Excerpts from contributor's article published on NRA Capital's website

OngPangAik 9.2016Ong Pang Aik, executive chairman of Lian Beng Group. NextInsight file photoLian Beng Group Ltd recently captured attention after announcing that it plans to spin off its property development business.

Lian Beng can trace its roots to the construction business. However, the group today operates a total of six segments – a) Construction, b) Engineering & Leasing of Construction Machinery, c) Property Development, d) Investment Holding, e) Dormitory and f) Manufacturing of Concrete and Asphalt.

To be split into Construction and Property Arms. Intuitively, Construction, Engineering & Leasing of Construction Machinery and Manufacturing of Concrete and Asphalt can be housed under one entity (Construction Group) while investments in properties and property development projects, including the rental of dormitory units, can be housed under another entity (Property Group), in a clear-cut split.



Property Group holds S$1.1 billion of assets. Alternatively, the company may choose to spin-off only its property development projects and retain the investment properties and completed dormitories within the parent company.

However, we see this scenario as unlikely as the property development company may from time to time develop properties designated as investments. Administratively, it will be easier for the property development company to hold these properties on its balance sheet, than to sell them to the parent company on completion.

The inclusion of investment properties in the spin-off is significant as the group has S$711.3m of investment properties on its balance sheet as of 1Q FY18 ended 31 August 2017. We estimate that the Property Group may hold at least S$1.1 billion of assets based on the group’s balance sheet as of 1Q FY18 ended 31 August 2017.      


Balance Sheet
(
31 Aug 2017)

S$m

Investment properties

711.33

Investment in joint ventures

19.01

Investment in associates

43.86

Amounts due from associates

45.00

Development properties

185.53

Amounts due from joint ventures

66.72

Amounts due from associates

89.17

Estimated Property Group Assets

1160.61

Other assets

448.88

LB Group Assets

1609.49

LB Group bank loans

647.55

LB Group Liabilities

278.73

LB Group common equity

603.41

Minority interest

79.80

Incidentally, the FY17 pre-tax return on net assets of 10.5% works out to an after-tax amount of 8.7% after deducting for 17% tax. This also implies an appropriate fair value of around 0.87x price-to-book given an earnings yield of 10%. As of 31 August 2017, Lian Beng had a net asset value per share of S$1.2076.

We assume that the bulk of investments in joint ventures and associates are in the property business.

Based on disclosures in the FY17 annual report, the material joint ventures and associates are all in the property development, investment or dormitory businesses, leaving other joint ventures and associates with a carrying value of about S$5.6m.
 

Investment in Joint Ventures and Associates as of 31 May 2017

S$m

Description

Investment in associates as of 31 May 2017

Oxley-Lian Beng

22.97

Developer of MidTown Residences/The MidTown

Spottiswoode Development

8.91

Developer of Spottiswoode Suites

Other joint ventures

2.66

34.54

Investment in associates as of 31 May 2017

Centurion-Lian Beng (Papan)

8.49

Owns ASPRI-Westlite Papan workers' dormitory and training centre

Epic Land and its subsidiaries

10.82

Owns strata office units in Prudential Tower

Oxley Bliss

15.82

Developer of Tampines Industrial Crescent project with Oxley

Oxley Sanctuary

5.92

Developer of KAP Residences

Other associates

2.92

43.97

Source: Annual report


As of 31 August 2017, Lian Beng has S$185.5m of development properties on its balance sheet. However, many of its projects are undertaken via joint ventures and associated companies that are not consolidated on the group’s balance sheet. Some of Lian Beng’s associated development projects include KAP Residences (former King Albert Park), Floraville/Floraview/Foravista and the Gaobeidian project in China. Investments in joint ventures and associates, including amounts due from them, totaled another S$263.8m as of 31 August 2017.

Rebuilding property development pipeline. More recently, the group has started to participate more actively in the Singapore market again. In May, its joint venture company successfully bided for a 36,811.1 square metres (395,350 sq. ft.) site known as Rio Casa at 344 to 350 Hougang Avenue 7, with a potential plot ratio of 2.8x. Based on data from joint venture partner Oxley Holdings, the site has an estimated gross development value of S$1.42 billion as opposed to a purchase price of S$575m and an estimated differential premium of S$208m to renew the land lease to 99 years. This works out to a land cost of S$707 per sq. ft. per plot ratio versus an estimated average selling price of S$1,283 per sq. ft. per plot ratio.   

In July, the group also successfully tendered for a 27,583.9 square metres (296,251 sq. ft.) site known as Serangoon Ville at 128 – 134 Serangoon North Avenue 1, with a potential plot ratio of 2.8x, via a joint venture with Oxley and other partners. Based on data from Oxley, the site has an estimated GDV of S$1.28 billion versus the purchase price of S$499.0m and an estimated differential premium of S$195m. Accordingly, the land and differential premium sums to S$837 per sq. ft. per plot ratio while the joint venture expects the property to be sold at S$1,543 per sq. ft. per plot ratio.

Meanwhile, the S$699m construction order book stretches to FY2020. Meanwhile, the Construction Group has been securing contracts, such as the S$435m 36-month contract to build a high rise industrial complex at Kim Chuan Road (secured in March 2017) and the S$162m 36-month contract to build a condominium development at Martin Place (secured in September 2017). As of 15 September, the Group’s order book stands at S$699m. Split over three years, it translates to construction revenue of S$233m per annum. In FY17, the Construction segment reported revenue of only S$103.5m. Assuming an average net margin of 5%, we can expect this segment to generate net profit of S$11.65m per annum.   


Construction Segment
 

FY15

FY16

FY17

FY15 to FY17

Revenue

628.81

348.93

103.46

1081.21

Segment pre-tax profit

39.83

10.74

24.43

74.99

pre-tax margin

6.3%

3.1%

23.6%

6.9%*

*6.9% x (1 – 17% tax rate) = 5.8% eff. after tax margin. We assume 5% net margin.

 

Valuation Workings – Investment Properties

Investment Properties

FY16

FY17

Investment properties

438.53

703.86

Investment properties held for sale

0

26.28

Total

438.53

730.14

Investment properties under construction

76.54

115.50

Rental yielding investment properties

361.99

614.64

Rental Income

FY15

FY16

FY17

Gross rental income

22.79

24.34

32.08

Other operating income

0.40

0.41

0.38

Direct operating expenses

-7.10

-8.77

-14.96

Operating rental income

16.09

15.98

17.50

Margin

70.6%

65.7%

54.6%

Average gross rental yield

6.6%

Rental income of S$32.08m / Average of rental yielding properties S$361.99m and S$614.64m

Investment properties as of 31 Aug 2017

711.33

Acquisition of Wilkie Edge (50% stake of S$280m)

140

Completed in September 2017

Expected Investment properties

851.33

711.33 + 140

Expected gross rental income based on 6.6% yield

55.9

Margin

70%

FY17 rental margin could have been higher due to higher repairs and maintenance expenses with the addition of S$278.6m of investment properties in FY17

Expected operating rental income

S$39.2m

Assumed borrowings

S$595.93m

@ 70% of carrying value of properties of S$851.33m. Property Development and Investment Holding segments carry liabilities equivalent to 70% to 80% of assets.

Financing cost @ 3%

-17.88

Pre-tax rental income

21.27

S$39.2m, less S$17.88m

Taxation

-3.62

@ 17%

Net rental income

17.66

Implied fair value / equity

255.40

S$851.33m less S$595.93m.

Effective yield

6.9%

S$17.66m / S$255.40m

 

Gearing

FY15

FY16

FY17

Finance costs (including capitalised costs)

6.90

11.78

13.98

Amts due to JV

33.15

30.12

17.82

Amts due to associates

12.93

16.35

1.36

Bank loans

277.16

428.06

680.50

Hire purchase

15.78

12.58

7.00

Total debt

339.03

487.10

706.68

Average borrowing cost

2.9%

2.3%

Note: As per the FY17 annual report, borrowing costs range from 1.1% to 4.5%. We assume 3%, which is slightly higher than the effective borrowing cost in FY17 and in line with that of FY16.  

Development Property Business as of 31 August 2017

S$m

Development properties

185.53

Investment in joint ventures

19.01

Amounts due from joint ventures

66.72

Investment in associates

43.86

Amounts due from associates

45.00

Amounts due from associates

89.17

Development properties, associates and JV

449.28

Assumed gearing @ 50%

-224.64

Equity

224.64

10% discount (no development profit factored in)

-22.46

Deemed fair value of development properties and associates and JVs

S$202.18

 

Sum-of-Parts Valuation

Sum of parts

Valuation 

Remarks

Investment properties

S$255.40m

Development properties, associates and JV

S$202.18m

At 10% discount from book value as of 31 August 2017, assuming 50% gearing

Construction

S$81.55m

Net profit of S$11.65m per annum x 7 times P/E. Group currently trades at 7.1x trailing 12m P/E. 

Engineering and leasing 

S$0m

Immaterial profitability in FY17

Manufacturing of concrete and asphalt

S$0m

Loss making in FY17

Total

S$539.12m

Works back to 10.9x trailing 12 month P/E.

Number of shares

499.69m

Fair value per share

S$1.08

53% upside from current share price of S$0.705

Book value per share

S$1.2076

Discount from book value

11.6%

Potential fair value of S$1.08 per share or 53% upside. Currently, Lian Beng trades at just 7.1x trailing 12-month P/E. We reckon that the low P/E multiple is partially due to the Group’s heavy balance sheet, comprising of mainly investment properties, and losses from the Manufacturing of Concrete and Asphalt.

The spin-off of the property business (and implementation of a dividend policy that pays out the rental income to shareholders) may trigger a re-rating to S$1.08 as shown in our workings.

In lieu of a conglomerate discount, we have assigned zero value to the less profitable Engineering & Leasing and Concrete & Asphalt segments. Ultimately, our fair value per share still reflects a 11.6% discount to the book value per share of S$1.2076.

[Click here for the full article contributed by Mr. Tay Eng How, a former journalist with the Singapore Press Holdings. While NRA Capital has edited and provided inputs to the article, the above views belong to the contributing writer and should not be construed as an investment recommendation.]


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