Even though CapitaLand (OTCPK:CLLDY) (CATL.SI) has established a reputation for itself as a quality property developer in Singapore and China, investors seem to be more scared of the near-term risks in Singapore and China than attracted to the long-term potential. Trading well below its average and median price/book and price/RNAV ratios, investors seem to be incorporating pretty pessimistic expectations for the business both in 2014 and beyond. Readers considering these shares today need to appreciate the risks of swimming against the tide, but patience could pay off given the company's leverage to China's growth and management's commitment to streamline and improve operations.
Focused On Two Principal Markets
CapitaLand has developed properties and held investments around the world, but the company is principally focused on property development in Singapore and China. The asset split at the end of 2013 was 45% China and 38% Singapore, while the EBIT split was a little more balanced (41% China and 47% Singapore).
CapitaLand pursues a balanced approach in both China and Singapore. China's asset mix is divided between residential (34%), retail (32%), and commercial/mixed development (27%), and CapitaLand has been quite successful with complex integrated development projects in China that command higher values. The company has focused on six primary city clusters in China and has a residential development pipeline that should extend for four or five years without further additions.
The mix in Singapore is similar but a little more retail-heavy, with 32% of assets in residential, 42% in retail, and 18% in commercial/mixed developments. While CapitaLand is positioned for growth in China, the company has taken a more conservative stance in Singapore in response to what increasingly looks like an over-supplied market. Management expects residential prices to fall around 10% in 2014 and has positioned itself so that its unsold residential inventory in Singapore is only around 10% of the asset base.
Commercial Operations Aren't A Throw-In
A lot of attention is paid to pace of residential units sold and the price paid in China and Singapore. I don't want to suggest that it is unimportant for CapitaLand (nor for rival developer Keppel Land (OTCPK:KPPLY)), but I wouldn't ignore the company's commercial and retail operations.
Occupancy in CapitaLand's Singapore office holdings is close to 99% and rents have been trending up for the past 18 months. CapitaLand also still holds roughly two-thirds of CapitaMalls Asia (OTC:CLPAY), one of the largest retail property developers in Asia. About 75% of CapitaMalls' value comes from malls already in operation. Three-quarters of CapitaMalls' operating malls are in China, but the company is looking to markets like Malaysia and India as future drivers of growth as well as ongoing expansion in China. Even in a year where consumer spending in China worsened notably, shopper traffic still rose more than 2% in CMA's Chinese malls (up slightly more in Singapore) and occupancy rates across the portfolio are in the high 90%s.
Looking ahead, I think there are reasons to expect ongoing growth from CapitaLand's Chinese development prospects. The company's Raffles City projects are large mixed-use developments that combine office, retail, and residential (in some projects) in attractive locations with a high-end client base. These projects are on the high end of the complexity spectrum, but successful execution improves the company's premium branding capabilities.
Streamline, Reinvest, And Improve
CapitaLand management is looking to improve its return on equity from the low single digits (on an operating basis) to a range of 8% to 12%. Improving margins (through that premium branding) is an important part of the plan, as is improving asset turns by accelerating residential launches and streamlining its asset base.
To that latter point, CapitaLand recently sold its remaining stake in Australand for nearly S$1 billion, and intends to redeploy the proceeds into Singapore and China. I would look for the company to continue building up its residential and commercial/retail pipeline in China, but also to start thinking about replenishing its land bank in Singapore. If worries about the residential market in Singapore come to fruition (prices decline by double-digits), there should be good opportunities to refill the development pipeline, but there could be some investor frustration on the timing of these investments (I expect management will wait for the opportunities to fall to them).
Management also does not appear to be in a hurry to build up its asset base in "developing Asia", including markets like Vietnam, Indonesia, and Malaysia. Given the opportunities and returns available in China, that seems like the better move today but I would look for the company to be opportunistic in these markets in a few years.
Good Value, But It Will Take Time To Realize
Modeling CapitaLand's cash flow, it looks like there's substantial potential value here. I calculate a net asset value of $6.25 per ADR, with roughly one-third of the value coming from CMA. CapitaLand China is close to 40% of the value of these shares, and CapitaLand Singapore is the bulk of the remainder. As a side note, the company's recent sale of that Australand stake was pretty much in spot on with most analysts' estimated NAV, but that does not seem to have reassured the market regarding the rest of the estimated NAV to the enterprise.
In addition to the cash flow-based NAV calculations, I decided to put the company through an excess returns model just to see what would happen. If the company hits the low end of management's long-term ROE guidance (8%), I get a fair value of $4.35 which is basically today's price. If I go to the high end, I come up with $7.50 per ADR in fair value.
The Bottom Line
In terms of near-term risk/reward, CMA/CLPAY is probably more attractive than the parent company, but that's a different article. I do believe that CapitaLand is significantly undervalued today, but I can't ignore that the shares could fall another 40% before hitting the prior record low for price/book value. Buying CapitaLand today certainly seems like a contrarian move given sentiment about the Singapore and Chinese property markets, but I find the underlying value to be pretty appealing at these levels.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.