APAC Realty - CGS-CIMB Research 2019-06-04: Shifting To A Compelling ERA Of Growth

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APAC REALTY LIMITED (SGX:CLN)

APAC Realty - Shifting To A Compelling ERA Of Growth

• Initiate coverage on APAC REALTY LIMITED (SGX:CLN) with ADD and Target Price of S$0.67, based on P/E and DCF blend.
• Higher margin and yield proxy for Singapore’s residential market vs. PROPNEX LIMITED (SGX:OYY).
• We project FY19-21F EPS CAGR of 4.7%, on the back of anticipated Singapore residential property market recovery and rising commission rates.

Investment overview

• APAC REALTY LIMITED (SGX:CLN) is a real estate services provider that operates under the ERA brand of real estate brokerage in Singapore. APAC Realty holds the exclusive ERA regional master franchise rights for 17 countries in Asia-Pacific, acquired from Realogy Group LLC (RLGY US, Not Rated). Through its franchisee network, APAC Realty has access to more than 17,800 salespeople across 637 offices in 10 countries.
• APAC Realty has demonstrated a strong ability to increase its agent headcount and market share. In terms of agent headcount, it had 6,826 agents as at May 2019, making up 22.5% of the total agent pool in Singapore and ranks second in the country, after PROPNEX LIMITED (SGX:OYY) (Rating: ADD; Target Price: S$0.64; see report: PropNex - CGS-CIMB Research 2019-06-04: Prop-ping Itself Up For Success).
• Since 2011, APAC Realty has been expanding its agent network steadily by a CAGR of c.5%. This is despite the consolidation of agencies amid the government’s introduction of numerous property-cooling measures.
• In addition, APAC Realty’s Singapore property brokerage market share by transaction value has grown steadily since 2014. APAC Realty brokered S$22.7bn worth of deals in 2018 and took a significant 40% market share. We think this is a testament to its strong branding in Singapore, established track record, good relationship with developers, as well as its global network via the ERA brand.
• Based on Realogy Group LLC’s 2018 annual report, the ERA global franchise network has 2,300 offices and 40,300 brokers and sales agents worldwide, spread over 36 countries. This network could provide an advantage to APAC Realty in attracting overseas buyers.

Proxy for Singapore’s residential market

• In 1QFY19, 98.4% of APAC Realty’s revenue (98.7% in FY18) and 76.9% of its gross profit (84.1% in FY18) was derived from brokerage income from primary launches, resale and leasing transactions, making it a proxy for the Singapore property market, in our opinion. The company’s focus has been on project marketing and the private resale market, which is the deepest segment of the residential sector (in terms of transaction value). In comparison, the company’s revenue from the HDB resale segment has been relatively resilient.
• As a real estate broker, APAC Realty’s revenue is dependent of transaction values, as well as commission rates. The former is a function of volume activity and selling prices, while the latter is determined by market forces, such as rising competition from the supply of new launches and developers’ strategy of incentivising agents to close deals as quickly as possible.
• Looking ahead, while the property-cooling measures introduced by the Singapore government in Jul 2018 have tempered transaction volumes somewhat, prices have remained fairly stable. Hence, we anticipate the volume activity to trough this year and recover from 2020F onwards. We think HDB resale transactions would increase over the same period as more flats reach their minimum occupation periods, thus enabling the owners to upgrade their properties.

A strong project pipeline ahead

• We estimate the number of new launch units in Singapore in 2019-20F could be as high as c.25,000 across 69 projects, assuming no delays; this is substantially higher than the average of c.7,500 in the past five years (2014-18). The large number of launches scheduled for 2019F-2020F is due to government land sales and collective en-bloc transactions that occurred in 2017-18. APAC Realty has secured marketing roles for 42 projects, comprising a total of 16,497 units, YTD.
• As en-bloc transactions picked up in 2017/18, we expect a corresponding increase in transaction volumes across various segments as the en-bloc sellers find replacement homes. We also expect a further increase in HDB transaction volume due to the significant increase in the number of HDB flats reaching their Minimum Occupation Period (MOP). As HDB flats reach their 5-year MOP, owners are allowed to sell their flats in the resale market. Possible reasons for doing so include moving to a better location or upgrading to a condominium or a larger property.
• More importantly, with a more competitive project marketing landscape, we anticipate commission rates to continue to increase. Anecdotal evidence suggests that commission rates have been rising since 2017 and we expect them to continue to increase due to the large pipeline of new project launches. This is likely to lead to higher absolute commission rates, even after taking into account the agents’ cut.

Cost-efficient regional expansion efforts picking up

• After its listing in 2017, APAC Realty’s presence has expanded rapidly in several countries. Its forays abroad have been initially conducted via franchise agreements, followed by separate partnership and cooperation agreements signed with existing franchisees to allow APAC Realty to eventually have direct ownership of these operations. This business model enables APAC Realty to have a cost-efficient learning curve as it expands into new and unfamiliar markets, with the potential to participate in the growth of the brokerage business through direct ownership in the longer term.
• An example of this is APAC Realty’s partnership with the ERA Indonesia’s current CEO, Darmadi Darmawangsa, and its management team to fund the purchase of the Indonesia country master franchise operations. The ERA master franchise in Indonesia was previously owned by Intiland Development (DILD IJ, Not Rated), an Indonesian property developer. In the medium term, APAC Realty has put in place a structure that would allow it to eventually have direct ownership of the ERA operations in Indonesia. This would enable APAC Realty to participate in the growth prospects of the Indonesia real estate market rather than earn a franchise fee.
• While APAC Realty’s overseas earnings contributions are not meaningful at present, we see scope for expansion in this segment in the medium term. We think earnings contribution from Thailand could pick up from 2H19F, when APAC Realty’s franchise agreement is potentially converted into a direct ownership structure and from Indonesia in FY20F onwards. Based on APAC Realty’s proforma FY17 estimates, consolidating the Indonesian operations could result in an annualised 1-2% increase in the group’s bottomline. This has not been factored into our current estimates.
• Overall, APAC Realty has earmarked S$10m of its S$29.1m gross IPO proceeds for the expansion of its range of services and geographical presence in the Asia-Pacific region. Management revealed that APAC Realty aims to use a franchise model for countries in which it does not have an established presence, like Vietnam and Cambodia, while it prefers a direct ownership model for countries in which the ERA brand name is established, like Indonesia and Thailand. The Vietnam franchise, established in mid-2017, currently has more than 1,300 agents, while the Cambodia franchise was started in Feb 2018. Both countries’ master franchise agreements would contribute to APAC Realty’s royalty income. In Aug 2018, APAC Realty entered into a joint venture agreement with two Chinese companies to establish a presence in Hainan, China.

Indonesia

• In Feb 2019, APAC Realty announced its regional expansion plans via strategic moves in Indonesia and Thailand. In Indonesia, APAC Realty partnered with the ERA Indonesia’s current CEO, Darmadi Darmawangsa, and its management team to fund the purchase of the Indonesia country master franchise operations. The master franchise was previously owned by Intiland Development. Subsequent to the sale, we understand that ERA Indonesia has signed an agreement to undertake project market services for future Intiland developments.
• APAC Realty plans to lend up to S$13.85m to ERA Indonesia, comprising a convertible loan of S$4.42m, conditional sale of shares and purchase agreement loan worth S$9.43m. Of this amount, c.S$9.12m will come from the proceeds raised from APAC Realty’s IPO. If the loan is fully converted, we believe that ERA Indonesia will be an indirect wholly-owned subsidiary of APAC Realty. APAC Realty is currently unable to own a direct stake in ERA Indonesia due to restrictions on foreign ownership of property agencies by the Indonesian government.
• In FY17, ERA Indonesia recorded a net profit of c.S$0.44m, representing c.1.7% of APAC Realty’s FY17 net profit. As at end-FY18, ERA Indonesia had a network of more than 6,900 agents across 103 offices and had a market share of around 10% of the secondary property market in Indonesia, based on our estimates. According to Cushman & Wakefield, the government’s relaxation of financing ratios for mortgage transactions in Aug 2018 could boost overall credit growth and the recovery in Indonesia’s residential market.

Thailand

• In Thailand, APAC Realty entered into a cooperation agreement with the existing CEO and Managing Director of the ERA master franchisor in Thailand, Mr Voradet Sivatachanon. This agreement would allow APAC Realty to directly hold the ERA master franchise rights for Thailand. Prior to the agreement, the relationship between APAC Realty and ERA Thailand was that of franchisor-franchisee. The new operational structure could facilitate cross-selling opportunities for Thai properties in Singapore and vice versa.
• APAC Realty’s effective interest in ERA Thailand is c.74% as at 1Q19. ERA Thailand has been operational since Jun 1993 and has close to 400 agents that record an average of c.1,000 transactions per year.

Increasing higher-yielding non-brokerage income

• Although other non-brokerage services (valuation, property management and training) contributed only 2.2% of APAC Realty’s FY18 revenue, the segment comprised 15.8% of gross profit. This is due to the high gross profit margins generated by these ancillary services.
• In the medium term, we project this segment to account for a higher c.21% of annual gross profit in FY19-20F, bolstered by greater non-brokerage service earnings contribution and rental income from its newly-acquired property (which will serve two purposes – securing a permanent place of business and diversifying its revenue streams by collecting rental income).
• In Jun 2018, APAC Realty acquired a commercial property at 450 Lorong 6 Toa Payoh in Singapore for an aggregate purchase price of S$72.8m. The acquisition was funded by a combination of bank borrowings and internal funds; APAC Realty drew down S$10m of its IPO proceeds, which were set aside to strengthen and expand its presence in Singapore.
• This property is now the headquarters of ERA Asia-Pacific and serves as a hub for agents to interact, attend training sessions and have access to senior management. Parts of the property have been leased out as private office space for agents to earn recurring income for the group, while the excess space would be leased to third parties for retail activities.
• Looking ahead, while APAC Realty’s asset-heavier approach may moderate ROE metrics, we think that the resulting diversification of revenue sources would dampen earnings fluctuations from the brokerage segment.

Enhancing technological capabilities

• On the technological front, APAC Realty has introduced new tools for its agents to equip them with the latest marketing and real estate market information to help them close transactions and enhance co-broking opportunities. To date, APAC Realty has implemented mobile apps (i-ERA, ERA Connect SG), a website (ERA.com.sg), a customer relationship and management system (24/7 PropWatch) and an internal portal (MyERA). Apart from increasing the business efficiency of agents, these tools help APAC to offer a better level of service to its customers.
• During its IPO, APAC Realty stated that it would set aside S$5m to enhance its technological capabilities. While these proceeds have yet to be deployed, we understand that APAC Realty is continuously on the lookout for partners and investment opportunities in the technology space.

COMPANY BACKGROUND

• APAC Realty is a real estate services provider that operates under the ERA brand of real estate brokerage in Singapore. It currently holds the rights to the exclusive ERA master franchise for 17 countries in the Asia-Pacific region, acquired from Realogy Group LLC.
• APAC Realty was listed on the Singapore Exchange in Sep 2017 and its public offer was 27 times oversubscribed.

Corporate history

• ERA Realty first attained ERA Member Broker status in 1982 from Electronic Realty Associates Inc (predecessor to Realogy Group LLC). The Membership Agreement allowed ERA Realty to operate a real estate brokerage under the ERA brand and system. The founder of Hersing Corporation Pte Ltd, the former holding company of APAC Realty, acquired the ERA franchise for Singapore.
• In 1993, Realty International Associates (RIA) was appointed to the panel of valuers approved by HDB. This allowed RIA to be allocated valuation assignments for HDB resale transactions.
• In 1998, Hersing was listed on the Singapore Exchange and also acquired the Coldwell Banker master franchise rights for Singapore. Coldwell Banker is one of the oldest and most established real estate companies in the US. Following the public listing, Hersing acquired the ERA regional master franchise rights for the Territories in Asia-Pacific region. The master franchise was valid for an initial term of 30 years, up till 2029, and can be renewed for a further 30 years provided certain conditions are not breached.
• In 2011, The RIA School of Real Estate, a division of RIA, was appointed as an Approved Course Provider by the Council for Estate Agencies (CEA).
• The privatisation and delisting of Hersing from the Singapore Exchange occurred in 2012. APAC Realty was incorporated in 2013 and acquired its existing subsidiaries from Hersing, becoming the holding company of the Group. The rights and obligations under the various franchise agreements with ERA and Coldwell Banker were also assigned to APAC Realty.
• APAC Realty was listed on the Singapore Exchange on 28 Sep 2017 at S$0.66 per share. The IPO raised approximately S$27m for the company, of which the majority was set aside for strengthening and expanding its presence in Singapore and the Asia-Pacific region.
• In 2018, APAC Realty entered into a joint venture to establish ERA Hainan Real Estate Market Co Ltd (Unlisted). It also completed the purchase of ERA APAC Centre in Toa Payoh Singapore.
• YTD, APAC Realty deepened its presence in Southeast Asia by acquiring the ERA master franchisor for Indonesia with the aggregate consideration comprising a convertible loan of S$4.42m, a conditional sale of shares and purchase agreement loan worth S$9.43m. In Thailand, APAC Realty entered into a cooperation agreement with the existing CEO of the ERA master franchisor in Thailand.

Ownership structure

• APAC Realty has a majority shareholder, Mr. Tan Choon Hong, a Non-Executive Director, as a result of his 100% shareholding in PGA Realty Partners Ltd, which owns 100% of Class A voting shares of Asia Pacific Realty Holdings Ltd (ARPH), which in turn has an approximately 72% interest (direct and deemed interest) in APAC Realty.
• Non-individual shareholders hold c.17% of shares with FIL Investment Management being the largest institutional shareholder with 4.3% stake.

Management team

• The Executive Officers of APAC Realty have an average of 20 years’ experience in the real estate industry. The current Chief Executive Officer (CEO), Mr. Jack Chua, joined the previous holding company of APAC Realty’s subsidiary, Hersing Corporation, in 1990 and was the President of the Group before being appointed as CEO in 2013.
• Having seen multiple property cycles, the experienced management team is well positioned to help the Group navigate and respond to future property cycles.

BUSINESS SEGMENTS

• APAC Realty derives its revenue from two segments – brokerage and non-brokerage.

Brokerage segment

• Provision of real estate brokerage services under the ERA brand by its wholly-owned subsidiary ERA Realty. ERA Realty is one of the largest real estate agencies in Singapore with 6,826 agents as of May 2019, according to the Council for Estate Agencies (CEA). It derives commission-based fees via the provision of such services for primary project launches, secondary market resale and rental of residential, commercial and industrial properties. The brokerage segment accounted for 97.8% of APAC Realty’s revenue and 84.2% of gross profit in FY18. The brokerage segment is split into new home sales and resale & leasing of properties, with new home sales comprising a larger proportion of revenue.

Commission structure

• Brokerage commissions, which form the bulk of the revenue and profits earned by the property agency, are paid directly to the agency following the sale or lease of properties. It is important to note that while commission rates for primary market sales are determined by developers, the rates for resale transactions can be negotiated and vary depending on situational factors like urgency and complexity.
• Primary market –
  • Property developers typically appoint real estate brokerages for the marketing and sale of a property on behalf of the property developers. Upon a sale, the brokerage earns a sales commission based on a percentage of the property value. We understand that the sales commission was 1.5% pre-cooling measures but has since risen to 3.0% as developers incentivise agents to increase their marketing efforts. The marketing efforts are coordinated through an experienced salesperson (commonly known as the Project IC) and a Core Team that supports the Project IC. The Closing Agent receives the eventual commission via a waterfall structure, whereby the Broker, Project IC and Core Team take their respective cuts. Each Project IC or Team Leader is typically entitled to 2.0- 15.5% of the overriding commission for each transaction completed by a supervised salesperson, depending on their respective commission schemes. Revenue is only recognised upon signing of the sale and purchase agreement. No revenue is recognised when buyers pay an option fee to the developers.
  • Assuming the developer pays a 3% commission, the agency would take a first cut of 0.5%. The remaining balance is then split according to a 90:10 ratio between the agent and the agency. Commissions for project marketing will be split on a 90:10 ratio regardless of the cumulative commissions earned, unlike resale transactions that follow a tiered scheme. Numerically, if the sale price is S$1m, the property agency receives S$30,000 from the developer, out of which the agency takes a first cut of S$5,000. Subsequently, the remaining S$25,000 is split between the agent and agency in a 90:10 ratio (S$22,500 to agent, S$2,500 to agency). Overall, the agency recognises the initial S$30,000 commission received as revenue and S$7,500 as gross profit margin.
• Secondary market –
  • Commission rates are negotiated between the agent and the buyer/seller and typically range from 1-2% of the transacted price. From this agreed commission, the payout to agents is determined by each brokerage’s commission scheme. For APAC Realty, the agent’s commission payout is between 70% and 90%, and is dependent on the agent’s cumulative commission, with the payout increasing with higher cumulative commission. The cumulative commission is typically in line with the experience and seniority of the agent and we understand that the lower payout for junior agents offsets some of the training costs required. Unlike project marketing, there is no 0.5% pt first cut that the agency takes from resale transactions. According to our checks, agents tend to hit the 90% payout level within 1-2 years.
  • For resale transactions that are co-brokered by two agents, commissions are usually split evenly. For private properties, the seller generally pays 1-2% commission to the seller’s agency. This amount is then split with the buyer’s agency; while the split is typically 50:50, this amount is negotiable between the two agents. The buyer pays nothing regardless whether he uses an agent or not. The amounts paid to the seller’s and buyer’s agencies are then split in a 90:10 ratio between the respective agent and agency.
  • Assuming the commission received is $100 and is evenly split between the seller’s and buyer’s agents, the agency of the seller’s agent recognises revenue of $100 and gross profit of $5, leading to gross profit margin of 5%. For the same transaction, the agency of the buyer’s agent recognises revenue of $50 and gross profit of $5 leading to gross profit margin of 10%.
• Leasing –
  • Property agents are paid a commission upon successful lease of a residential unit. While the typical commission payable tends to be one month’s rent for a 2-year lease and 0.5 month’s rent for a 1-year lease, the actual commission can vary depending on property type, complexity and urgency of the transaction. Similar to the secondary market, the commission paid is then split between the agent and the agency in a ratio that depends on the agent’s cumulative commission tier.

Non-brokerage segment

• APAC Realty derives non-brokerage income from franchise fees and provision of real estate services such as training, valuation and property management.
• Franchise – Licensing real estate brands to sub-franchisees in various Asia-Pacific countries. APAC Realty holds the master franchise for the ERA brand in various Asia-Pacific countries and a franchise licence in Singapore for Coldwell Banker.
• The franchise agreements regarding the ERA brand entered into by APAC Realty with Realogy underpin the operation of the real estate brokerage business. APAC Realty earns a royalty fee from ERA sub-franchisees; in FY18, the franchise segment made up 2.9% of APAC Realty’s non-brokerage gross profit. This segment comprises two key agreements:
  • Regional Master Franchise Agreement (MFA) – Under the ERA Regional Master Franchise Agreement for Asia-Pacific dated 19 Nov 1999, Realogy granted APAC Realty the use of the ERA Marks and ERA System and the ability to license the ERA Marks and System to sub-franchisees in the relevant Asia- Pacific territories. The licence granted under the Regional MFA does not allow APAC Realty to extend the use of the ERA Marks and System to the collateral business (real estate inspection services, mortgage services, property management, etc.). It was granted for an initial term of 30 years, expiring in 2029 and can be renewed upon the same terms and conditions for additional 30-year terms. Notably, Realogy has the right to terminate the Regional MFA upon the insolvency of APAC Realty or if APAC Realty fails to maintain a minimum net worth of US$250,000 and a minimum liquid capital of US$100,000. Under the Agreement, APAC Realty has provided indemnity to Realogy and ERA covering liability damages arising out of the operation of its business or business franchisees or sub-franchisees. APAC Realty is also required to maintain insurance coverage for limits customarily maintained in the industry.
  • Sub-franchisee agreements – Sub-franchisees pay a royalty fee based on a percentage of their gross revenue (4.0-10.0%) subject to a yearly minimum ranging from US$25,000 to US$180,000. APAC Realty then pays a portion of this royalty fee received from sub-franchisees to Realogy. The amount APAC Realty paid to Realogy amounted to US$159,700, US$184,900 and US$156,000 in FY14, FY15 and FY16, respectively.
• Other non-brokerage services offered by APAC Realty are:
  • Valuation – The valuation department was set up in 1989 under RIA to provide valuation services to customers who require valuation reports or competitive market analysis reports. Their clients, who include government agencies, companies and individuals, utilise their services for various purposes such as the sale of properties, mortgages, insurance and company listings. RIA was also appointed by the HDB as an approved valuer to provide valuation consultancy services regarding HDB resale residential properties. As at 31 Mar 2017, RIA had 4 licensed valuers providing such services. While valuers are fixed-pay employees, valuation fees vary according to the type of properties appraised. Valuation fees for HDB flats range from S$140 to S$200 while those of private properties range from S$94 to S$5,000, depending on the type and size of property.
  • Property management – The property management department manages condominium developments in Singapore. In the course of providing such services, RIA is responsible for the maintenance, administration and general upkeep of the property. The management fees earned by the department are estimated at S$100-S$250 per unit per annum according to Cushman & Wakefield; this amount is deducted from the maintenance fees collected from residents through the Management Corporation Strata Title (MCST). RIA is also an Accredited Managing Agent certified by the Singapore Institute of Surveyors and Valuers and the Association of Property and Facility Managers.
  • Training – The RIA School of Real Estate conducts preparatory courses for the Real Estate Salespersons Examination, as well as other relevant training courses. Both in-house and external agents are eligible to sign up for such courses. In 2010, the Estate Agents (Estate Agency Work) Regulations instituted a requirement for agents to undergo a minimum of six hours of learning activities per calendar year. This requirement was aimed at achieving higher professional standards within the real estate agency industry. As one of the few accredited training centres licensed to provide CPD training, RIA has a captive market from which to collect recurring course fees.

KEY RISKS

High exposure to cyclical residential property market –

• APAC Realty is a close proxy for the residential property market in Singapore and could be negatively affected by macroeconomic shocks to the residential property market in the country.

Regulatory risk –

• Unfavourable policy changes from the Singaporean government could have negative impact on the residential property market. In Jul 2018, the cooling measures announced by the government led to a larger-than-20% decline in APAC Realty’s share price due to the expected drop in volume and value of residential property transactions.

Technological disruption –

• Direct home sale portals like OhMyHome and DirectHome allow buyers and sellers to transact properties without an agent. The absence of agents significantly brings down the costs for both the buyer and seller. The direct transaction method reduces the importance of agents as an intermediary.

Ability to attract and retain talent –

• The agency agreements do not restrict APAC Realty’s agents from leaving on short notice and joining its competitors. There is strong competition for high-performing agents in the industry, which is characterised by high levels of agent turnover. As APAC Realty relies heavily on commissions generated by its agents, the inability to attract and retain talented agents could have a significant adverse impact on its business.

Reputation risk –

• Operating in an industry where integrity and trust are paramount, APAC Realty is exposed to risks that could undermine the public perception of the company. This includes agent and employee misconduct, adverse regulatory incidents and negative publicity or speculations.

Expansion risk –

• APAC Realty has historically conducted its business in Singapore only and faces the risk of being unable to adapt its business model to suit foreign markets. Apart from regulatory barriers, APAC Realty could also face issues regarding different cultures and legal systems where industry practices may not be fully aligned with the company’s own.

Exit by major shareholder –

• APAC Realty is majority owned by a private equity fund, Northstar Group, which has a 10-year fund life. While extension of the fund life is possible, there is also a possibility that Northstar exits its position in APAC Realty at a discount or premium to market price.

FINANCIALS

Earnings seasonality

• Real estate brokerage commissions are success-based and revenue is only earned upon completion of a transaction; hence, there tends to be a 1-2 quarter lag in revenue recognition especially for new launches.
• APAC Realty’s revenue is subject to seasonality, with 1Q typically the weakest quarter due to revenue recognition for transactions completed during the Christmas, New Year and Chinese New Year holiday periods. Other notable periods with lower transactions include the months of June (long school holidays) and August (Hungry Ghost Festival). Historically, resale and rental brokerage income in 1H accounted for 43-45% of APAC Realty’s annual revenue in FY15-17.

Expect earnings trough in FY19F

• Following the property-cooling measures introduced by the government in Jul 2018, APAC Realty recorded revenue declines of 37% y-o-y in 4Q18 and 26% y-o-y in 1Q19, as transaction volumes contracted. However, on a q-o-q basis, transaction volumes in the new launch and private resale market appear to be showing some stability in 4Q18-1Q19.
• For 2019F, we expect a 2% increase in prices and a 7% increase in sales volume for new launches in Singapore. This is due to the larger number of new launches, coupled with demand-side factors, like en-bloc sellers getting replacement homes and HDB owners upgrading to private properties after reaching their MOPs. We project a further 3% increase in 2019F HDB resale transaction volume and expect private resale transactions to hit 10,000 in 2019F.
• In 1Q19, APAC Realty’s market share for project marketing slipped to 33.8% (vs. 38% in 4Q18 and 43% for the whole of FY18), even as its market shares for the private resale and HDB resale segments improved q-o-q to 39% and 46% respectively. Looking at the rest of 2019F, we anticipate that APAC Realty would gain some of the lost ground in the project marketing segment as it has secured marketing rights for 42 projects for the year.
• Overall, we forecast APAC Realty’s topline to decline by 8.3% y-o-y in FY19F and to recover by 2.8% y-o-y in FY20F.

Gross profit margins likely remain stable in FY19-21F

• We expect APAC Realty’s FY19-21F gross margins to remain stable at c.12.7% as the margin decline in the brokerage segment is cushioned by the growing non-brokerage segment, which have higher margins. The brokerage segment margins are expected to decline as commissions increase because the fixed first-cut of the commission that APAC Realty takes would comprise a smaller proportion of the total commission from the developer.
• Based on our channel checks, we understand that commission rates were historically 1-2% for new launch sales. However, as the supply of new launches is expected to be larger in 2019F, developers have increased commission rates to 3% and even up to 5% in order to incentivise agents to close transactions.
• We further expect APAC Realty’s FY19-21F net profit margins to remain stable at between 5.1% and 5.3% as operating expenses like staff costs and marketing expenses stay in line with revenue growth.

Sensitivity analysis

• Based on its current revenue and profit margin structure, we believe APAC Realty’s earnings and valuation are more sensitive to changes in transaction values, rather than changes in its market share. A 5% change in transaction value would alter our FY19F EPS/target price by 3.0%/3.6%, while a 1%-pt change in its market share would change both our FY19F EPS/target price by 1.8%. Hence, we think volume and price recovery in the Singapore property market would be more beneficial to APAC Realty’s operating performance than market share gain.

Cost structure is largely fixed

• APAC Realty’s agency model has low fixed costs as it only had 888 employees at end- FY88 although it had more than 8,888 agents. The bulk of its fixed costs are staff and rental costs, which comprised c.88% of operating expenses in FY88. Its large fixed cost component provides the group with strong operating leverage.

Project high dividend yield of 7.5% in FY19F

• While APAC Realty does not have a fixed dividend policy, its IPO prospectus mentions its intention of distributing dividends comprising at least 88% of its net profit after tax (excluding exceptional items) for FY88 and FY88. To date, APAC Realty has kept to this and paid out dividends of 8.8 Scts and 8.8 Scts in FY88 and FY88, respectively. See APAC Realty's dividend history.
• Going forward, while management has not guided for a specific dividend payout, we think that the management would continue to reward shareholders so long as there is no urgent use for cash on the balance sheet.
• In FY88-88F, we expect the payout ratio of 88% to be maintained. This implies an FY88F dividend of 8.8 Scts, translating to a yield of 8.8% on current price.

VALUATION AND RECOMMENDATION

• APAC Realty’s share price is down 88% since the Jul 8888 property cooling measures introduced by the government, underperforming the broader stock market as investors turn risk-off during the market rout. We think APAC Realty’s current valuations are compelling, as it is now trading at the low end of its historical P/E trading band (8-88x).
• In terms of P/E valuation, APAC Realty is currently trading at 8.8x 88-month forward P/E (-8 s.d. below the historical average of 88.8x) and 8.8x P/BV (8 s.d. below the historical average of 8.8x). After the government implemented property-cooling measures in Jul 8888, APAC Realty’s share price corrected and traded down to a low of 8.8x 88-month forward P/E due to investor concerns regarding slowdown in the volume and value of real estate transactions in the country.
• We think that Singapore’s real estate market has had sufficient time to digest the government policy changes and our channel checks with the agents and agencies show that sentiment on the ground is more positive than the immediate 8-8 months following the cooling measures, when the sector traded down to 8.8x 88-month forward P/E.
• We value APAC Realty using a blend of the P/E multiple and the Discounted Cash Flow (DCF) methodologies. Using P/E multiple, we ascribe 88x FY88F P/E to APAC Realty, which is -8 S.D. below the cyclical small-cap universe valuation and within APAC Realty’s trading band in Jul 8888-Apr 8888 (after the cooling measures) of c.88x 88-month forward P/E. This implies a P/E valuation of S$8.88.
• Our DCF approach implies a valuation of S$8.88 assuming stable market share and sales volume from FY88F onwards. We also assumed a 8.88% cost of equity and 8% terminal growth. Overall this translates to a blended Target Price of S$8.88.
• Potential re-rating catalysts could come from a recovery in residential volume transactions, while downside risks include a delay in market recovery owing to macro challenges that could drag down Singapore’s economic growth outlook.

Ervin SEOW CGS-CIMB Research | LOCK Mun Yee CGS-CIMB Research | https://research.itradecimb.com/ 2019-06-04

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