Chip Eng Seng Corp (CHIP SP) - UOB Kay Hian 2018-03-20: Cheapest Dividend Proxy To Property Recovery

CHIP ENG SENG CORPORATION LTD C29.SI

Chip Eng Seng Corp (CHIP SP) - Cheapest Dividend Proxy To Property Recovery

With a solid operating and dividend track record (no missed dividends since 1999 listing), reputable property developer Chip Eng Seng (CES) is the cheapest dividend proxy to ride on Singapore’s multi-segment property recovery.
With an S$1.15b property portfolio, S$127.5m profits secured, S$1.4b development value pipelined and an attractive 4.3% FY18 dividend yield, the clearing of legal issues will help catalyse the stock.
Initiate coverage at BUY and SOTP-based target price of S$1.38, offering 46.8% upside.

INVESTMENT HIGHLIGHTS

Initiate coverage with a BUY and SOTP-based target price of S$1.38, offering 46.8% upside.

We conservatively estimate Chip Eng Seng’s (CES) property RNAV at S$1.15b and apply a 30% discount to get a discounted RNAV of S$804.1m. Add its construction business at S$67.7m and we have S$1.38/share of fair value.
Its foray into the education segment is likely to help CES’s valuation going forward, given the bright outlook and higher PEs that the market attributes for education. We view CES as the cheapest dividend proxy in play to the property recovery, currently trading at 52% discount to its RNAV while offering a 4.3% FY18 dividend yield.

Riding on Singapore’s property and construction recovery.

Singapore’s property market appears to be in the early stages of an upcycle recovery with multiple segments, namely residential, commercial and hospitality, currently showing clear signs of revival. Also, the linked construction industry is seeing upturn signals after being hit by continued waves of weakness.
Related New Zealand and Australia property sentiments also appear to be positive. We believe CES is a well-positioned proxy for investors to ride this property and construction recovery given the discounted price and its exposure to the recovering segments.

Reputable home-grown property developer with solid operating and dividend track record.

With roots tracing back to the 1960s, CES is a reputable home-grown property developer with a strong operating track record (responsible for landmark projects like Pinnacle@Duxton). Likewise, its dividend record shows similar strength with no missed dividend year since its listing in Nov 1999 (special dividend in good years such as 2014 with S$0.02/share).
With the sale of the Melbourne Tower project and good times to come, another special dividend could come soon in our view.

Robust S$1.15b property portfolio with litigious cloud cleared; S$1.4b development pipelines on track.

CES holds a solid property portfolio that we value at around S$1.15b with a series of future developments in Singapore and Australia.
While persistent delays arising from long-running litigation on its Melbourne Tower project had loomed large on the background of this otherwise well-run company and directly impacted its share price, this litigious cloud has since been cleared.
Future projects like the Woodleigh Lane are on track for its launch by mid-18 while the completion of collective sale of Changi Garden is pipelined for 2Q18.

Clear earnings visibility with S$127.5m profits secured.

A large majority of CES’ property inventory has already been sold but profits will only be recognised in the coming years. This includes 100%-sold projects like High Parks and Fulcrum while other major projects like Grandeur Park have seen increased sales recently (to 87.5% sold). This offers clear earnings visibility as S$127.5m profits are already secured.

VALUATION

Initiate coverage with a BUY and a SOTP-based target price of S$1.38.

With an estimated S$1.4b of gross development value (GDV) to be unlocked, we believe CES is an excellent proxy to ride the Singapore property upcycle. We like CES for its:
1. robust pipeline of development projects to ride the property upturn,
2. integrated business model with a construction arm to drive cost savings, and
3. steady build-up of recurring income.

Discounted RNAV property portfolio value is conservative.

Our discounted RNAV valuation of S$804m (S$1.38/share) is conservative as we put majority of its property portfolio at book value and we further apply to all of its properties asset value a 30% discount, which is more than fair for a reputable developer with a good track record and next to no Qualifying Certificate (QC) and Additional Buyer Stamp Duty (ABSD) burden.

Park Hotel Alexandra valued at S$0.83m/key or S$366.8m.

For CES’ prized Singapore hospitality asset, Park Hotel Alexandra, we opt to use the value per key of comparative hotel buildings in city fringe locations in arriving at our fair value, though actual market value could be higher due to the unique location of Park Hotel Alexandra.
Based on our S$0.83m/key estimate, this S$366.8m implies a 2.5% yield which is in line with asking prices by Singapore hotel owners where said hotels typically yield between 2.5-3.0%.

Peer Comparison

Small- and mid-cap developers to catch up with improved market sentiment surrounding tier-1 and tier-2 developers. With the market quick to recognise the main beneficiaries of a property upswing among tier-1 and tier-2 real estate owners/ developers, we believe it is time small- and mid-cap peers who have built up a sizeable scale with a good track record to play catch-up.
The below figures detail our summary of discounts at which the different tiers are trading to their RNAV.

Construction Peer Comparison

Construction business fair value at 7.0x 2018F PE.

Construction peers are trading at an average of 7.1x 2017 PE. As a Grade A1 contractor for both civil engineering and general building works, CES holds the highest available grade amongst its construction peers. It is also not limited by contract value when tendering for public sector projects.
With strong track record with over 30 years of experience, we opine that pegging CES’ construction business to peers’ average is fair.

Construction business projected to register S$9.7m in profit in 2018.

Despite BCA’s improved projections on construction demand from both public and private sectors, we have still conservatively assumed S$200m of new orders with a burn-rate of about 37% (4-year historical average 36%). Based on these assumptions, we estimate construction business’ 2018F earnings to be S$9.7m.

BUSINESS OUTLOOK

Property Development:

Property development sales rising amidst favourable backdrop.

The most important segment for CES in terms of both revenue and profit is property development, and with the recent recovery of Singapore’s property market, there has been renewed buyer interest for private residential properties.
With the favourable backdrop, CES’s ongoing developments saw greater sales for its units. By the end of 2017, all remaining units at Fulcrum had been sold and the number of units sold at Grandeur Park rose to 87.5%.

Majority of development profits secured, only awaiting recognition.

This means that a large majority of CES’s developments have been already been sold and an estimated S$127.5m of profits are already secured and only awaiting progressive recognition (Singapore projects are recognised on percentage of completion basis). As such, this provides great clarity in in terms of property development earnings visibility for 2018-20.

Completed Australian projects currently in the process of handing over.

For its Australian projects (which are on a completion contract basis), the handover of the remaining townhouses at Williamsons Estate is scheduled for the coming months while the handover process for Willow Apartments will commence in Mar 18. The Gladstone project is still currently in its Phase One with a scheduled launch date in 2Q18 and we estimate completion to be in 2022.

Woodleigh Lane to be ready for launch in 2H18.

With regard to new projects, CES’ 99-year residential site at Woodleigh Lane is expected to be ready for launch in 2H18.
Located just next to Woodleigh MRT, the JV site will be adjacent to the upcoming Bidadari New Town and can accommodate more than 800 dwelling units.

Changi Garden sale tender to complete in 2Q18 and pipelined for launch in 1H19.

Going forward, CES has also secured the collective sale tender for Changi Garden with completion of sale estimated in 2Q18. Situated at the junction of Upper Changi Road North and Jalan Mariam, the freehold residential property will be re-developed into approximately 320-unit low-rise condominium with full facilities and some retail shops and is currently pipelined for launch in 1H19.

Finality to litigious cloud hanging over Melbourne Tower/150 Queen Street.

Legal proceedings brought about by the owners of an adjoining property which had stalled demolition works on 150 Queen Street, Melbourne (or Tower Melbourne) appears to have been finally resolved. CES has found a buyer who is willing to pay A$55m (S$56.6m) for the site with the adjoining property owner concurrently selling its adjoining property as part of the same sale process.

Still yielding positive returns with S$13.6m gains on disposal estimated.

The persistent delays arising from this long-running litigation had loomed large on the background of this otherwise well-run company and directly impacted its share price.
Nonetheless, the investment of 150 Queen Street still yielded positive returns for CES and we estimate a gain on disposal of S$13.6m (based on 1AUD:1.02SGD).

Future re-development of South Perth site.

Future developments overseas include the A$10.9m ($8.31m) JV development in South Perth. The three vacant residential buildings that occupy the lots (comprising of an aggregate site area of 2040 sqm) will be redeveloped into mixed-use development comprising residential apartments and retail/office suites.
We conservatively opt to exclude any development value for this and keep at book value until further details have been firmed up.

CES confident of 60%-owned HCM mixed development.

Other than the South Perth development, we also opt to exclude the development value of CES’s recent US$19.7m (S$26.0m) acquisition of 60% stake in a Ho Chi Minh (HCM) mixed development. The development will have two residential tower blocks and a five-storey commercial centre with a land area of 4,829 sqm and total gross floor area of 50,000 sqm.
CES is currently confident that it will be able to generate strong sales from the residential component of the project while the commercial component is well-positioned to generate strong recurring income.

Over 300,000 sf of unutilised landbank in Australia.

Going forward, CES is looking for the right opportunity to utilise its landbank of over 300,000 sf in Australia and currently has applied for the land use at its Perth West Coast Highway site to be changed from Industrial to a mixed Residential/Commercial.
Meanwhile, CES has stated that they will continue to look for opportunities to further replenish its landbank in Singapore.

Construction: Weakness To End With Recovery in Sight

Previously experiencing a wave of weakness.

Since the introduction of cooling measures in 2013, construction demand had largely weakened with public sector projects driving the lion’s share of demand.
CES’ construction business had ably resisted the tide but was not spared from the overall weakness of its industry which had seen new order dropping significantly from S$268m/annum in 2016 to an estimated S$111m/annum in 2017. CES’s total construction orderbook had slipped further to S$397.1m at the end of 2017 compared with S$537.4m in 2016.

2018 the year of recovery with new order win supporting that outlook.

However, with BCA’s forecast that 2018 will be a stronger year for the industry with projected demand that will exceed 2017’s, the industry appears to be seeing signs of recovery.
Other than supporting that bright outlook, CES’s recent win of an S$168m design and build contract from HDB will also bump up the Group’s order book in 1Q2018 and reinforce CES’s strong design capabilities and its competitive edge in the industry.

Prefabrication expertise makes it well positioned for government’s prefabrication push.

While some other contractors have hesitancy in adopting the government’s push for prefabrication (despite almost half the government land sale sites mandating the use of PPVC), CES is already a first mover in PPVC technology, going as far back as 2006.
CES currently holds a L6 classification from the BCA, permitting it to bid for public sector prefabrication contracts of an uncapped value.

Bright outlook prompts cautious optimism.

A steady pipeline of new public housing construction, upgrading works for HDB, and the collective sale boom in 2017 which will contribute some S$3.6b in private construction demand are all factors that we believe contribute to the brightened industry outlook. This will bode well for CES’s construction business though we opt to conservatively only assume S$200m order win p.a. for the business going forward (4-year average: S$259m).

Hospitality and Investment

Generally positive growth prospects for hotel portfolio.

With steady growth expected for international visitor arrivals in Singapore, CES expects the occupancy rate of its Singapore-based hotel, Park Hotel Alexandra to maintain. As for Grand Park Kodhipparu Resort, CES is also expecting better contribution from a full year of operations in 2018 though we believe this will be somewhat impacted by political unrest.
With regard to new additions to the portfolio, the acquisition of the Mercure & Ibis Styles Grosvenor Hotel in Adelaide, Australia should be completed in Mar18.

Recent Auckland acquisition to be more earnings accretive than Melbourne divestment.

CES has divested its office building at 420 St Kilda Road in Melbourne while jointly acquiring a Grade-A office building at 205 Queen Street, Auckland, New Zealand. Comprising two commercial towers and a retail podium, the property is well located within Auckland’s central business district and is close to prominent city landmarks.
Also, it is close by the upcoming mega infrastructure project, City Rail Link, which should offer upside when it is completed in 2020. The Auckland property is expected to bring in greater rental income compared with the Melbourne one.

General pick up expected for other investment properties in Singapore.

As for its other investment properties in Singapore, there have been some improvements in the occupancy rates in Singapore but rental rates have remained soft. There should be some pick-up going forward as Singapore experiences a multi-segment property recovery.

Education

CES foray into education positive given rising demand for early education.

CES announced their foray into the education business and we are generally positive on it. We understand the initial focus should likely be in the early childhood education segment. Demand for early childhood education in Singapore is expected to grow on the back of elevation in awareness of the importance of early childhood education, growing married females’ labour participation rate and better affordability and accessibility of early childhood education.

Partnering with a premium international brand and headed by education expert.

We understand that rather than starting from scratch, CES will be partnering with an international premium brand that has yet to enter Singapore, providing the necessary operating expertise. Also, CES’s new executive director, Mr Tan Tee How, who is an education expert, will have primary oversight of this new education segment.

Providing recurring income of a non-capital intensive nature.

Unlike the property/construction business, the education business is one that is able to provide recurring income without requiring intensive capital. As such, we do not expect a large initial investment into its Education segment, which should lower risk significantly.

Education should help CES hit higher valuations.

Education businesses typically enjoy a higher PE valuation than property/construction businesses. One recently IPO-ed comparable on the SGX is Mindchamps, which is currently trading at about 43x TTM PE, a far higher valuation than CES’s property/construction business. So from a pricing perspective, this foray should be “valuation accretive” and help move CES market value higher.

FINANCIAL OUTLOOK

Singapore property development to benefit from property upswing.

We forecast the property development segment to contribute revenue of S$446.3m, S$730.6m and S$720.7m in FY18-20 as CES progressively recognizes its pre-sold developments and launches its Singapore and Australia development properties in 2018-19.

Construction business humming along.

Despite BCA’s improved projections on construction demand from both public and private sectors, we conservatively assumed S$200m of new orders with a burn-rate of about 37% (4-year historical average: S$259m, 36%).
Based on these assumptions, we estimate construction business’ revenue to be S$220.4m, S$212.9m, S$208.1m in FY18-20.

Expecting uptick in RevPAR from Maldives and Singapore hotels.

With the Maldives ramping up and Singapore continuing to benefit from strong fundamentals, we forecast RevPAR to register a CAGR of 48.1% and 2.7% in FY17-20. The 48.1% CAGR of Maldives RevPar is a result of a low base from its ramp-up phase.
We have adopted a conservative stance in forecasting Maldives occupancy rate at 50% in 2018 (taking into account the political unrest) while stable state occupancy is estimated to be at 65%.
Hotel revenue is estimated at S$48.2, S$51.6m and S$52.5m for FY18-20.

EBITDA margins lifted by hotel and property segments.

While the eventual completion of Grandeur Park and High Park will result in a slight dip in 2018’s core EBITDA, timely completion and strong sales from Singapore and Australian property developments should support strong growth EBITDA growth in FY18-20. This will also be supported by strong fundamentals in Singapore hotel coupled with Maldives hotel’s steady ramp-up. The addition of The Sebel Mandurah and Mercure & Ibis Styles Grosvenor Hotel will also contribute positively to EBITDA.
We forecast group core EBITDA to come in at S$96.5m, S$137.8m and S$140.0m in FY18-20 respectively and an associated uplift in EBITDA margins from 13.3% to 14.1% in the same period. Our core EBITDA does not take into account the S$13.6m expected gain on disposal for the original Melbourne Tower.

Strong earnings will strengthen balance sheet.

CES’ aggressive property investment coupled with working capital demand for its property development and construction businesses had brought down its net cash position in FY17. Despite that, we believe the handover of Australian projects (Willow Apartments & Williamsons Townhouses) as well as the eventual completion of Grandeur Park and High Park will alleviate the current strain on its balance sheet.
We expect robust operating cash flow of S$142.2m, S$355.7m and S$114.0m in FY18-20 respectively which should sustain dividends of at least 4.0 Singapore cents per share. Net gearing is also expected to trend downwards to 1.77x as CES grows its cash pile.

Dividend payout may surprise on the upside.

Since its 1999 listing, CES had consistently shared the fruits of management’s labour with shareholders in its long corporate history. For example, its strong performance recently in 2014 prompted management to propose a special dividend of 2.0 S cents special dividend on top of its final dividend of 4.0 S cents. With this precedence, we think FY18’s dividend may surprise on the upside given the disposal of 150 Queen Street and expectations of robust earnings.
Nevertheless, we opt to be conservative and assume a continued Singapore 4.0 cents dividend pay-out in FY18-20.

COMPANY BACKGROUND

Reputable Home grown developer with S$1.15b in Property Portfolio

Reputable property developer with roots going back to the 1960s.

Tracing its roots to the 1960s, Chip Eng Seng Corporation Ltd (CES) is one of Singapore’s leading homegrown property developments and construction groups. Listed since 1999, CES’s businesses spread across the areas of property developments, construction, property investments, and hospitality.
Most recently, it has announced that it will be entering the education segment. Apart from its operations in Singapore, the Group also has a presence in Australia, Malaysia, Vietnam and the Maldives.

Solid construction track record and experienced management team.

CES undertakes both public and private construction projects and has established a solid track record over the years. It was the builder for the biggest and tallest public housing project The Pinnacle @Duxton. Most of the key management officers have more than 20 years of construction-related experience, adopts a hands-on policy, and are actively involved in the daily operations.

Highest classification allows CES to bid for public sector projects (including prefabrication) of unlimited value.

CES is registered with the BCA under the highest A1 classification for both general building construction and civil engineering as well as precast with L6 heading. This permits CES to bid for public sector projects of unlimited value as well as public sector prefabrication contracts of an uncapped value.

Robust Property portfolio worth S$1.15b spans across multiple countries and segments.

We conservatively value CES’s property portfolio at S$1.15b with some of its future development only at book value. This property portfolio consists of multiple segments such as residential, commercial/office, hospitality and industrial.
While primarily focused in Singapore, CES’s property portfolio also spans across Australia, Malaysia, Vietnam and the Maldives.

RISK FACTORS

Property development and tourism could be affected by geopolitical developments and external events.

Geopolitical developments or external events such as terrorism, natural disasters, economic slowdown or even a disease outbreak greatly affect market segments like property development and tourism. For instance, housing prices in Perth previously fell along with the commodity slowdown while political unrest in the Maldives is currently affecting the occupancy rate.

Foreign-currency fluctuations.

CES has investment/development properties in multiple countries and is susceptible to the fluctuations of the domestic currency in each country to its reporting currency, the Singapore dollar. It is exposed primarily to the Australian dollar, New Zealand dollar, Vietnamese dong, Malaysian ringgit and US dollar.
Nonetheless, CES’ primary focus remains in Singapore and while fluctuations may affect the bottom-line, it is unlikely to pose too significant an impact at this moment as the exposed currencies remain relatively stable.

Execution risk.

As in any forays into new ventures, CES’s venture into the education segment presents execution risk. However, while there are no concrete details, its partnership with an international brand and appointment of its executive director with extensive education experience to oversee the new business should lower this risk significantly.

Edison Chen UOB Kay Hian | Yeo Hai Wei UOB Kay Hian | http://research.uobkayhian.com/ 2018-03-20

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