SC Asset Corporation

SC Asset Corporation Plc (SC)

Action and recommendation

We initiate coverage on SC with an Outperform rating. Our 2013 fair value based on a DCF methodology of B25.0 offers an attractive 39% upside gain from the latest closing price. Given SC’s proven historical record of growth, its clear development plan and the strong recent increase in its backlog, we believe that its growth prospects are robust. A re-rating story should be seen once it delivers on our expectations.

Key Investment Points

Solid growth prospects mainly driven by condominiums: We expect SC to deliver 2012-2014 earnings growth of 6%, 34% and 40%, respectively. In addition to a steady increase in low-rise revenue, a big jump in revenue from condominium products will drive its earnings. Also, an expansion of its development area and the addition of new market segments should support our projections.

Right development strategy boosts pre-sales and backlog: Like other large developers, SC has implemented a business expansion by entering new locations and product segments. Moreover, it has resumed its exposure to the condominium market in late 2010 after freezing new launches for 1.5 years. Thanks to the clear selling points of its products, its pre-sales and backlog continue to rise. SC’s current backlog has climbed to Bt8.3bn, 1.2x its 2012 sales revenue target, from just Bt3.0bn at the end of 2011. The growth opportunities are thus very clear.

Entering an accelerating stage of growth, pre-cast technology is next: To support its huge revenue growth target in 2013 (Bt10.0bn from Bt8.0bn in 2012), SC will utilize pre-cast technology for its new medium-to-low-end projects. The company will not build a pre-cast factory itself but will find strategic partners to reduce the risks associated with the change. Construction will be divided into two phases totaling Bt450mn (Bt150mn for the first phase) with a start date in 2013. While the cost-reduction benefits are small, the construction period for TH projects will be shortened to 3-4 months from 6 months. Vista Park Rama 2 will be the pilot project for the adoption of this technology.

Sizable recurring income provides a good cushion: Apart from the great outlook for its housing business, SC generates a sizable recurring income from its rental business. Five office buildings with a total rental space of ~107,000 sq.m. and two plots of land as well as 111 land sites and technical buildings for rent have provided a solid source of cash flow and income to SC. Over the past five years, this business has accounted for 26.7% of SC’s core profit, or an average of Bt509mn per annum.

Re-rating story highly likely: SC’s robust growth potential, comparable business model and similar recent performance to other large developers will support a re-rating of the stock to bring its valuation in line with those of its peers.

Attractive valuation: SC is trading at a 2013 PER of just 7.8x and 2013 PBV of 1.1x.
These ratios are clearly below the averages of other large developers at 10.2x and 1.9x, respectively. In addition, stripping out its recurring income assets with a 20% discount on its value, its residential business is trading on a 2013 PER of just 6.8x.
Price catalysts:

Strong pickup in pre-sales in 2H12, on a number of new projects launched in the period (Bt12.8bn), which are worth more than its entire project value in 2011 (Bt11.6bn).
 

Robust revenue and earnings growth in 4Q12 due to three new condominium projects scheduled to start rights transfers in the period.

Solid business performance and status
Sales revenue has continued to increase since IPO in 2003
SC is one of only a few residential companies that have been able to deliver sales revenue growth every year since its IPO in 2003, with the exception of 2005 due to its low initial base (Figure 1). This is in line with its original mission to build stable long-term growth for shareholders. It has achieved this despite encountering two extremely challenging periods, the 2008 Hamburger crisis and the 2011 floods. We attribute this solid performance to its well-managed new launch strategy, which has allowed pre-sales to increase gradually every year. Its low-rise pre-build strategy has been a key factor behind this success (Figure 2). In addition to smooth pre-sales, its balance sheet has been carefully controlled. Even though the strategy has raised concerns among some investors that its expansion has been overly conservative during a period of surging demand, since new launches were frozen for some years (Figure 3), its great performance over the past 9 years shows it has followed a prudent path.

New market segments and products support upward direction of pre-sales
Starting with only two brands in 2003 -- Bangkok Boulevard for SDHs and Baan Chalisa for THs -- plus one condominium brand, Centric, which was introduced in 2005, SC now has many more brands (Fig. 4) designed to capture a wider range of homebuyers. In 2H12, it will launch a new brand for SDHs and condominiums while at least one more brand for THs will be added next year. In our view, the larger target market and the fact that SC will gradually expand its coverage to new areas will clearly support its growth prospects. Currently, SC has one condominium project in Hua Hin and plans to add one more in Pattaya as well as a SDH project in Cha-am in 2013. However, the company will still focus on medium-to-high-end segments in the Bangkok Metropolitan Area (BMA) while its target revenue share between low-rise housing and condominiums will be 70:30.

Solid recurring income
In addition to a great improvement in its housing for sales business, SC enjoys a sizable and concrete income from a rental business. This not only helps support fixed administrative expenses but also accounts for a big chunk of SC’s valuation (explained later). Three office buildings (SHIN Tower I, II and III) and 111 land sites for mobile switching and a maintenance center for rent (to ADVANCE) are major contributors to this group of assets. While the new accounting standards for investment property, gross margin and net margin from this type of revenue are high at 65% and 50%, respectively, since there are no depreciation items, fair value adjustment (using an income approach), both positive and negative, is realized in the P&L every 2Q and 4Q. Based on this assumption, SC will have approximately Bt400mn of profit and cash flow from its rental interests to support its fixed expenses, which stood at Bt653mn in 2011 and are likely to increase to Bt753mn in 2012. Moreover, the business has accounted for nearly 40% of SC’s net profit over the past few years. This is despite the robust expansion of housing sales revenue, which would have boosted its fixed costs and reduced the revenue portion from this business to total revenue. Note that SC has no plans to make a huge investment in this kind of property in the near future as it is focusing on its housing for sales business.

Outlook is very bright – Entering an accelerating stage
Condominiums are the key earnings driver
We believe that SC is entering a new phase of accelerating growth, particularly from 2013 as many condominium projects launched since late 2010 will start the rights transfer process from 4Q12. Note that SC froze new launches of condominium products for 1.5 years after developing a few projects in the early years, which resulted in a drop in condominium revenue in 2011, as shown in Figure 1.
Thanks to the recent success of several new condominium projects, SC’s backlog at the end of 3Q12 surged to about Bt8.3bn, up dramatically from Bt3.0bn at the end of 2011. Of the latest backlog figure, 93% came from condominium products (Figure 7). This amount will act as a revenue base for SC until 2015. The biggest portion will be realized in 2014 (Figure 8). Based on the schedule for rights transfers shown in Figure 9 below, we expect revenue and earnings growth will jump sharply in 2014.

Big launch of low-rise projects to boost low-rise revenue further
While we expect the surge in condominium products to be the main driver of growth, low-rise housing will remain a key source of income. Growth of low-rise products, despite showing only a gradual improvement both in terms of pre-sales and revenue for many years (SC has adopted a pre-build strategy for its low-rise projects so they are transferred a quarter after pre-sales, which means its backlog from this product category is normally low), it should rise on the planned larger project value launched (Figure 10). Normally, SC sets its development period for each project at about 2 years to reduce project risk and frequently launches new house products in every new project to add more value to customers. Moreover, the introduction of a pre-cast construction technology will accelerate the development speed of the low-rise business, boosting its ability to grow.

Industry outlook
Favorable situation for housing market
Housing demand is generally accepted to be directly tied the macroeconomic situation. It has a high positive correlation to GDP and a negative correlation to interest rates. Given the favorable current macro economy in Thailand (2012 and 2013 GDP is expected by KResearch to grow by 5% in both years) as well as the current low interest-rate climate worldwide due to the economic crisis in Europe, we expect robust growth in housing demand in 2012-2013. Moreover, the pent-up demand due to the floods in 2011 should further drive demand in 2012.
During 9M12, the monthly average take-up rate (for the first month of launches only) rose to 34% of total sales vs 21% for the same period last year, thanks to the robust demand for condominiums. This is although the number of new launched units during the period was down 4% YoY to 69,662 units with a total value of Bt194bn, down 12% YoY (Figure 11), according to data from AREA. Clearly, condominiums lead the way with a market share of 64%, followed by 18% for THs, 12% for SDHs and the rest for “others”. In addition to the strong macro picture, the likelihood that house prices should jump dramatically in 2012 to 2013 due to the big increase in housing development costs caused by the much higher minimum wage and land price appreciation from the expansion of mass transit routes, will prompt many homebuyers to rush their buying transactions.
Big players still gaining market share
Despite a lower overall new launch value during 9M11, pre-sales at the 8 leading listed housing developers (AP, LH, LPN, PS, QH, SC, SIRI and SPALI) rose strongly by 16.5% YoY to about Bt125bn (Figure 12). This clearly shows the strong market share expansion by the major players in the market. Note that during 9M12, all listed developers accounted for 74.4% of total new unit launches in Bangkok and its vicinities. We attribute this strong growth to the development strategies they have adopted over the past few years on the extension of their market targets to new locations, new products and new segments. Clearly the success of the strategy has been supported by their stronger financial positions and brands than the smaller developers as well as the healthy demand for condominium products.

Going to pre-cast technology
We see advanced construction technology such as pre-cast and tunnel system techniques gradually being adopted by all the big developers. The shorter time needed for construction than for conventional techniques and the lower dependence on labor will be key factors underpinning the popularity of these methods while costs are comparable to the conventional techniques. This technology offers a way out for all developers to deal with the rising minimum wage and the labor shortage problem. The great success enjoyed by PS, which was the first to implement this strategy, has been a good reference for the others. In addition to PS, SIRI has completed construction of its own pre-cast concrete plant. AP, LH, LPN, QH and SC are also moving to deploy these construction techniques.

Financial position moving in line with business plan
Due to its conservative development strategy, SC’s D/E ratio from 2003 to 2011 was very healthy at a level below 1.0x (Figure 14). This is despite its sizable portfolio of investment properties (office buildings and land for rent) on its balance sheet. However, as it has now entered an aggressive growth mode, with a focus on condominium projects, we see its D/E ratio rising in the early years of this new cycle. This is because it has to build up a large amount of inventory while it won’t receive the cash for about 2 years when it can begin rights transfers. We have no worries about this kind of situation if those condominium projects attract a strong response from homebuyers. Normally, breakeven for a condominium project requires a pre-sales rate of 65%. Many large listed developers such as AP and SPALI are used to dealing with such a situation. Once the development cycle is completed, its D/E ratio should return to a normal level (below 1.0x). Note that we expect SC’s D/E ratio will peak in 2013 at 1.48x, still below its internal policy rate of 1.5x.
Recent success & future prospects are better than those of other big developers
Not only has it demonstrated a proven record of revenue and earnings expansion over most of the past 10 years, but SC’s development is unmatched by other large developers. Compared to the average revenue and earnings growth of the 7 major residential developers, SC has showed better growth in both the short term (2007-2011) and long term (2003-2011), as illustrated in Figures 15-16. In addition to the past success, we see SC continuing to show faster growth than its peers over the next three years (2011-2014). This is despite the stronger growth being accompanied by the expansion of its D/E ratio, as mentioned earlier.

3Q12 preview – still not exciting but big jump seen in 4Q12
We expect SC to report 3Q12 earnings of Bt188mn, down 36% YoY but up 6% QoQ. While its GPM should rise strongly on a YoY basis, a sharp drop in revenue due to the lack of a contribution from condominiums and SDH will cause the YoY drop. Meanwhile, moderate growth of sales revenue caused by better pre-sales at its low-rise housing in 3Q12 against 2Q12 should support the QoQ growth. Note that SC added about Bt4.5bn of pre-sales in 3Q12 (Bt1.5bn of low-rise and Bt3.0bn of condominiums) from Bt1.9bn in 2Q12 (Bt1.0bn of low-rise and Bt0.9bn for condominiums). 9M12 earnings thus will account for just 48% of our full-year forecast. As a result, 3Q12 earnings will be unexciting, in our view. However, the robust earnings growth in 4Q12, which we expect will reach an all-time high for quarterly earnings, should be a strong share price catalyst during the results announcement period (expected in Feb 2013). Our view is based on expectations that SC will start rights transfers of three big condominium projects in the period (Figure 3).

Valuation

Comparable business model to create re-rating story
We initiate coverage of SC with a DCF-based 2013 fair value of Bt25.0, equivalent to a 2013 PER of 10.8x. Our key assumptions are a WACC of 7.9%, beta of 1.0 and a terminal growth rate of 3%. Despite trading at levels much higher than its historical 5-year mean of 6.0x for PER and 0.71x for PBV, we believe this valuation is justified by the dramatic increase in its earnings prospect as based on our current estimates, our 2013 fair value of Bt25.0 is equivalent to a 2014 PER of just 7.7x and 2014 PBV of 1.30x. Moreover, after stripping out the value of its investment property, its residential business alone is trading on a 2013 PER of just 5.8x or 6.8x with a 20% discount on its value.
In addition, comparing SC’s recent development with other developers, we see a re-rating story for the stock. The average daily trading value of SC has stood just slightly below that of its peers and its market capitalization has risen continuously to above Bt10.0bn, although this is still the lowest compared to other large developers. The ticker point for the startup of a re-rating period, in our view, is the time its total revenue surpasses Bt10.0bn, which is likely to be happen in 2013 (its tenth anniversary) so this is a good time to start accumulating the stock.
Other valuation indicators show that market has not yet fully factored in SC’s great recent developments and future prospects since the stock is still trading at a level below its peers while its share price performance YTD is on par with the others. The valuation factors in Figures 29-30, showing EPS growth & PER and ROE & PBV, offer a clear explanation for the under value trade of SC. Note that currently SC is classified as a stock in the SET 100 and SET HD as well as being on MSCI Global Small Caps list. Given the attractive upside potential from the latest closing price to our fair value of 39% plus a dividend yield of 4-5%, we initiate our coverage with an Outperform rating.

Rising D/E ratio over the expansion phase will be kept under control
A gradual increase in its debt over the expansion phase (in condominiums) will clearly lift SC’s D/E ratio, as explained earlier. However, based on its proven solid internal controls, we believe SC can keep the ratio under its covenant of 1.5x. A slowdown in land acquisition will be another way to reduce this kind of risk. Currently, the land needed for planned launches in 2013 has been fully acquired. Moreover, asset divestment, despite the very low potential it will be implemented, could raise as much as Bt5.0bn of cash for SC, which is more than enough to support its current expansion plan over the next few years. In addition, the adoption of pre-cast construction technology should boost its ability to turn its cash flow.

Labor shortage will be compensated by advanced construction technology
The current labor squeeze is another key risk factor for all developers. Not only is demand coming from the housing market but there is a number of government projects under construction as well as more in the pipeline that will raise demand for unskilled and skilled labor. However, a dramatic increase in the minimum wage nationwide to be completed in 2012 will accelerate the inflow of labor from neighboring countries. Moreover, as SC focuses on the medium-to-high-end market, it has an advantage over other developers in hiring at higher rates for some basis construction tasks such as for house structures. In addition, advanced construction techniques will dramatically help reduce this kind of risk over the long run.  

Flood concern apply less to SC
Flooding is another big concern for all low-rise housing developers with projects in the ring road area, including SC. However, based on the great success it had in dealing with the flood crisis last year with not a single house at its projects suffering from water damage, thanks to its effective flood protection team and the fact that most of its projects are located on main roads, SC has gained trust from potential homebuyers. Moreover, it has adopted more effective flood protection tools at every project under development such as bridges and water systems and higher landfill levels.