PropNex - CGS-CIMB Research 2019-06-04: Prop-ping Itself Up For Success

SGinvestors.io

PROPNEX LIMITED (SGX:OYY)

PropNex - Prop-ping Itself Up For Success

• PROPNEX LIMITED (SGX:OYY) is an integrated real estate services group in Singapore. It is the largest home-grown real estate agency by agent count (May 2019, Council for Estate Agencies). It has four key business segments, namely real estate brokerage, training, property management and real estate consultancy.
• Cash generative business with 40% of its market cap made up by net cash as at end-FY18, sustaining a dividend yield of c.7.2%.
• Initiate with ADD at a Target Price of S$0.64, based on P/E and DCF blend.

Dominant market share brings about key benefits

• PROPNEX LIMITED (SGX:OYY) is the largest real estate agency in Singapore with > 25% market share in terms of number of agents and has over 7,700 agents (as at May 2019) according to the Council for Estate Agencies (CEA).
• Since 2015 (end-2015 – May 2019), its salesforce has grown at a c.9.4% CAGR, faster than the industry average as evidenced by its rising market share. Its large salesforce makes it one of the preferred real estate agencies amongst developers in Singapore; as of May 2019, it had been appointed for 46 out of 66 expected launches in 2019- 2020. This size has brought about two key benefits as discussed below.

Larger outreach –

• Developers tend to prefer agencies with the widest outreach and a good track record to market their new launch projects. PropNex’s dominant market position implicitly allows it to reach out to the largest number of clients and also handle a larger volume of transactions, in our view. The larger salesforce also allows PropNex to have dedicated staff for each project to be ‘taggers’.
• The ‘tagger’ system implemented by PropNex is where certain agents with specialised in-depth knowledge of a project are stationed at showrooms to assist other PropNex agents to close transactions. This allows the other PropNex agents to focus on reaching out to clients even if these other agents only have with basic knowledge of the project. To reduce the complexity in managing multiple agencies, developers tend to appoint 1-4 marketing agencies for new launches.

Cost efficiencies –

• Larger agencies like PropNex can afford to spread out the cost of ancillary services like training and compliance across a larger revenue base. Its scale also allows it to enjoy bulk discounts for other outsourced services like marketing materials.
• Apart from making it attractive to developers, PropNex’s salesforce size also makes it attractive for clients who prefer working with agents under agencies that can offer the widest range of options and services. In this virtuous cycle, non-PropNex agents and other agencies are also attracted to join or partner with PropNex to enjoy access to its wide customer base, relationships with developers and agent services like training programmes.

Educating its way to top spot

• Despite already being the largest real estate agency in Singapore by the number of agents, PropNex intends to continue growing its sales force and expanding its customer base to capture greater market share. One of its key strategies is to educate both agents and consumers via training programmes and consumer seminars respectively.

Agent training and career development programmes –

• We think that its training programmes, Dual Career Path scheme and strong branding help it to retain its competitive edge and grow its agent pool. PropNex has delivered impactful training and development programmes for its agents and also held quarterly conventions where government officials were invited to help agents understand macro trends and government policies. Such trainings and conventions have also been extended to agents of its overseas franchisees in a move to replicate its local success.
• The Dual Career Path scheme was introduced in 2000 to groom agents with leadership potential to be Team Leaders. To be eligible, agents would have to meet certain criteria, including completing certain training courses and achieving certain commission targets. They would first become a Team Manager and may be subsequently promoted to be a Team Leader. Team Leaders perform various supervisory duties like interviewing and providing training sessions to new agents. Agents under the scheme can continue to earn a commission from successful transactions on top of enjoying over-riding commissions from their team on a monthly basis.
• PropNex also has a number of training programmes for agents to choose from, some of which are listed in the figure below. We think that this wide range of training programmes is only possible due to its economies of scale which help reduce the training provision cost per agent. This variety of programmes also help to attract non-PropNex agents and agencies to either cross over to PropNex or partner with it to gain access to such programmes which may not be available elsewhere.

Consumer seminars –

• PropNex has had regular engagement with consumers via its Consumer Empowerment Seminars since 2013. The aim of these seminars is to equip consumers with a deeper understanding of the property market to make more informed decisions. In 2018, 30 consumer seminars were conducted for over 7,000 consumers. Apart from helping consumers understand macro trends and policies like the property cooling measures, PropNex also conducts seminars specific to new launches in it markets.
• Overall, this helps to improve the mindshare of PropNex and contribute to its positive branding.

Transaction volumes to rise

• The number of new launch units in 2019F-2020F 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 from 2014-2018. The large number of launches in 2019F-2020F is due to the government land sales and collective en bloc transactions that occurred in 2017-18.
• As en-bloc transactions picked up in 2017/2018, we expect an increase in transaction volumes across new launches, private and HDB resale, as en-bloc sellers find replacement homes from FY19-21F. We also expect a further
• increase in HDB transactions 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 on the resale market. Possible reasons for doing so would include moving to a better location or upgrading to a private property or larger property.

Debt-free cash cow

• PropNex has a cash generative business that has consistently achieved positive cash flows from operating activities and grown its non-IPO cash balance; from 2015 to 2018, its non-IPO cash balance has grown at a c.28% CAGR. As at end-FY18, PropNex also had c.S$35m of its IPO proceeds remaining, representing 91% of net proceeds raised and c.46% of FY18 cash balance. Its end-FY18 cash balance of S$75.7m makes up c.40% of its market cap. In addition, PropNex runs an asset-light business model that has no major foreseeable capex requirements, in our view, and has no borrowings to service.
• To date, it has utilised 8.7% of its net IPO proceeds to renovate its new office, form new Auction and En Bloc departments and enhance its technological capabilities. We think that its cash balance provides it with the flexibility to pursue further expansion geographically and widen its range of services.
• With a target to be amongst the top five agencies for its overseas franchisees, we believe PropNex could possibly take a direct stake in its franchisees once this top-five target is reached, in our view. The non-IPO portion of the cash could also help to reduce the volatility of dividends through the cycle and reward shareholders in the form of higher dividend payout ratios, in our view.

Regional diversification efforts picking up

• During its IPO in 2018, PropNex earmarked S$12.0m for expanding its presence locally and regionally. It aimed to strengthen its presence in existing markets like Indonesia and Malaysia while developing new business opportunities throughout the rest of South East Asia. PropNex has c.1000 salespeople across 18 offices in Indonesia, c.300 salespeople in Malaysia and c.100 salespeople in Vietnam as at end-FY18.
• For each of its overseas markets, PropNex has the ambitious goal of being among the top 5 real estate agencies within five years of establishment. To date, the overseas offices operate as a franchise model rather than direct ownership by PropNex. Royalty fees from the use of the PropNex brand are recognised based on a percentage of franchisees’/licensees’ monthly sales.
• In 2016, PropNex entered into a master franchise agreement with PT PropNex Realty Indonesia (Unlisted). This coincided with a new regulation passed by the Indonesian government that will allow foreigners to own landed homes for a period of up to 80 years.
• PropNex expanded to Malaysia by entering into a licensing agreement with PropNex Realty Sdn Bhd (Unlisted) in Mar 2018. The agreement is for an initial term of 10 years and can be renewed for another 10 years subject to the fulfillment of conditions stipulated in the agreement.
• In Aug 2018, PropNex Realty (Vietnam) Company Limited (Unlisted); PropNex Vietnam) was launched via the initiation of a Master Franchise Agreement with PropNex Limited. The agreement is for an initial term of 10 years and can be renewed for another 10 years subject to the fulfillment of conditions stipulated in the agreement. PropNex Vietnam will be 25% owned by PropNex Realty and 75% owned by unrelated parties.
• While PropNex has no presence in the Philippines and Thailand currently, it is constantly looking to grow its Southeast Asian footprint and has aimed to penetrate a new market every year according to management’s guidance.

M&A and partnerships locally

• In 2017, PropNex entered into a business takeover agreement with Dennis Wee Realty (Unlisted) to transfer 845 DWR agents to PropNex. This move allowed PropNex to overtake APAC REALTY LIMITED (SGX:CLN) (Rating: ADD; Target Price: S$0.67; see report: APAC Realty - Shifting To A Compelling ERA Of Growth) as the largest agency in Singapore based on agent numbers.
• The aggregate purchase consideration of up to S$5m included:
  • One-time cash payment of S$700,000 to DWR
  • Monthly installment of 1.5% of the aggregate gross commission earned by ex-DWR salespeople for that calendar month. This amount is payable up to S$4.3m and for the period up to 10 Jul 2027. If the balance S$4.3m is not fully paid up after 10 Jul 2027, PropNex will not be liable for the remaining amount.
  • After the S$4.3m is paid out or 10 Jul 2027, whichever is earlier, biannual installments will be paid over 10 years with each installment being 0.5% of aggregate gross commissions earned by ex-DWR salespeople.
• In 2019, PropNex entered into a strategic collaboration with Global Alliance Property Pte Ltd (Unlisted; GAP), which operates under the Century 21 franchise, for the transfer of GAP’s salespeople to PropNex. We believe this collaboration would further strengthen PropNex’s position as Singapore’s largest listed real estate agency.

COMPANY BACKGROUND

Corporate history

• The Group was formerly known as First Class Consultants Pte Ltd, (Unlisted) which was formed in 1999 from the consolidation of Nooris Consultants (founded by Mr Mohamed Ismail) and Prulink Realty (founded by Mr Alan Lim and Mr Joseph Lee).
• In 2003, the three co-founders incorporated their controlling shareholder, P&N Holdings (Unlisted). In the same year, PropNex Grandeur Homes (Unlisted) was also incorporated with the intention of penetrating the luxury homes real estate market.
• In 2004, a unified PropNex Realty was formed via the merger of four franchisee partners with 3,000 salespersons. Post-merger, the entity moved into its headquarters at HDB Hub.
• In 2006, the Life Mastery Academy (Unlisted) was incorporated to provide training and real estate courses to salespeople and the general public. This was aimed at providing more holistic training to the salespeople. PropNex International (Unlisted) was incorporated in 2007 to market real estate projects for the local and international markets. In 2008, PropNex Property Management (Unlisted) was incorporated to be a professional consultancy agency to manage boutique and high-end condominiums.
• In 2013, Mr Joseph Lee retired and sold his equity interest in the controlling shareholder P&N Holdings to Mr Mohamed Ismail and Mr Alan Lim. In 2014, PropNex entered into a JV with JLL to tap the project marketing strengths and global outreach of JLL. This JV saw ex-JLL salespeople joining as PropNex salespeople.
• In 2017, PropNex entered into a business takeover agreement with Dennis Wee Realty Pte Ltd (Dennis Wee Realty). This led to the transfer of 845 salesperople from Dennis Wee Realty to PropNex which led to PropNex becoming the largest real estate agency in Singapore with 6,688 agents as at 10 Jul 2017.
• PropNex was listed on the Singapore Exchange on 1 Jul 2018 at S$0.65 per share. The IPO raised approximately S$40m for the company, of which the majority was set aside for local and regional expansion, the enhancement of its real estate brokerage business and expansion of its range of business services.
• In Feb 2019, PropNex entered into a strategic collaboration with Global Alliance Property Pte Ltd (GAP), which operates under the Century 21 franchise, to transfer GAP’s salespeople to PropNex.

Management team

• The management is highly experienced, and is run by two of PropNex’s co-founders, Mr Mohamed Ismail and Mr Alan Lim. Both co-founders have worked for over 20 years in the real estate industry.
• Mr Mohamed Ismail is responsible for the group’s strategic direction and oversees business operations while Mr Alan Lim is responsible for formulating the group’s corporate strategies and business development opportunities.
• Mr Kelvin Fong was formerly one of the top Team Leaders in PropNex and oversees the training development curriculum and is also responsible for the development of real estate salespeoples’ skills.

BUSINESS SEGMENTS

Brokerage

• PropNex’s primary business is in the provision of real estate brokerage services, comprising agency services and project marketing services. The agency services segment includes private resale and leasing and HDB resale and leasing, while the project marketing segment represents the sale of new launch private residential properties from developers. The brokerage business is operated through its fully-owned subsidiary, PropNex Realty which is supported by PropNex International in project marketing. As of May 2019, it has the largest sales force of over 7,600 agents, up c.14% from 6,684 in Jan 2018.

Commission structure –

• Brokerage commissions form the bulk of revenue and profits earned by PropNex and are paid directly to PropNex following the sale or lease of properties. It is important to note that while commission rates for primary market sales are determined by developers, 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 sales of 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 while this has been 1.5% prior to implementation of cooling measures in Jul 2018, it has since risen to 3.0% as developers incentivise agents to increase marketing efforts.
  • The marketing efforts are coordinated through an experienced salesperson (Project-in-charge) and a project sales team that supports the Project-in-charge. The closing agent receives the eventual commission via a waterfall structure where the broker, team managers and team leaders take their respective cuts. Each Team Leader is typically entitled to up to 5% of over-riding commission for each transaction completed by a supervised salesperson depending on their respective commission scheme. 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.
  • In the example illustrated above, assuming the developer pays a 3% commission, the agencies 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 which follow a tiered scheme; this applies for both agencies.
  • Numerically, if the sale price is S$1m, the property agency receives S$30,000 from the developer and out of this S$30,000, the agency takes a first cut of S$5,000. After which, 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 a gross profit margin.
• Secondary market –
  • Commission rates are negotiated between the agent and the buyer/seller and typically range from 1% to 2% of the transacted price. From this agreed commission, the payout to agents is determined by each brokerage’s commission scheme. For PropNex, the commission payout is between 70% and 90% and is dependent on an agent’s cumulative commission with the payout increasing with a 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 helps to offset some of the training costs required. Unlike Project Marketing, there is no 0.5% point first cut that either agency takes from resale transactions. According to our channel checks, agents tend to hit the 90% payout level within 1-2 years.
  • For resale transactions that are co-brokered by two agents, the commission is usually split evenly. For private properties, the sellers pay 1-2% commission to the seller’s agency. This amount is then split with the buyer’s agency; while the split would typically be 50:50, this amount is negotiable between the two agents. The buyer pays nothing regardless of whether they are using 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.
  • In the example illustrated above, assuming commission received is S$100 and is evenly split between the seller’s and buyer’s agents, the agency of the seller’s agent recognises revenue of S$100 and a gross profit of S$5 leading to a gross profit margin of 5%. For the same transaction, the agency of the buyer’s agent recognises revenue of S$50 and a gross profit of S$5 leading to a gross profit margin of 10%.
• Leasing –
  • Property agents are paid a commission upon successful leasing 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 and complexity & urgency of transaction. Similar to the secondary market, this commission paid is then split between the agent and the agency in a ratio which depends on the cumulative commission tier the agent is on.

Non-brokerage

• Training –
  • PropNex’s training arm is Life Mastery Academy, which provides training to individuals who intend to pursue careers as real estate agents to meet the licensing and registration framework of the Council for Estate Agencies (CEA). It is also an accredited provider of continuing professional development courses by the CEA.
  • The current regulatory framework requires all practicing agents in Singapore to undertake a minimum of six hours of learning activities per calendar year. This provides the Life Mastery Academy with a captive market from which to collect recurring course fees. In FY16-18, revenue derived from training formed c.0.3% of total revenue.
• Property Management –
  • The property management arm under PropNex Property Management aims to be a one-stop professional consultancy to manage boutique and high-end condominiums. Services provided include building diagnostics, facilities management and project management.
  • Notable properties managed by PropNex in Singapore include Canberra Residences, Orchid Park and Dairy Farm Estate. In FY16-18, revenue derived from property management formed c.0.6-0.8% of total revenue.
• Real Estate Consultancy –
  • The real estate consultancy arm was established in 2018 to provide auction and corporate sales services and investment or en bloc services. The corporate sales and auction services department undertakes transactions across all real estate segments including industrial and commercial space in addition to residential property.
  • In Feb 2019, PropNex launched the first HDB Auction service as a means to tap into the large number of flats reaching their 5-year Minimum Occupation Period in 2019. The service offers an alternative option to HDB owners to market their flats and assist them in the price discovery process. These consultancy services form part of the brokerage services PropNex offers to complement the existing services which PropNex provides.

KEY RISKS

High exposure to the cyclical residential property market –

• PropNex is a close proxy to the residential property market in Singapore and could be negatively impacted by macroeconomic shocks affecting the residential property market in Singapore.

Regulatory risk –

• Policy changes from the Singaporean government could negatively impact the residential property market. In Jul 2018, the cooling measures announced led to a more than 20% decline in the share price of PropNex due to the anticipated 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 cost. The direct transaction method reduces the importance of agents as an intermediary, in our view.

Ability to attract and retain talent –

• The agency agreements do not restrict agents from leaving on short notice and joining competitors. There is strong competition for high-performing agents in the industry, which is characterised by high levels of agent turnover. As PropNex 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, PropNex 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 speculation.

Expansion risk –

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

FINANCIALS

Earnings seasonality

• Revenue experiences seasonality with 1Q being 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 are the month of June due to the long school holidays and in August which coincides with the Hungry Ghost Festival.

Projected to maintain market share in FY19F…

• The brokerage segment has historically made up the majority (c.99%) of PropNex revenue. In FY18, it experienced a 30% y-o-y increase in revenue due to the increase in salesforce from 6,684 in Jan 2018 to 7,771 in Jan 2019. Revenue dipped in 4Q18 and 1Q19 due to the impact of the property cooling measures in Singapore which were implemented in 3Q18. Revenue recognition tends to happen 2-3 months after a sales transaction is booked due to the time required to process the various sale documents.
• We expect project marketing volume and price to grow in FY19-21F while PropNex maintains its market share. For its agency services segment, we expect prices to trend upwards. While we think HDB resale and leasing volumes can achieve y-o-y growth, we expect the private resale market to be weaker.

…while gross margins may slip due to commission split structures

• We project overall gross margins to decline y-o-y in FY19F before stabilising from from FY20F onward. We think gross margins could increase slightly due to the higher proportion of income from project marketing but this is offset by the increased commission rates for agents from developers.
• The inverse relationship between gross margins and commission rates is due to the fixed component that PropNex takes out of the overall commission; this fixed component becomes a smaller proportion of total commission.

Sensitivity analysis

• In terms of sensitivity of earnings to changes in market conditions such as transaction value and market share, we estimate that a 5% change in transaction value in Singapore would shift PropNex’s FY19F EPS by 1.4% and Target Price by 1.4%. Conversely, a 1% pt move in market share in Singapore would change PropNex’s net profit by 1.7% and Target Price by 1.7%, based on our estimates.

7.2% yield sustained by cash hoard

• PropNex does not have a fixed dividend policy but paid out a final dividend of 1.5 Scts and a special dividend of 2.0 Scts for FY18; this translated into a payout ratio of c.66.7%. See PropNex's dividend history.
• During the IPO, PropNex declared an intention to distribute at least 50% of the profit attributable to owners for the period from IPO to 31 Dec 2018 and for FY19. In FY19-21F, we expect a flat 3.5 Scts dividend to be paid out p.a., representing a 71-78% payout ratio which translates into a yield of 7.2% based on the current PropNex’s share price. We think this is reasonable even if earnings fluctuate as we believe PropNex has sufficient cash to maintain its absolute dividend and increase its payout ratio. In addition, we do not think that PropNex has substantial capex requirements due to its asset-light nature.

VALUATION AND RECOMMENDATION

• PropNex’s share price is down 30% from its post-listing high and is currently trading at 12.0x 12-month forward P/E (vs. its historical average of 12.7x since listing in Jul 2018 until May 2019) and 2.6x 12-month forward P/BV (vs. its historical average of 3.5x since listing in Jul 2018 until May 2019.
• Based on the current PropNex’s share price, the stock is trading at close to its -1 s.d. 12-month forward P/E band.
• We value PropNex using a blend of the P/E multiple and the Discounted Cash Flow (DCF) methodologies.
  • On a P/E basis, we ascribe a multiple of 10x FY20F P/E, which is in line with -1 s.d. of our cyclical small-cap universe valuation. This implies a Target Price of S$0.44.
  • Our DCF approach implies a target price of S$0.83 assuming stable market share and sales volume from FY21F onwards. We also assumed a 9.60% cost of equity and 1% terminal growth.
  This translates into a blended target price of S$0.64 and a 12-month forward P/E of 14.7x.
• Upside catalysts could come from a recovery in the Singapore residential market while downside risks include a longer-than-expected time for improvement of transaction volumes.

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

SGX Stock Analyst Report ADD INITIATE ADD 0.64 SAME 0.64