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Developers' cost of capital could be in vain

Singapore Business Review

Trade income-dependent developers seen to struggle the most next year.

All developers will not meet their cost of capital in the year ahead and the market is rightly bearish in pricing them below book, said MayBank KimEng.

According to the research house, operating environment remains challenging as intense competition for land could weigh on margins.

As such, in this environment, it believes developers with stable streams of recurring income and good development earnings visibility could outperform.

Here's more from MayBank KimEng:

Our forecasts suggest that all Singapore developers will not meet their cost of capital in the year ahead. We expect large cap stocks - CapitaLand, UOL and CDL – to generate the smallest ROE and ROIC spread in 2017, while returns for mid-cap developers - Wing Tai and Ho Bee – should remain significantly below their cost of capital.

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In order to capture relative stock performance, we compare P/BV vs ROE to screen for developers that can generate decent returns amidst the market headwinds. UOL is in a favourable quadrant with relatively low P/BV and decent ROE. While Ho Bee and Wing Tai are amongst the cheapest stocks in our universe, we believe they are unlikely to perform given their thin earnings base and lackluster ROE profile.

Returns from taking on new development projects may be low as intense competition will continue to keep land cost elevated.

Risk-reward for new residential projects remains unfavourable as cooling measures will limit velocity of sales and the system of penalties for missing sell-by dates heightens the risk of cost overruns.

Hence, developers highly dependent on trading income may struggle to generate a decent risk-adjusted return for shareholders. Furthermore, with risk appetite remaining low, we expect the market to favour developers with large recurring income streams as investors seek safety along the lower end of the property risk spectrum. CapitaLand and UOL scores best on this.



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