United Engineers - CIMB Research 2018-03-30: Overlooked, For Now, But Not Forgotten

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UNITED ENGINEERS LTD ORD U04.SI

United Engineers - Overlooked, For Now, But Not Forgotten

• Strong asset backing with a sizeable portfolio of rental and hospitality assets.
• Benefiting from the broadening office rental upcycle.
• Potential unlocking value from low-hanging AEI opportunities within its portfolio.
• Higher development carrying cost post PPA exercise, but projects remain profitable.
• Maintain ADD with a slightly lower Target Price of S$2.94.

Refocusing on operational growth 

• Following the completion of the recent takeover exercise, with Yanlord Perennial Investment Singapore (YPIS) gaining a 33.72% stake in United Engineers (UEL), the company can now focus on ramping up its operational growth. 
• United Engineers (UEL) is backed by a sizeable c.S$1.9bn of wholly-owned rental and hospitality property portfolio, half of which are office assets. Its other businesses comprise property development, engineering, distribution and manufacturing activities.

Beneficiary of a broadening office rental upcycle 

• United Engineers (UEL) has gone unnoticed in the current office rental upcycle as the market was focused on the core Central Business District (CDB) recovery. As the office market upcycle broadens, amid tight CDB supply, we believe UEL’s assets such as UE Square and UE Bizhub Tower could benefit from rising rents, thus lifting property performance and operating margins and accrete to asset value.

Asset enhancement opportunities to create value 

• We believe there are low-hanging opportunities to unlock value from its properties such as UE Bizhub City, through increasing property utilisation or optimising the size and use of its hospitality assets. 
• Our scenario study shows that increasing floor area utilisation of the former by 5-15% would add between 4 Scts and 13 Scts (or 1-3.5%) to UEL’s RNAV. This does not include organic improvement in rents due to the ability to command higher rates from the upgraded property.

Higher development carrying cost for UEL but still profitable 

• We have done a deep dive into UEL’s China property development portfolio. Located in the prime areas of Chengdu, Shenyang and Shanghai, it has benefited from the price appreciation trend since 2016. Although the carrying cost is higher post the 2013 purchase price allocation exercise, these projects remain profitable. 
• We estimate a net discounted after-tax surplus of c.S$146m when these projects are fully monetised.

Non-property businesses kept at book value 

• We currently value the group’s non-property businesses at book. Should the group continue to streamline its operations in the medium term and divest the non-property businesses, we believe there could be upside from pricing these operations as going concerns. 
• In FY17, the engineering, manufacturing and distribution businesses generated total operating profit of S$13.3m. In addition, the potential to redevelop its sand mine in Australia, once exhausted in the long run, could further boost underlying value.

Maintain ADD 

• We introduce our refreshed FY18-20F earnings estimates. Our revised RNAV of S$3.46 does not include upside from any potential AEIs. However, our Target Price of S$2.94 is a tad lower than before due to lower than projected development profits, while maintaining an unchanged 15% discount to RNAV. 
• United Engineers (UEL) is trading at a 25% discount to our RNAV and offers 13% upside to our Target Price. We maintain our ADD call. 
• Re-rating catalysts could emerge from realising low-hanging fruits from any asset enhancements at its properties.
• Downside risk could come from execution delays.

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Overlooked but not forgotten 

• United Engineers (UEL) has been the target of a few takeover attempts since 2014, the most recent being the successful exercise by Yanlord Perennial Investment Singapore (YPIS) to secure a 33.72% stake. Oxley Holdings (OHL SP, Not Rated), has also been increasing its stake in the company progressively since Aug 17 to 16% currently.
• The attraction of UEL is touted to lie in its sizeable and largely freehold or long leasehold investment property portfolio. Since the acquisition and subsequent privatisation of WBL Corporation (WBL) in 2013 by UEL, the latter has been streamlining its non-core businesses to become more property-centric.
• In its FY17 results, UEL’s management articulated that the company is looking to
  1. continue to grow and streamline its existing portfolio of businesses,
  2. enhance existing investment properties via asset enhancement initiatives,
  3. make selective property acquisitions and seize opportunities in other businesses and geographies, as well as
  4. execute existing projects and embark on new property development projects.
• We think this is a timely move to take another look at the portfolio to optimise leverage on the recovery of the office and hospitality sectors in Singapore.
• In this report, we attempt to identify any low-hanging opportunities and assess the additional potential that can be derived from its Singapore investment property portfolio and its other businesses.

Sharpening property focus? 

• To recap, since spending c.S$854m to acquire a 67.6% stake in WBL in 2013 and subsequently divesting close to S$2bn worth of assets between 2013 and Mar 2018 to trim non-core activities or unlock value from its mature property assets, UEL’s total asset base stands at S$3.35bn as at end-FY17, of which c.S$2.47bn or 74% are backed by rental, hospitality and development property assets. Its remaining business activities comprise engineering, distribution and manufacturing activities. 
• Under the current structure, UEL holds the Singapore rental and hospitality properties and Malaysia development project directly, while the remaining businesses – China property development, engineering, distribution and manufacturing - are held via WBL.

PROPERTY RENTAL & HOSPITALITY

Optimising value from property portfolio 

• United Engineers (UEL) is well known for its sizeable commercial and industrial portfolio in Singapore. Its key assets include the UE Bizhub City, UE Bizhub Tower, UE Bizhub Central, UE Bizhub West and the Rochester Mall and Park Avenue Rochester Hotel. This is in addition to a 30% stake in Seletar Mall. 
• This portfolio comprises an attributable 1.4m sq ft of NLA and 537 keys and carries gross asset value of about S$1.9bn as at end-FY17. It also owns a 30% share of Seletar Mall. Excluding 450 Alexandra Rd, this portfolio enjoys an average occupancy of between 85% and 95%.
• Based on an estimated FY17 operating EBIT of S$64.9m (excluding revaluation and writeback in provision of rental support), this translates into an EBIT yield of 3.4%. We believe there is room to improve the returns from this portfolio to c.4- 5%, in line with other landlords.
• In addition to organic earnings growth through its leverage to the rising office rental market, we see a potential second income boost through opportunities to lift leaseable areas at UE Bizhub City as well as UE Bizhub Tower through better space utilisation at these properties. Another low hanging fruit for value creation would also be to improve property returns at its serviced apartment portfolio by reconfiguring apartment sizes.

Value creation in UE Bizhub City 

• Management has indicated that it is looking to enhance existing properties via asset enhancement initiatives. The longest-held property and also the crown jewel in its portfolio is UE Bizhub City, consisting of UE Square office and retail as well as Park Avenue Clemenceau serviced residences and 977 car park lots. The property was completed in 1997.
• The latest valuation of UE Biz Hub City is at S$722.4m, accounting for about 38% of the group’s rental and hospitality portfolio gross asset value. We estimate this property generates an estimated 3.8% property yield currently. 
• We believe the asset’s performance can be improved in the medium term. In the section below, we assess some of the possibilities that can be explored to improve asset performance. For one, we think the property is under-rented as rents have lagged the market given its older condition. Sprucing up the property will potentially enable the property to better leverage the current office leasing market recovery and boost rents and returns. However, we note that the retail and office component is 85-95% occupied and any asset enhancement opportunities would likely have to dovetail with lease expiries.
• The other option would be to assess any opportunity to improve space utilisation and optimise usage, given that this development was built more than 20 years ago. We delve in deeper detail below on the risk/reward potential of increasing the space utilisation of its rental portfolio and optimising usage such as the serviced apartment component.

Potential additional boost from AEI 

• According to Urban Redevelopment Authority (URA) approvals obtained in 1994-96, the plot ratio of the property of the UE Bizhub City land parcel was 3.9x with an allowable 128,631 sqm of gross floor area (GFA). An estimated 38,300 sqm and 17,700 sqm of GFA was approved for office and retail use, respectively, while another 59,020 sqm was slated for residential units for sale. The latter was launched and fully sold in 1994. This implies that a residual 13,300 sqm GFA was allocated for serviced apartment usage.
• However, looking at the reported NLA in the valuer’s report in a shareholders’ circular dated 31 Jan 2018, the NLA for office, retail and serviced apartments came in at 28,807 sqm, 7,404 sqm and 9,089 sqm, respectively, implying a low 65.4% utilisation rate for the property. Hence, we believe there could be scope to expand NLA or utilisation of the property. UE Square’s weighted lease to expiry is estimated to be around two years, thus giving UEL the flexibility to manage its leases in tandem with any potential AEI.
• Our scenario study below is based on a 5-15% increase in overall NLA, which would boost overall utilisation rate to 68.6-75.2%, current infrastructure permitting. This would translate into a c.2,265-6,795 sqm of additional NLA created, or +5% to +15% of existing rental property NLA. Assuming the additional NLA is valued at Dec 17’s levels and taking into account additional capex required, we reckon that the value of UE Bizhub City could be improved by 3.8-11.5% post AEI.
• Furthermore, the additional NLA is likely to boost earnings and current property yields by 5-15%, i.e. to 4.0-4.5%. This does not factor in any potential hikes in rental rates, which could provide an added boost in the medium term.

Reconfiguring serviced apartments for today’s demand 

• The other possibility to enhance returns on UE Bizhub City could include updating the size of the serviced apartment units to the current trend of smaller unit sizes. Apartment sizes at Park Avenue Clemenceau range from 460-1,800 sqft for one- to four-bedroom units, while those at Park Avenue Robertson range from 495-1,420 sqft. 
• Comparisons with newer properties show that some of the larger units could potentially be reconfigured into additional and smaller units. The additional rooms created could result in higher revenue and potentially increase returns from the development.
• UEL has a proven track record in conducting AEI on its hospitality properties, such as the Park Avenue Rochester. Completed in mid-2017, the enhancement exercise added 80 more rooms to the property, from 271 to 351 keys. This was done through reconfiguring the larger suites into standard rooms to better to cater to market demand. The first phase involved adding 40 more rooms to the property at an estimated capex of c.S$2.5m and the second phase would further boost room count by another 40 keys. Based on an estimated total capex of c.$5m, we estimate the ROI from this exercise could be around 25-30%.

Scope for enhancement at UE Bizhub Tower 

• In the same vein, we note that the utilisation of the gross floor area at UE Bizhub Tower is low at c.70%. We think there could be some further opportunities to improve space utilisation in the medium term. However, as this is a smaller property compared to UE Bizhub City, we think any asset improvement could happen later rather than sooner.

Hotel Sector On The Path To Recovery 

• After a multi-year decline in hotel and serviced apartment room rates owing to accelerated new supply and slowdown in global corporate demand on the back of anemic economic performance, the short-stay and extended accommodation industry is set to enjoy a respite as new supply dwindles and economic growth outlook improves.
• In Singapore, new hotel room supply growth is expected to be a minimal 0.6%- 2.5% annually between 2018 and 2020; while there is little new serviced apartment inventory until 2020. At the same time, tourist arrivals and corporate travellers are expected to pick up due to better economic activity. With occupancy remaining fairly stable in the 80s% range over the past few years, we think any improvement in demand should translate into an uplift in room rates.
• We are projecting up to a 7% hike in hotel Revpar for 2018. Hence, we think there could be room for UEL to enjoy a further boost to room rates and occupancy as it updates its rooms as well as optimises apartment sizes, into the rising upcycle.

Riding On The Office Upcycle 

• A recovery in the office rental market has been well articulated. Limited new incoming supply and growing demand on the back of the broadening economic recovery in Singapore would mean upward pressure on office rents. Over the past year, a flight to quality has meant that CBD office rents were leading the recovery in the office rental market, while office rents in other locations had lagged. However, based on URA statistics, the uplifting impact is starting to filter down to other segments, including the city fringe and CBD fringe locations.
• There is an estimated 1.65m sqft and 0.8m sqft of new office space slated to be completed in 2018 and 2019. Apart from Frasers Tower and Robinson Tower along Shenton Way, with a total of 0.8m sqft, the other new buildings are located outside of the CBD or are strata properties. Meanwhile, according to media reports, Frasers Tower is 70% pre-committed, while nearby supply in the Tanjong Pagar area, such as Tanjong Pagar Centre, Capital Tower, Mapletree Anson and Twenty Anson, are all above 90% occupied. Hence, we believe that as the supply of new office space tightens, demand could broaden across the office spectrum.
• UEL has a mixture of both CBD fringe and city fringe office properties, such as UE Bizhub City office tower, UE BizHub Tower and 450 Alexandra Rd. Its office portfolio currently enjoys occupancy ranging between 85% and 95%.
• UE Bizhub Tower was UEL’s first office foray into the CBD through the acquisition of 79 Anson Rd in 2012. The 18,767 sqm property is currently estimated at slightly above 80% occupied, after experiencing vacancy from tenants in the oil and gas industries. Management is working to backfill the space into the rising market and enquiries have somewhat picked up pace.
• UE Bizhub West comprises an office building and a B1 industrial property at 450-452 Alexandra Rd. The office component is currently vacant after the departure of HP last year. Efforts to re-lease the space are ongoing but the leasing environment remains competitive given vacancies in other nearby office buildings such as Alexandra Technopark and Fragrance Empire Building. Hence, we expect improvements in asset performance to be modest in the near term.

Cessation of rental top-up provision for UE Bizhub East in the medium term could boost book value 

• UEL has not fully utilised its provision for rental top-up at UE Bizhub East even though the support for the business park component is set to expire in Nov 2018.
• To recap, as part of the agreement to sell the UE Bizhub East, comprising the business park, retail space and hotel, to Viva Industrial Trust (VIT SP, Not Rated), UEL has undertaken to provide rental income support for five years from the date of listing in Nov 2013. The agreed amounts include S$26m for the first two years, S$27.3m for the next two years and S$28.7m for the fifth year. At the same time, under the terms of the agreement, UEL will continue to manage Park Avenue Changi hotel through a hotel lease for five years at a rent of S$8.55m p.a. As agreed, UEL has the option to renew the hotel lease for three successive terms of five years, subject to JTC Corporation renewal for each renewal. Upon JTC’s approval for the first option term, UEL is obliged to exercise an option term of five years at a rent of S$9.66m p.a.
• As at the end of FY17, we estimate UEL has utilized/reversed out c.S$63m out of the original S$108m of provisions allocated. Even after taking into account the additional provisions to be utilised in FY18 (up to Nov 18), we think UEL still has a significant amount of unutilised provisions.
• Assuming the master lease for Park Avenue Changi hotel is renewed for another five years, we believe these provisions are unlikely to be written back immediately. However, should the provisions not be utilised, then the remaining quantum could be written back in the longer term, thus boosting UEL’s book value. Every S$10m of writeback could lead to a 1.6 Scts or 0.5% boost to book NAV.

PROPERTY DEVELOPMENT

What does WBL’s China developments mean for UEL? 

• The China development projects are owned by UEL through its 67.6% stake in WBL Corporation. Currently, there are three remaining property development projects in China – in Shenyang, Chengdu and Shanghai. These projects are in various stages of development.
• Much has been debated about the value of and potential returns from these projects to WBL and UEL. Due to previous corporate exercises that had taken place and subsequent accounting adjustments, the carrying cost of these assets has also been adjusted. In the section below, we attempt to determine the new carrying cost of these projects to UEL and assess the potential profits that can be derived from these developments.

Implied carrying value of the development properties is higher at UEL than at WBL due to PPA 

• These projects were already in WBL’s portfolio at the point of acquisition by UEL. Post the completion of takeover of WBL, there was a purchase price allocation (PPA) review of WBL Group’s identifiable assets and liabilities conducted by UEL in 2013.
• In the table below, we display the effects of the PPA on WBL’s assets and liabilities (at UEL level) post allocation. We note that there is a S$159m adjustment in the value of the properties held for sale. Hence, we believe that the carrying value of WBL’s development properties have been marked to fair value at UEL’s level, post acquisition, to reflect some of the premium to book value paid during the acquisition exercise.

Determining carrying value of development projects 

• In order for us to calculate UEL’s RNAV and potential profits from these projects, we first try to determine the current carrying cost of these projects in UEL’s books. To do this, we use a two-step methodology to first determine the estimated overall premium the portfolio is carried at and secondly, apply this premium to the 3QFY13 project values.
• We also note, post the PPA exercise, that UEL has made provisions for properties held for sale of S$15.9m/S$12.5m/S$16m/S$9.7m in FY14/15/16/17. This is in part due to the downturn in overseas markets, such as Shenyang.
• Firstly, using the value of properties held for sale as at 3Q13, we add the PPA adjustments of S$159m and deduct the provisions made on these projects between FY14 and FY17. As a result, we deduce an implied property value of c.S$605m or a 21% premium above the original property costs.
• Secondly, we assume that this premium is applied equally across all three developments. Using the information provided by the Jan 13 and Oct 17 independent valuers’ reports, we estimate the carrying value of these projects to UEL by attributing the 21% premium to their 2013 book values and add the net development cost that has been sunk into these projects between 2013 and 2017.
• As a result, we arrive at an average carrying value of Rmb5,617psm for the remaining Chengdu Orchard Villa project, Rmb8,155psm for the Shenyang Orchard Summer Palace and Rmb2,967psm for the Shanghai Olympic Garden.
• Finally, based on our assumption of average selling price or valuation of Rmb13,000-15,000psm for Shenyang, Rmb12,000-12,500psm for Chengdu and Rmb60,000psm for Shanghai projects, we estimate these three projects have a potential attributable GDV of S$1.25bn (including Shanghai Olympic Garden) and net discounted surplus of about S$145.9m (or 22.9 Scts/share).

Chengdu Orchard Villa 

• The Chengdu villa development is well located in the Dongsheng Section of Dajian Rd, Shuangliu County in Chengdu, with a total of 1,358 units, spread over 319,361 sqm of land area. Phases 1-3 are developed and 97-100% sold, while P4 comprising 164 townhouses is complete and c.99% sold. Construction of P5 consisting of 231 townhouses is ongoing. The remaining 59,498 sqm of landbank in P6 will likely be progressively developed over the next few years.
• The outlook for Chengdu’s residential market remains upbeat. Chengdu’s residential prices picked up in 2016 and are now close to decade-highs, while saleable inventory has declined. A quick check of developments in the vicinity, such as Keppel Land’s Hill Crest Villa and Serenity Villas, show that average selling prices in the area range from Rmb13,000 to Rmb14,000psm. 
• Based on our earlier assessment, we estimate this project to have a carrying cost of Rmb5,617psm for the remaining land yet to be developed in P5 and P6. Assuming an average selling price of Rmb12,000-12,500psm for the remaining P5 and P6, we reckon that UEL can generate about S$380m of revenue and S$88m of gross profit for this development, when fully sold.

Shenyang Orchard Summer Palace 

• The Shenyang Orchard Summer Palace is located along Qingnian Street, in the prime Shenhe District in Shenyang. The mixed development comprises a shopping mall, 348 units of Grade A offices, 408 units of serviced apartments and 448 residential apartments, spread over 33,518 sqm of land area.
• We had earlier arrived at an estimated carrying value of Rmb2.03bn or an average Rmb8,155psm GFA for the Shenyang project. However, this is a mixed development and we think each component would have a different market or carrying value. Hence, we further breakdown the estimated carrying value of the project by its various components.
• Ascribing the percentage breakdown in value provided by the independent valuers’ report in Oct 17, we allocate our estimated carrying cost to the various components of the development. Hence, we derive a carrying value of Rmb5,336-11,644psm for the various segments.
• The office, serviced apartments and retail components have been completed as at end-FY17. As at Dec 17, some 40% of the office block has been sold or leased. The remaining 99,944 sqm of GFA is slated for residential use and is currently under construction. As at Dec 16 (based on annual report), this portion is 19% constructed.

Outlook for Shenyang property market has improved 

• The Shenyang property market has improved since 2016 on the back of lessening oversupply drag and an uptick in demand. Based on CRIC data, Shenyang residential prices have risen by 30-40% since the beginning of 2016, with the prime areas performing better. Our China property analyst expects this market to remain stable in terms of price and volume transactions in 2018.
• Meanwhile, the supply of new office and retail space remains fairly elevated and rents continue to be under pressure. Nonetheless, we note that the latest land transaction such as a mixed use residential/retail land parcel in Shenhe which was acquired by Shenyang Jindi Hengsheng Investment Co Ltd for Rmb1.8bn in 4Q17, translates to a land cost of Rmb12,900psm of GFA.
• Using these benchmarks and taking into account this project’s prime location, we value the various components of the Shenyang Orchard Summer Palace development at an average Rmb13,000-15,000psm. We reckon this development could generate a GDV of S$679m and gross profit of S$195m when fully monetised.

Shanghai Olympic Gardens 

• UEL holds an effective 30.5% stake in the Shanghai Olympic Garden. The project is located along Laiyin Rd, Songjiang District in Shanghai. The development has a remaining phase (P3.2) comprising residential units. Based on our estimates, the carrying cost of the project is around Rmb2,967psm.
• Given the skyrocketing residential land and home prices in the city, we reckon UEL should generate robust margin from this development. At an assumed selling price of Rmb60,000psm, we estimate the attributable share of net profit from this project could amount to S$66m.

More activity in the development space 

• Since embarking on the group’s last residential project, Eight Riversuites, UEL was absent from the Singapore residential development land market until 2016.
• It has participated, although unsuccessfully, in a number of government land sale tenders including the Martin Place, Margaret Drive and Sumang Walk plots.
• The group intends to become more active in the Singapore residential development space and could look at selected property acquisitions.

ENGINEERING, DISTRIBUTION & MANUFACTURING ACTIVITIES

• United Engineers (UEL) has been divesting and streamlining non-property activities since 2014. Todate, it has monetised close to S$1.4bn worth of non-property assets/businesses, including the Wearnes automotive distribution and UE E&C businesses for S$685m in 2014, as well as monetised its stakes in MFS Technology and MFlex in 2014 and 2016, respectively, for close to S$630m.
• Today, its non-property businesses comprise manufacturing, engineering and distribution activities. Management has indicated that it would continue to grow and streamline its existing portfolio of businesses. However, we believe there is nothing imminent in the works for now. As such, we expect these divisions to remain fairly stable in the near term.

Engineering 

• The engineering division provides applications and solutions for the communications, broadcasting, multimedia, info-communications and security and surveillance industries. This is through the O’Connor’s group of companies.
• This division generated revenue of S$58.2m and operating profit of S$3.3m for FY17. This division has a total asset base of S$57m as at end-FY16 and book NTA of S$36.6m as at end-Sep 17. This translates to an estimated operating margin of about 5.7%. We anticipate contributions from this division to remain relatively stable in the current FY.

Distribution 

• The distribution division comprises equipment distribution and sand mining businesses. The former distributes architectural ceiling and partition systems, fire protection systems and wall paneling and cladding systems for the construction industry. It also distributes laundry and boiler equipment and automotive parts.
• The sand mining division is engaged in sand mining operations through Pacific Silica. It produces high quality processed silica sands for commercial and industrial use in Queensland, Australia. We understand that this 2,500 acre mine could potentially be redeveloped into a residential area, once the sand mine is exhausted in the long run.
• This division generated S$4.7m of operating profit in FY17 and has total assets of S$104m as at end-FY16. We expect the sand mining business to continue generating steady profits.

Manufacturing 

• The manufacturing division consists of services in the precision engineering, specialising in aluminium die-casting and precision machining, primarily for the automotive industry, and provision of turnkey manufacturing solutions. This division generated revenue and operating profit of S$85.6m and S$5.4m, respectively, in FY17.

FINANCIALS

FY17 results boosted by one-offs 

• United Engineers (UEL) doubled its net profit in FY17 to S$89.6m on the back of a 12% rise in revenue to S$539.4m. Stripping out revaluation surplus and write-back of rental top-up provision totaling S$61.2m, core net profit would have delivered a 19% improvement, thanks to the property development and engineering divisions.
• The improved property development revenue came on the back of higher revenue recognition from Chengdu Orchard Villa P4 in China, sale of office space in Shenyang Orchard Summer Palace and The Manhattan in Malaysia, as well as lower impairment losses from overseas development projects.
• Meanwhile, the engineering and distribution divisions reported lower y-o-y operating PBIT due to a decrease in the sale of building materials due to a more competitive construction industry. This led to lower prices and margin compression.
• In the manufacturing segment, an unfavourable product mix from the components business and lower revenue contribution from the precision engineering business was a drag on performance. New programmes within the latter have yet to reach mass production volumes to pick up the slack from programmes that have reached end-of-life.
• The rental and hospitality division experienced a dip in operating profit due to the loss of seven months of income from 450 Alexandra Rd.

Property divisions should drive growth 

• Looking ahead, we project UEL’s earnings to trough in FY18F and to recover from FY19F, led by a stronger performance in the property businesses. We are projecting a 74% revenue CAGR and 68% operating profit CAGR between FY17-20F, led largely by the property development division.
• We anticipate Singapore rental income to pick up in tandem with the recovery in the office leasing market and higher occupancy at 450 Alexandra Rd as it backfills the vacant spaces. Meanwhile, we project property development contributions to improve with profits from Shanghai Olympic Gardens and launch and sale of P5 and P6 of Chengdu Orchard Villa.
• We believe there could be more upside as our current projections have not factored in any boost in income from any asset enhancement initiatives from the Singapore rental and hospitality property portfolio.

Low net debt to equity 

• Net debt to equity ratio stood at a low 0.23x as at end-FY17 due to asset sales. This is on the lower end of the range for developer peers. 
• We expect this ratio to rise slightly over FY18-20F, should the talked-about asset enhancements take place. This does not include any potential reinvestment of capital into new opportunities or developments.

VALUATION & RECOMMENDATION

Strong underlying asset backing 

• An estimated 82% of UEL’s gross asset value is backed by its rental and hospitality property portfolio. Office assets such as UE Square office, Bizhub Tower and 450 Alexandra Rd make up about half of the value of this portfolio. This puts the group in a strong position to leverage the expected recovery in the office leasing and hospitality sectors in 2018. 
• Organic growth in rents and room rates should boost revenue and operating margins from these properties. Hence, we see room for further valuation upside from these properties in the short- and medium-term.

Potential upside from AEI not imputed into current estimates 

• Our current RNAV valuations have not imputed any potential accretion from asset enhancement initiatives that the group could undertake. Based on our scenario analysis in previous sections, we believe value creation activities at UE Square could conservatively lift UEL’s RNAV by 4-13 Scts or c.1-4% through adding more leaseable area.

Non-property businesses kept at book value 

• In addition, we have not valued the non-property businesses as ongoing concerns but have kept them at book value. Hence, we believe any disposal of non-core assets at market value may result in some potential uplift to RNAV. 
• We have also not reflected any value from redeveloping the sand mine land when the mine is fully exhausted in the long run.

Stock is trading at a 25% discount to RNAV, maintain ADD 

• United Engineers (UEL) is trading at a 25% discount to our base case RNAV of S$3.46, which has not included upside from any asset enhancement exercises. UEL has gone unnoticed in the current office upcycle, dragged by previous corporate exercises as well as the lag in non-CBD office cycle recovery. As we move into a broader office market upcycle, we believe UEL would benefit from improving asset performance and operating margins from this business.
• Our target price of S$2.94 is based on an unchanged 15% discount to RNAV. This implies 13% upside to the current share price level. Hence, we maintain our Add rating.
• Re-rating catalysts could emerge when it provides details on its planned asset enhancements at UE Square or when its China projects achieve higher sell-through rates. 
• Downside risks could include execution delays.

LOCK Mun Yee CIMB Research | http://research.itradecimb.com/ 2018-03-30

CIMB Research SGX Stock Analyst Report ADD Maintain ADD 2.94 Down 3.03