Singapore Small Mid Cap Stocks Strategy - DBS Research 2017-12-05: Property-driven Recovery Plays

Singapore Small Mid Cap Stocks Strategy - DBS Vickers 2017-12-05: Property-driven Recovery Plays Singapore Small Mid Cap Stock Picks SMC Strategy Stocks To Buy Singapore Property Stocks Singapore Construction Stocks

Singapore Small Mid Cap Stocks Strategy - Property-driven Recovery Plays

  • Recovery in property development set to turn construction sector around.
  • Current construction landscape improving with construction GDP falling at a lower rate, and recovering tender prices.
  • Large-cap property stocks have outperformed; second liners and construction-related plays next.
  • Uniquely positioned construction and/or development plays - APAC, Chip Eng Seng, Hong Fok, Hock Lian Seng, Lian Beng, Tiong Seng and Keong Hong.

Multi-Year Recovery In The Property Market, All Stars Aligned 

  • The Singapore 3Q17 private residential price index registered its first increase after 15 consecutive quarters of decline, with all segments – private and public residential, office and retail – turning up. 
  • The property market recovery is expected to be gradual in the next 12 months with more transactions across all segments of the real estate market. Our property team is expecting transaction value to hit S$40.0bn for FY2017F (+40% y-o-y), S$42.2bn for FY2018F (+5% y-o-y) and S$44.3bn for FY2019F (+5% y-o-y) for the total private residential market, including both primary and secondary markets. 
  • We see multiple catalysts for residential prices to head higher in the next two years. We expect a price recovery to the tune of c.3-5% per annum over the next two years.

Factors driving the recovery include :- 

  1. Low unsold inventories. The total number of unsold private residential units has been declining for the past two years and reached 17,178 (including ECs) as at 30 September 2017.
  2. Affordability. According to industry research Cushman & Wakefield, Singapore’s housing to income ratio of 4.8 in 2016 is lowest compared to other global cities like Hong Kong (18.1), New York (5.7) and London (8.5). This could mean that transactions in Singapore will likely remain robust and international investors could look to invest in Singapore given the relative affordability of its houses.
  3. Increasing demand from foreigners. The growth in the number of high net worth individuals and wealth per capita, coupled with the still low interest rate environment, has led to much capital inflows into the property market. However, the proportion of foreign buying is still low at 6%, below the historical average of 9%.

Construction Sector To Benefit From The Recovery Of The Property Market 

Stable construction demand ahead 

  • Construction demand for 2018-2019 is projected to be in the range of S$26-35bn, similar to the S$28-35bn range in 2017.
  • The strong demand from the public sector in 2017 are mainly from projects like the second phase of the deep tunnel sewerage system, North-South Corridor, Circle Line 6 and the public housing projects. Construction of some of the projects like the fourth desalination plant and tourist attractions and recreational facilities at Mandai Lake had begun at end-June this year. 
  • Other key infrastructure projects in the pipeline include Jurong Regional Line, Cross Island Line and the development of Changi Airport Terminal 5.

Construction sector in the doldrums for the past few years 

  • The construction sector has been lacklustre in the past few years, with declining contribution to the Singapore GDP.
  • Though construction demand has been healthy, averaging at about S$30bn since 2010, keen competition has led to lower tender prices, thus affecting profitability.

Keen competition affected tender prices. 

  • Competitive tenders for construction projects, with contractors aggressively trying to outbid each other, had led to the steep decline in tender prices from 2014-16. Both Korean and China contractors have tendered competitively for projects in Singapore, leading to three years of tender price decline.

Earnings growth has been choppy. 

  • Singapore’s construction sector earnings had generally grown in 2007, 2009-11, and 2014. There was a decline in 2008 declined due to high base and construction boom in 2007-08. After foreign worker levies were raised in 2010 and 2011, earnings again declined in 2012 and 2013, affected by higher worker compensation and lower margins. 
  • Better tender prices in 2014 led to earnings growth while decline in tender prices along with post tightening of foreign worker policies had also led to earnings decline in 2015-16.

Year-till-August projects awarded fell short of forecast. 

  • As at August 2017, total projects awarded, both from the private and public sectors, amounted to only S$12.63bn, way below the S$28-35bn projected at the beginning of the year. The shortfall was mainly due to the underperforming public sector.

Light At The End Of The Tunnel For Construction Sector? 

BCA: Outlook improving for small- and medium-sized contractors. 

  • The Building & Construction Authority’s (BCA) business expectations of the construction sector for 2H17 have improved slightly from 1H17. Larger A1 and A2 building contractors’ outlook remain weak while small- and mediumsized (B1/B2/C1/C2/C3) building contractors’ outlook improved from 1H17. Civil engineering contractors’ outlook remain largely similar to 1H17 as larger A1 contractors are more optimistic.

Better funding support for small- and medium-sized firms.

  • The BCA has been paying greater attention to small and medium firms (which form the majority of contractors here) in recent years, aimed at mitigating cost challenges, improving productivity, and raising their competitiveness in the global playing field.
  • The S$800m Construction Productivity and Capability Fund, which firms can tap into to purchase or lease equipment, implement process-improvement plans, adopt new technology and/or develop their workforce, is one key initiative. Approximately 90% of these funds will go to small and medium-sized firms.

Singapore construction GDP falling at a lower rate. 

  • Growth for Singapore Construction GDP has been decelerating since 2009, and shrank the most in 2017. In each of the three quarters in 2017, Singapore Construction GDP shrank by 6- 7% y-o-y, the most severe in seven years. One positive is that the rate of decline has stabilised at c.6% y-o-y for the last three quarters. 
  • With our economist expecting the Singapore economy to grow by 3.2% in 2017 and 3.0% in 2018, coupled with the recovery of the property sector, we believe a recovering macro economy will support sustainable improvement in the current construction landscape.

Tender prices may have bottomed and could recover if construction pace picks up. 

  • The three-year decline in tender prices came to a halt in 1Q17 as players, especially the foreign contractors, eased off in aggressive tender bidding for construction projects. While there is no lack of construction projects in Singapore, keen competition from the foreign contractors has resulted in competitive bidding and lower tender prices. A sustained recovery in tender prices would be beneficial to contractors. 
  • With net margins in recent years squeezed to sub 2%, profitability could become a key focus for companies going forward. If the pace of construction activity picks up, companies will stop undercutting each other at some point, which will lead to a more improved tender pricing and margin environment for the whole sector.

Contracts awarded for 9M17 down 20% y-o-y but 3Q17 showed 35% uptick. 

  • The Singapore construction market continues to be supported by public projects. Based on BCA’s quarterly data for contracts awarded, 9M17 value of S$17bn represented a 20% y-o-y decline. Only the public and private industrial segments and public commercial sectors showed growth while the rest of the segments declined. 
  • One positive however, came from 3Q17’s number, which showed a 35% y-o-y uptick, boosted by the award of public civil engineering projects. Meanwhile, private residential contracts awarded were down 17% y-o-y in 3Q17 and fell 10% y-o-y for 9M17.

More en-bloc sites beneficial to developers and contractors.

  • With the increasing demand for property, construction companies should benefit from this rising trend. Furthermore, the recent en-bloc fever is also another contributing factor to the rising demand for property. As en-bloc sales have been very active over the past 1-2 years, the redevelopment of these en-bloc sites will benefit both property developers and contractors. 
  • DBS Research estimates that c.15,000 potential units from redevelopments of en-bloc sales (and up to 21,000 including available parcels on government land sales) could be added over the next 1-2 years - essentially 2x that compared to the last 2-3 years on average.

Companies with dual property development and construction exposures are prime beneficiaries. 

  • In addition to the recovery in the property market and improving construction outlook, we opine that selected companies with these dual exposures could outperform given potential synergies arising in the form of cost savings and productivity.

Stock Performance - Large-cap property stocks outperformed second liners and construction-related plays 

Large-cap property stocks have outperformed. 

Lee Keng LING DBS Vickers | Carmen TAY DBS Vickers | Alfie YEO DBS Vickers | http://www.dbsvickers.com/ 2017-12-05
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