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Taiwan Area: Taiwan Property Sector

2011/11/09

 Taiwan Property Sector

Reminiscent of the crisis? Let’s look at cash flows and balance sheet

● We revise down our property price assumptions from ‘flattish’ to ‘down 0-10%’ for 2012E given the sharp fall in transaction volumes. We continue to believe the luxury segment will fare better given its tight supply and rich customer base while there is more pressure on non-prime areas.

● In tandem, we revise down property companies’ 2012 EPS by 10- 50%. However, we believe focus now is more on their cash flows and balance sheets given intensifying concern within the globaldebt and equity markets. Given a light land inventory strategy and ample cash flows generated in past two years, Taiwan’s developers usually have lower gearing & decent balance sheets.

● Major property names are still trading at a 20-57% discount to new NAV estimates, which is close to the trough valuations. While there appears to be no catalyst for the next quarter, we believe the risk-reward profile looks decent in a mid-to-long term perspective. We like Huaku for its high-end exposure, Hung Poo for its deep valuation and Taiwan Fertilizer (TF) for its diverse earnings stream from its non-property business. We, however, downgrade Chong Hong and Prince to NEUTRAL.

Property names not far from trough valuations

Mild price decline in 2012 but luxury segment will hold up Despite resilient pricing, residential property transaction volume has fallen by 10-15% YTD due to weaker market sentiment. Government’s  unfavourable proposals pushed away speculative buyers while the increasing uncertainty of both the macro and the capital market outlook made replacement/ upgrade buyers remain on the sidelines for better bargaining opportunities. We revise down property price assumptions from ‘flattish’ to ‘down 0-10%’ for 2012E given the sharp fall in transaction volumes. However, we do not expect a crash of property prices in the next year given disciplined supply from both primary and secondary markets. A low interest rate environment implies sellers’ opportunity cost to ‘wait’ (for better sentiment) is low.
As for developers, decent balance sheets and cash flows (thanks to locked-in cash from projects sold in previous years) imply aggressive price cuts (for cash) are unlikely in the next 12 months. We continue to believe the luxury segment will fare better given its tighter supply and rich customer base while there is more pressure in non-prime
areas.

Decent cash flows/ balance sheet; low solvency risk Equity market volatility and the large fall of transaction volumes has led to market worry about the developers’ earnings outlook as well as a potential credit problem, reminiscent of the financial crisis in 2008.
The pre-sales scheme is a favoured business model for Taiwanese developers in terms of creating cash flows. We continue to foresee very low credit risk for developers as their balance sheets appear decent (gearing has come off since 3Q08) and there are good cash flows (thanks to projects sold in 2009/10). Light assets and an increasingly JV format business model also helps alleviate developers’ land bank and gearing risks.

Even under a worst-case scenario (assuming no new unit is sold in the next 12 months), developers may generally remain in very good shape and be far from facing any solvency problems. We expect a low default risk from contract buyers as it is not justified (unless property prices correct by more than 30% in 2012). Among the companies we cover, asset plays have the least credit issue while developers such as Huaku and Hung Poo also seem to have very good protection from locked-in profits. However, among all of them, Prince appears to have
a higher gearing due to its larger exposure to commercial property and given the slower turnover for its residential projects outside Taipei City.

Huaku, Taiwan Fertilizer and Hung Poo are our top picks Base on lower price assumptions, slower sell-through of new projects in the next 12 months and a new share base post ex-dividend, we revise down property companies’ 2012E EPS by 10-50%. We also trim our NAV forecast by 10-25% per these new assumptions. Stock prices have fallen by an average 20-25% in the past two months, which implies a very bearish scenario. Property names are still trading at a 20-57% discount to the new NAV estimates, which is not far from the trough valuations seen during the financial crisis in 2008-09. While there appears to be no catalyst present for the next quarter, we believe the risk-reward profile looks decent in a mid-to-long term perspective. With healthier balance sheets, we expect the generous payouts to continue into 2012.

We like Huaku for its high-end exposure and Taiwan Fertilizer (TF) for its diverse earnings stream from its non-property business. We, however, downgrade Prince and Chong Hong to NEUTRAL on valuations. Huaku, Taiwan Fertilizer and Hung Poo are now trading closer to their trough valuations seen during the 2008-09 financial crisis. On a regional perspective, Taiwan’s developers are at a mild premium to their Chinese peers, which we believe is justified given the lighter financial burden and risk in Taiwan (low interest rate and lighter land inventory on developers’ accounting book).

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