Cheamer By the dozen
THE KL Property Index (KLPI), which is basically a market capitalization index of all Bursa Malaysia listed property companies, recently hit a low of 765 pts.
Since hitting an all-time high of 1,524 pts in August of 2014, the KLPI has dropped an astonishing close to 50% of its value to its current level. In fact, the KLPI is now hovering at its lowest point since May of 2010 and clearly has emerged as one of the worse performing sectors in recent times. Why is the sector in the doldrum? Are property companies suffering from the overhang and unsold properties? Have the dynamics of market changed so much or are people simply not interested in property stocks anymore, no matter how cheap they are?
Year-to-date, the KLPI is down 12.4% and of course some individual stocks are clear under-performers and chief among them are the large capitalized stocks like S P Setia, Eco World Development Group (EW) and IOI Properties Group (IOIPG), which are down 43.3%, 28.6% and 26.6% as at Oct 10.
There are some 97 constituents in the KLPI and out of this, 14 companies can be deemed to be large property companies with market capitalization in excess of Rm1bil each.
Today, Malaysia’s largest property company by market IOIPG with total market capitalisation of Rm6.22bil while the largest company by total enterprise value (EV), i.e. net debt plus equity, is also IOIPG at almost Rm16bil.
Out of these 14 large market capitalisation companies, with the exception of YNH Property, 13 are trading below their respective net asset value (NAV) and hence they are deemed to be more attractive in the current market environment. In addition, UOA Development is also not part of this analysis as it is a net cash company, despite trading at about 0.75x price to book (P/B) value.
From here, analysing the balance 12 companies, we observed that debt has now become an integral part of property companies today to the extent that net gearing (total debt less cash divided by shareholders funds) among these large companies today is at about 46.1% on average. The 12 companies have net gearing ranging from as low as 16.5% for Mah Sing Group (MSGB) to as high as 88.1% for IGB.
As debt has become prominent among property companies, the EV among property companies today is significantly represented by debt, and this among the 12 companies ranged between as low as 23.4% for MSGB and as high as 63.3% for EW. In actual fact, net debt today represents almost 50% of EV of these 12 companies.
With the KLPI down to the level it is today, the 12 property companies that trade below their respective NAVS have a range of P/B from a low of 0.33x for IOIPG to as high as 0.73x for Eco World International.
We can observe that there is a mild correlation between net gearing level and how market perceives a property company.
Chart 1 shows that in general, as net gearing rises, market’s valuation of a property company as measured by the P/B valuation matrix deteriorates, which explains that market in general does not like companies taking on added debt as it burdens a company’s financials to the extent a company’s operating profits are eaten up by expenses related to debt services.
Why are property companies increasingly in debt? The obvious answer is that the property market cycle is indeed not in favour of the developers and we are also seeing some of them holding large amount of inventory in the form of completed units that remained unsold.
The business of a property developer is simple. Unless the landbank of a property developer has been with the company for ages, most property developers do landbanking activities first to have the required capacity to develop and to remain in business. Hence, most of them, unless if they are cash rich or have been holding their respective landbank for a considerable period of time, carry out landbanking activities, and typically between 50-70% is financed with bank borrowings.
Having done the required planning, feasibility studies and approval, the developers will then launch their project to the market. Not long ago, whenever there are property launches, we will see investors and buyers making a beeline to book their next purchase and within hours or days, the project launch is fully sold out. Those were the days when the property market was just three words - buy, buy and buy.
These days, a property launch event is hardly a talked-about event and developers have to go to great lengths to attract buyers to their launch parties, let alone to close a sale. Worse, even after a launch, very rarely do we see or hear developers achieving 100% sale.
With the introduction of credit cards, some of the easy credit risks have been transferred to banks. Retail outlets have to pay their suppliers on shorter credit terms. White goods suppliers and their chain stores sell direct to consumers on credit card installment plans.
Chain stores are better managed financially nowadays, traditional wholesalers and independent grocery stores have diminished in numbers and importance, and overall credit risks in the retail supply chain have reduced, leading to a healthier retail industry, going forward.
With the online shopping disruption underway, supermarket chain stores all over the world have to speed up internal transformation to meet new challenges. Malaysian retailers and supply chain players should study supply chain format transformation practices of advanced countries, as they have a much longer history.
John James Sainsbury and his wife Mary Ann opened a grocery store in Drury Lane, Holborn, in 1869.
A grand 150 years later, Sainsbury’s has a 16.9% market share of Britain’s grocery retail market. Besides the chain of supermarkets and convenience stores selling groceries and fresh food, Sainsbury’s sells petrol at its gas stations normally situated next to its supermarkets. Sainsbury’s Argos sells general merchandise through a hybrid model of online and offline/high street stores.
My eldest son, who has lived in the UK for six years while pursuing his education, describes his experience with Argos and Sainsbury’s - if he needed general merchandise urgently, he would walk into an Argos high street store, place the order via the computer terminal placed at the shopfront and the staff would then pick up his order and hand it to him over the counter. As an Amazon Prime member, he can order online from Amazon for next-day delivery. He can also check online and compare prices of the same merchandise in both market places.
When in Cambridge, he would buy his groceries and toiletry supplies from the Sainsbury’s mini market, located just across the street from his college dorm at Sidney Sussex. When in London’s Kensington High Street, he would walk across the street to either Sainsbury’s or Tesco Express. Shopping online or offline is all about convenience and lower prices to the Millennials.
Such shopping demands from the Millennials weigh heavily on Mike Coupe’s mind. As the CEO of Sainsbury’s, he has to constantly drive his team to improve his supply chain in terms of sourcing, quality and lower prices.
He has to continuously tweak his store estates in terms of size and location, being mindful that the cost of last-mile delivery to customers is manageable without sacrificing the convenience and service quality required by his discerning customers.
To compete with the online grocery competition, Sainsbury’s now has to sell online while at the same time delivering to homes. Home delivery of groceries is not profitable, as it does not make economic sense due to small-sized purchases and poor routing efficiencies. The tipping point for cost-efficient home delivery will be when Sainsbury’s can fully fill up the truck with orders before it leaves its warehouse/supermarket. Still a long way to go.
To help Coupe and his team of buyers understand customer habits and preferences, Sainsbury’s employs 800 data analysts to crunch customer purchase data through loyalty cards and debit/credit card purchases. Besides the basic analysis of sales numbers, sophisticated software can help reveal minute details like the peak sales time for sandwiches by location, the delivery time of fresh sandwiches, the type of sandwiches needed, and the purchase patterns of these sandwiches.
With AI, you can actually predict consumer demand and stock the right kind of sandwiches by store, time and location. Real-time information can be given to sandwich suppliers the night before as they start to prepare the orders by store throughout the night, assuming deliveries start from 6am the next morning. Centralised orders are written by computer softwares based on previous days’ sales figures, so no manual instructions need to be given. Shelf space is allocated by space management software based on a predicted sales volume for each individual store for the day. This is the future of efficient store operations.
With AI, Sainsbury’s will understand each individual customer’s purchase pattern, frequency and type of products purchased. AI can help predict when this individual customer will buy a particular product and at what price.
This information will help buyers plan strategically in terms of product stocking and maximising margins due to the criteria of availability and not product price.
As for Argos, I was curious as to how it competes with Amazon with its high cost of managing high street stores. Surprisingly, 40% of Argos sales come from walk-in customers. The stores actually act as a fulfillment centre, where walk-in customers can purchase immediately, or for those who order online, pick up the items at the nearest store when there is no one at home to accept online deliveries.
With AI, Argos can expand its product range, as it will help predict the right mix of merchandise to be made available at its fulfillment centres. Stores that have fewer walk-in customers can be closed down, as the fulfillment can be done by online deliveries. Some Argos stores have been moved to Sainsbury’s supermarkets for efficient space utilisation and cost-savings. From a catalogue sales company, Argos has morphed into an efficient and profitable general merchandise retailer hybrid - online and offline. To remain relevant and sustainable, Argos will continuously transform its distribution channel to fulfill changing consumer needs.
In 2018/19, Sainsbury PLC achieved annual sales of £29bil and an operating profit of £518mil. As the CEO, Coupe’s annual salary was £3.9mil. His annual salary requires approval from shareholders in their annual AGM. Being a transparent PLC, the board of directors and the CEO are open to public scrutiny. When asked about his role and responsibility, Coupe told me that he is in a position of stewardship in Sainsbury, planning for the long-term sustainability of its retail business model and preserving shareholder value in this iconic company.
Biased as I may sound, “Honest” Mike is the consummate retailer who has morphed into an elegant corporate leader in the UK. Friendship will be put aside the next time we meet to discuss the supplier and retailer relationship. I might have lost the war but I intend to win a few battles yet. It is personal.
The views expressed here are the writer’s own.