Keppel Corporation (KEP SP) - UOB Kay Hian 2017-10-20: Land Sales From TJEC Potentially Worth Over S$1.1b

KEPPEL CORPORATION LIMITED BN4.SI

Keppel Corporation (KEP SP) - Land Sales From TJEC Potentially Worth Over S$1.1b

Keppel Corporation's stake as master developer at Tianjin Eco-City (TJEC) positions it to yield supernormal profits from land sales, given the recent rise in land prices.
Our base case points to a valuation of S$1,082m or S$0.60 per share. Valuation could expand if the plot ratio rises to 2.0x (currently: 1.1x). Incorporating this into our valuation, alongside a revision to a RNAV valuation for its property division, raises our target price to S$8.35.

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BACKGROUND

Tianjin Eco-City, a landmark bilateral project.

Tianjin Eco-City (TJEC) is a landmark bilateral project between the governments of Singapore and China, to create a practical, scalable and replicable model for sustainable development for other cities in China.
Founded in 2008, the city spans 30 sq km and is located 15km from the Tianjin Binhai New Area and 150km from Beijing. It is designed to house a population of 350,000 residents, with development occurring in phases over a period of 10-15 years starting from 2008.

From wasteland to paradise.

The Eco-City site is situated on a former wasteland of saltpans and inhospitable barren land with a wastewater pond filled with industrial sludge.
After nine years of redevelopment, the site now stands as an area of high-rise buildings and green spaces, with the former wastewater pond transformed into the 2.6 sq km Jing Lake, which now teems with marine life.

SSTEC the Master Developer of Tianjin Eco City.

The master developer of TJEC is led by Sino-Singapore Tianjin Eco-City Investment and Development Co. (SSTEC), a 50-50 JV between a Chinese consortium led by Tianjin TEDA Investment Holdings, and a Singapore Consortium led by the Keppel Group, who effectively holds a 45% stake.
As master developer, SSTEC works closely with the governments and private sectors of China and Singapore, as well as other international partners to plan, and develop the Eco-City.

Region at inflection point; on the verge of take-off.

Bilateral efforts to develop the region places TJEC at an inflection point for a new stage of growth. In 2020, a new 44km high speed rail line that links TJEC to the rest of the Binhai New Area will come on stream.
According to Deputy Prime Minister Tharman Shanmugaratnam, this will see the region transform as a whole and help it take-off. Additionally, a review of the master plan for SSTEC on its 10th anniversary next year (2018) could see initiatives to accelerate development of the project.
All in all, the conflux of these factors could trigger increased demand for land in the city and accelerate land sales.

LANDBANKING TO RICHES

TJEC base case valuation of S$1,082m.

Of the original 30 sq km of land that TJEC was initiated on, approximately 16.5 sq km (55%) of land remains for sale. Given the low land acquisition cost and land prices reaching recent highs of Rmb13,800psm in 2017, Keppel stands to profit handsomely.
Assuming that sales momentum continues, our base case points to a valuation of S$1,082m for TJEC or S$0.60 per share.

Land sales yield a net margin of c.37%.

Under the agreement, SSTEC pays a fixed land price throughout the entire development period. Land acquisition is done progressively based on assessed demand, so there are minimal upfront cash outlays and holdings costs. It also includes development cost for basic infrastructure (internal roads, street lightings, sewage, etc).
The 1Q17 transaction of 3 land sites implies a land cost of Rmb900-1,000psm. At current prices, the maximum Land Appreciation Tax (LAT) of 60% applies, translating to a net margin of c.37%.

Development margins to be stable going forward.

SSTEC had not made supernormal profits previously despite the low land acquisition price owing to the development costs for building basic infrastructure on the land sites.
Between 2014-15, profit was recognised after the cost of land, but was unprofitable at the project level. However, this reversed when land prices roses to ~Rmb6,000psm. We understand that much of this has been completed and going forward, development margins are expected to be comparable to 1Q17 levels.

Land to take at least 15 years to fully sell.

Taking into account:
1. net efficiency of 45%, and
2. 70% of the land is available for residential development,
we estimate about 5.2 sq km out of the remaining 16.5 sq km of land can be sold at the prevailing price of Rmb13,800psm.
All land sales have to go through a government approval process that takes about 6-12 months, so TJEC hypothetically makes 1-2 sizeable transactions p.a. Current sell-rate of ~330,000sqm p.a. implies at least 15 years to fully sell the land.

Transactions require 100% cash upfront.

To prevent speculation, the government had mandated that all land purchases at TJEC require 100% upfront cash payment. This should eliminate any concerns of receivables risk.

Land sales have mostly been done on a 1.1x plot ratio.

Land sales at TJEC are transacted on a GFA basis, which is a function of the plot ratio on the land. While we understand that the land is marketed on a 1.2x plot ratio, permissions are granted discretely on a per project basis and historical transactions show most sales occurring on a 1.1x plot ratio.

Plot ratio change allows for valuation expansion.

Keppel is working to raise the plot ratio to 2.0x across the board, which will allow for a massive expansion in valuations. Cetris paribus, raising the plot ratio to 2.0x sees the RNAV valuation for TJEC jump to S$1,802m or S$0.99 per share.
Historical precedents indicate that this is possible: Two transactions above the current 1.2x plot ratio occurred in 2015 (1.68x) and 2016 (1.80x).

Sensitivity analysis shows a RNAV valuation range of S$862m-3,472m.

The valuation of TJEC is sensitive to three key assumptions:
1. price inflation,
2. plot ratio assumption, and
3. time taken to sell all the land.
Our sensitivity analysis ballpark the valuation of TJEC to lie between S$862m-3,472m or S$0.47-1.91 per share.

PROPERTY SEGMENT UNDERVALUED: UPGRADE TO BUY

Earnings showing sequential improvement.

Core earnings appear to have bottomed out with the second qoq improvement in 3Q17 from the bottom in 1Q17. While earnings continued to be supported by the other divisions sans O&M, the key property segment might see a short-term slowdown in the near term. With most projects in China completing in 1H18, the slowdown in China sales could impact earnings.
Earnings should pick up from 2H18 as Vietnam projects approach completion. That said, this view could change quickly as Keppel’s diversified portfolio allows for flexibility in launches, allowing it to target more favourable markets as soon as demand picks up.

Cut 2017-19 earnings by 1-14%.

This comes on the back of lower earnings for the O&M, property and infrastructure divisions, but offset by assumptions on land sales from TJEC.
Our revised 2017-19 earnings are S$638m (-14%), S$798m (-1%) and S$846m (-5%).

Upgrade to BUY, target price raised to S$8.35.

We incorporate TJEC into our valuations, and simultaneously update our property valuation methodology to the RNAV method. The cumulative result translates to a target price of S$8.35, which assumes 1.0x P/B for the O&M segment, and 19x 1-year fwd PE for Keppel Capital.
Our valuation implies that current prices accord zero value for the O&M business, while discounting the remainder of its businesses.
Upgrade to BUY on a valuation basis.

Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-10-20

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