Seeking Alpha

CapitaLand May Finally Be Breaking Out On A Clearer Path To Strong, Sustainable ROEs

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About: CapitaLand Limited (CLLDY)
by: Stephen Simpson, CFA
Stephen Simpson, CFA
Long only, growth at reasonable price, value, research analyst
Summary

CapitaLand management has gone to some lengths to highlight how it is much more than a property developer, though property development does remain a part of the core focus.

Development will be focused on the mature Singapore market, new growth opportunities outside residential/commercial in China, and emerging markets like India and Vietnam.

Management is looking to improve ROE, as well as earnings sustainability and predictability, by growing fund management and serviced residences.

CapitaLand looks at least 15% undervalued today in addition to its 3%-plus dividend yield.

I’ve long lamented that no matter what CapitaLand (OTCPK:CLLDY) (CATL.SI) did, it just couldn’t seem to break out above S$4/share. That seems to be changing, though, as investors have not only gotten more bullish on the near-term prospects for Singapore’s property market, but also management’s commitment and ability to drive long-term ROEs toward the double-digits (including gains and revaluations).

I’ve been bullish on CapitaLand for a while, and I still am. With demonstrated successes in Singapore and China to build on, and significant growth opportunities in India, Vietnam, fund management, and managed residences, I believe CapitaLand is well on its way with a plan that will deliver better returns for investors. I believe fair value is at least another 15% higher from here, with upside beyond that if management execution can shrink the risk premium in the shares.

Singapore Looking A Little Better

Given its globally diverse operations, CapitaLand really isn’t the best way to play the Singapore property market – for that you might want to look at a name like City Developments (OTCPK:CDEVY). Still, the company has about one-third of its assets under management in Singapore, and this remains a core part of the company’s long-term development business.

Based both on recent development announcements and management’s strategy discussion at its December investor day, I don’t expect CapitaLand to be a big player in buying up more property to build its land bank. Instead, the company is going to look to turnover its existing investment portfolio for redevelopment, with projects like Liang Court and Science Park I. Of course, it should be kept in mind that the acquisition of Ascendas certainly expanded its holdings in Singapore, so it’s not really accurate to say they haven’t acquired more property.

As far as the core market, the Singapore residential market looks a little better now than it did for most of 2019. Low office supply could create some opportunities in the commercial portfolio, but I’d also point to a slight slowdown in growth within the mall portfolio, with same-mall growth slowing from 3% in the first half of 2019 to 2% in the third quarter.

China Almost Seems Overlooked

Between seemingly open-ended growth opportunities in India and Vietnam and the lower-growth but more certain returns in Singapore, it sometimes feels like China is an afterthought to at least some of the analysts who cover CapitaLand. With over 40% of the company’s AUM, it’s anything but for the company on an operating basis.

Management is basically done with its Raffles City projects, and I don’t expect to see more grand projects on that scale. That’s not to say that the company is done with residential development, but it’s changing its focus a bit. At the same time, the company is looking to leverage the property and expertise acquired with Ascendas to increase its focus on business parks in China; with local authorities keenly interested in driving job growth, this could create some attractive development opportunities for CapitaLand over the next few years, and business parks have the added benefit of shorter development timelines and faster capital recycling.

Going For Growth

CapitaLand has several drivers in place that should contribute to meaningful earnings and cash flow growth in the coming years.

Increased property development in India and Vietnam is certainly part of that. Management believes they have first-mover advantage in Vietnam, and while I’m not sure it’s entirely true (it may be for foreign developers), the opportunity is nevertheless large and this is the one market where management is actively exploring the acquisition of larger land banks to support a growing residential development opportunity.

In India management is focusing more on new opportunities in logistics and warehouse, but is also open to the mixed-use projects that worked so well in China. One note of caution here – while Ascendas significantly expanded the company’s asset base in India, CapitaLand’s prior efforts in India really didn’t work out well. Hopefully management has learned from prior mistakes (and/or will leverage the talent base it brought in with Ascendas), but this remains a “show me” story from my perspective.

Other growth opportunities revolve around doing more of what CapitaLand is already good at. Management claims they’re now the 9th-largest asset management firm in their sector, and they’re looking to increase AUM from S$72 billion (external) to S$100B by 2024, with management fees growing to 10% of overall company profits. In the serviced residence business (Ascott), management wants to increase keys under management from 112K to 160K by 2023.

The Outlook

CapitaLand management has gone to some length to emphasize how the business has changed – namely, that development is less than 20% of EBIT now and management is focused on significant growth in fee-based businesses (like fund management) and recurrent revenue businesses like serviced residences. Not only should a greater mix of higher-margin businesses boost ROE, it should reduce the risk premium when it comes to valuation. That’s particularly true provided management stays on track with its leverage reduction targets (management is targeting a 0.64x gearing ratio by the end of 2020).

I expect mid-single-digit core adjusted earnings growth from CapitaLand across the next decade. My modeling assumptions work out to a long-term ROE on the low end of management’s target range (below 10%), but I do believe 10%-plus ROEs are attainable. I’d also note that every half-point of long-term ROE improvement translates into around S$0.25/share of added fair value (around $0.35/ADR).

The Bottom Line

CapitaLand’s ADRs are not particularly liquid and buying the shares in Singapore may be more hassle than some readers want to go through. For those who are willing to go to the trouble, though, I think there is at least 15% upside from here over the next year or two (in addition to the 3%-plus dividend yield), and more upside beyond that over the long term. CapitaLand is one of the best-run real estate companies I know, and it is still valued too much like a risky developer as opposed to the more balanced, profitable business it actually has. I certainly can’t promise that the shares will at long last break out of their long-term trading range, but it looks like there’s more positive attention on this name than there has been for a while.

Disclosure: I/we 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.

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