-villa luxury resort.
  • Most recently, the group announced that it had signed an agreement to purchase a 4.5-star hotel The Sebel Mandurah in Mandurah, Western Australia, for A$15m.

Investment properties offer steady, recurring income stream.

  • Rental income grew at 66% CAGR from S$2.3m in FY13 to S$10.6m in FY16, alongside the expansion in CES’ Investment Property portfolio.
  • Following the sale of its freehold office building located in St Kilda, Melbourne, for A$68.8m (vs book value of A$58.5m) in Aug 2017, five diverse investment properties currently remain and were valued at approximately S$232.5m as at 31 Dec 2016. In the same month, Roxy-CES (a joint venture between CES’ wholly owned subsidiary and Roxy-Pacific Holdings) also entered into an agreement to acquire a commercial property located at 205 Queen Street, Auckland, New Zealand for a consideration of c.NZ$174m.
  • While contributions from investment properties are expected to remain small (1.4% of FY16 revenue) compared to the Property Development and Construction segments, it should continue to serve as a steady source of passive income for the group.

Robust Property Development Pipeline 

Property development segment represents lion’s share of the business. 

  • CES’ key Property Development segment typically represents more than half of the group’s annual revenues, and has ranged between 45% and 69% over the last five years. Given fewer handovers, this segment only contributed 45% to top-line in FY13. Against the 55% contribution to revenue in FY16, we estimate that Property Development contributed 66.2% of the group’s profit before tax.

Property development and construction businesses are key earnings contributors. 

  • Traditional Property Development and Construction segments - which tend to be more volatile - continue to represent the lion’s share of group sales, making up c.95% and c.90% of FY16 revenue and EBIT, respectively.
  • Ahead, the progressive sale and revenue recognition from six available-for-sale development properties (and a further four projects in the pipeline) in Singapore and Australia, coupled with a construction net order book of approximately SGD538.4m (or 1.8x of FY16 construction revenue) as at 30 Jun 2017 provides earnings visibility.

Singapore developments are key drivers of top-line performance. 

  • Owing to the steady stream of launches and progressive payment structures, CES’ local developments have been key drivers of top-line performance.
  • Apart from FY12 where the group had a bumper year from its Australian property development business following the launch of its highly anticipated Tower Melbourne project, we note that CES’ local developments have typically been the key drivers of top-line performance for its Property Development segment. 
  • Based on our estimates, it appears that more than 80% of CES’ segmental revenues over FY13-16 were derived from developmental projects in Singapore.

Substantial proportion of ongoing developments pre-sold ahead of completion. 

  • The progressive sale and revenue recognition from six available-for-sale development properties provides earnings visibility over the next few years. This includes Alexandra Central, Fulcrum and Williamsons Estate, for which construction have already been completed. Going forward, incremental sales from these projects will be fully recognised in the year of sale.

Recent launches have been well received. 

  • As at 30 Jun 2017, a substantial proportion of units at ongoing developments were pre-sold ahead of their completion – at least 78% for Grandeur Park Residences (which was only launched in March 2017) to 100% for High Park Residences (a collaboration between CES, Heeton Holdings and KSH Holdings).
  • Tower Melbourne was launched in 2012 and is currently 98% sold but has yet to progress on the development front due to several litigation issues. We further discuss this under Key Risks.

Softer residential housing demand in Australia. 

  • Impacted by fewer end-financing options for foreign buyers and a stamp duty hike for foreign purchases of residential property in Victoria from 3% to 7% (implemented July 2016), residential housing demand has softened in recent months. Demand for Willow Apartments (part of Williamsons Estate) suffered as a result, and could remain weak following the imposition of ghost taxes, or additional taxes on properties deemed to be empty for six months or more. As at 30 June 2017, only 43 of 67 apartments were sold.
  • Against this backdrop, CES is currently reviewing plans to launch its South Melbourne project in 2H17.

2017 poised to be a banner year for property developments.

  • With the launch of Grandeur Park Residences earlier this year, pick-up in demand for its Fulcrum project and the progressive handover of completed townhouses and apartments at Williamsons Estates in 2H17, we believe that FY17F could be a banner year for the group’s property development business.

Growing land bank signals earnings potential beyond 2021.

  • Beyond the existing development projects, we believe that CES’ unutilised land bank is indicative of the group’s longer-term earnings potential and cash flow generation capability. While the majority of CES’ landbank currently lies in Australia, we are comforted by the group’s recent moves to replenish its Singapore land bank.
  • The site at Woodleigh Lane was secured on 11 July 2017, through a 60% owned JV with Heeton Holdings (20%) and KSH Holdings (20%). This site has a maximum allowable GFA of 631,212 sq ft and acquisition cost worked out to be SGD1,110 psf. On 17th Oct 2017, the group also announced the successful enbloc tender of Changi Garden – a freehold site which has a maximum allowable GFA of 280,131 sq ft, for S$248.8m (or S$888 psf ppr).
  • This add to CES’ existing land bank of over 300,000 sq ft (or GFA of c.300,000 sq ft assuming a conservative plot ratio of 1:1) of freehold land in Australia. We believe that both the Woodleigh and Changi land plots could add more than one thousand new units for sale, with an estimated combined GV of close to S$1.5 bn.

Hotels and Investments Portfolio Could Potentially be Revalued at over S$860 m

Steady expansion in Hotels and Investments portfolio. 

  • Over the years, CES has been increasingly active in the management of its hotel and investment portfolio, resulting in a growing asset base and higher recurring income.
  • In Sept 2017, the group completed the disposal of 420 St Kilda Road and realised a respectable S$10m gain. 
  • Separately, CES also entered into two separate agreements in 2H17 to acquire
    1. 4.5-star hotel The Sebel Mandurah (purchase includes strata restaurant property) for A$15m, and
    2. a commercial property at 205 Queen Street, Auckland for NZ$173.98m - through 50% joint venture with Roxy-Pacific. The proposed acquisitions will likely be completed by end- FY17F.

Recurring income pool to grow by > 35% to S$51.4m by FY18F. 

  • We expect hotel room sales to improve in FY17F as occupancies at Park Hotel Alexandra and Grand Park Koddhiparu pick up.
  • Assuming that the proposed acquisitions are completed on time, we estimate that CES’ recurring income base would be boosted by S$0.3m from the restaurant property at The Sebel Mandurah and NZ$5.5m (captured at the JV level) to c.S$51.4m in FY18F. This would represent approximately 6.6% of consolidated revenue – up from 5.1% in FY16. Further acquisitions could provide more upside.

Potential transactions in Singapore hotel space could spark revaluation of CES’s Park Hotel Alexandra. 

  • On the back of strong transaction velocity in the office sector investor attention has been moving to the hotel sector. Investment sentiment has also picked up on the back of an anticipated rise in visitor arrivals and a drop-off in hotel supply growth from 2018 onwards.
  • We also understand that the recent solicitation of interest for 300-room Park Hotel Farrer Park – reportedly for S$390m or S$1.3m a key - has attracted strong interest from institutional investors. We note that key transactions across Singapore’s hotel property market over 2013-2015 averaged S$942 a key.

Bulk of portfolio value could thus potentially come from Park Hotel Alexandra as realisable value could be closer to S$488m. 

  • Stripping out transactions for The Westin, Grand Park Orchard and Mandarin Orchard - which were at a premium due to their more central location - we believe that a potential realisable market valuation for Park Hotel Alexandra would be c. S$850k a key or close to S$376m, when pegged to peers’ average. This represents a S$166m premium to the cost of S$210m incurred by the group for the construction of the hotel a few years ago, or a potential uplift of 27 Scts per share to current NAV.

Current Construction Net Order Book of S$538.4m (as at 30 Jun 2017)

Near-term construction outlook still favourable. 

  • CES’ construction revenues are mainly derived from Singapore public housing, public transport infrastructure and private residential projects. During Budget 2017, the government also shared plans to bring forward SGD700m worth of public sector infrastructure projects from 2017/2018. According to the Housing and Development Board (HDB), supply of public housing projects should continue to hold steady over the next two years given plans to launch 17,000 built-to-order homes in 2017 (vs 18,000 in 2016) and introduction of flats with shorter waiting times from 2018 onwards.
  • The increased supply in the upcoming 2H17 Government Land Sales is expected to continue to support near-term private residential development and construction activity. While local construction outlook still appears favourable at this juncture, the extent to which CES is able to truly benefit from these positive trends hinges upon the success and viability of its tenders.

Construction net order book of S$538.4m provides revenue visibility. 

  • CES recently clinched a S$110.8m contract from the HDB for the construction of nine blocks of residential buildings and community facilities at Toa Payoh- Bidadari, which raised its construction net order book from S$457.2m in 1Q17 to S$538.4m at the end of 2Q17.
  • While CES has taken on various public transport/infrastructural projects, we note that majority of its construction projects are mainly residential, particularly public housing projects, and accounted for approximately 81.5% of its estimated gross contract value of S$1,175.5m. 
  • In its 2Q17 results announcement, CES has also shared that it will remain active in submitting tenders for public housing projects over the next twelve months.

Key Risks 

Potentially higher working capital requirements on growing overseas exposure. 

  • Working capital needs for building- under-construction development projects in Singapore are mostly met by an initial deposit (20% of purchase price) and progressive payments made by purchasers into a project account, which are subsequently drawn down in stages as the property is constructed. 
  • Meanwhile, working capital requirements for off-the-plan apartments in Australia – CES’ second largest market for property development – is largely borne by developers as the initial deposit (c.10% of purchase price on average) is usually held in a trust, and the remaining typically paid upon completion (which could be 3-4 years out). 
  • With approximately one-third of its current land bank in Australia and plans to accelerate overseas growth, we anticipate higher working capital needs for the group ahead.

Cost and margin pressures arising from competition and higher landbanking costs. 

  • More than 90% of CES’ revenues are derived from the Property Development and Construction segments. Based on our estimates, EBIT margins across these key segments over FY12-16 were as follows: 
    1. For property development, variances are typically due to the stages of completion and geographical location of the respective sites – FY14 was skewed by the completion and handover of several projects, including Alexandra Central. Judging by the recent spike in en bloc tenders at record sale prices and heightened competition for landbank, land prices are expected to rise further. This could impact CES’ ability to replenish its landbank (at a reasonable price), which is imperative for future profitability and growth.
    2. Meanwhile for the construction business, we note that EBIT margins have come off over the years and remain watchful of the competitive landscape in the local construction sphere Company Focus Chip Eng Seng as this could lead to more aggressive bidding among contractors and ultimately, compression of margins.

But fate of Tower Melbourne still uncertain. 

  • Marketed and sold from end-2012 and currently 98% sold, with completion that was projected to take place in 2016. However, construction has been delayed due to a demolition delay of the existing building on the Tower Melbourne project’s site as a result of a series of legal disputes between Building Appeal Board (BAB) and the owner of the adjoining building concerning the protection of the adjoining building.
  • While subsidiary CEL Australia (CEL) has been successful in five BAB appeals (and several other Supreme Court, Court of Appeals and High Court appeals) to date, one further appeal to the BAB remains and must be determined before CEL is able to recommence demolition works on site. As such, the timeline to resumption and eventual completion of building works for Tower Melbourne remains uncertain.
  • CES had c.SGD93m sitting in its project account as at end- 2016, of which we estimate c.SGD60m to be tied to the Tower Melbourne development. Currently, there is a risk that these funds could be refunded to purchasers in the event
    1. the project planning permit is cancelled, or
    2. at the purchasers’ discretion if CEL fails to complete development works before the sunset clause kicks in, which is estimated to be sometime in 2018.
  • Considering
    1. Tower Melbourne’s premium location and architecture, as well as
    2. median prices for Melbourne CBD units have risen by nearly 50% from AUD456,000 in the quarter ended Dec 2012 to AUD681,000 in the quarter ended Jun 2017 (based on statistics compiled by the [REIV]), 
    we believe that the risk of purchaser-led rescission and litigation remains low at this point. This also bodes well for CES if it chooses to subsequently relaunch the site at a later date.

Possible equity fund raising to pare down debt. 

  • We project that net gearing will rise to 2.2x over the next two years on the back of a rise in land-banking activity, which are primarily covered by loans and believe that the company could potentially look at equity fund raising ahead to pare down gearing to a more sustainable level.


Developers are trading at 0.9x P/NAV. 

  • While share prices of developers have done well year-to-date, up by close to 35%, we continue to see catalysts to drive prices higher with the potential to trade above its historical mean. 
  • CES, although a smaller market cap developer and contractor, could also re-rate given that it has substantial exposure to the Singapore residential market (26% of the property’s division’s RNAV).

Potential upside of 31% to our SOTP-based TP of S$1.18 given that CES is trading at 0.7x P/NAV and 52% discount to RNAV. 

  • Our RNAV is based on the valuation of its existing investments and projects, including the potential revaluation of Park Hotel Alexandra based on historical transactions and buyers’ interest in the Singapore hotel space.
  • Assuming potential sales value of S$0.85m a key (based on average valuation of its close peers) vs Park Hotel Farrer Park’s recent solicitation of interest at S$1.3m a key - which has garnered strong interest from institutional investors - we revalue the hotel at S$376m vs estimated cost of S$210m. The premium of S$166m translates approximately to 27 Scts per share.
  • After imputing a 45% discount to RNAV (vs 10% discount for large cap developers) and after valuing its construction business at peers’ average of 8x FY18F PE, we arrive at a SOTP-based TP of S$1.18 for CES. 
  • At current price, CES is trading at just 0.7x of P/NAV, and offers potential upside of 31% to our TP.

Carmen TAY DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-10-19
DBS Vickers SGX Stock Analyst Report BUY Initiate BUY 1.18 Same 1.18

Updated on 2017-10-21 to include sections after company background.