City Dev upgrade to Buy

City Dev is the Singapore residential bellwether, and has the best leverage to volume recovery. In the current environment, we favor well capitalized residential developers with large land banks. Although the stock has risen considerably off its deep trough valuations earlier this year, we think that if transaction volumes can be sustained and we are indeed in the early stages of a gradual recovery, there is still substantial re-rating potential given stock still trades below mean P/B and slightly above its minus 1SD P/B range. Given City Dev’s large Singapore land bank, NAVs are sensitive to residential price changes. On our estimates, every 10% rise in residential prices increases NAV by 6%.

Since adding the stock to our Sell list on July 28, 2008, City Dev’s share price has fallen 26% vs. a 23% drop for the STI over the same time (12-month performance: -28% vs. -29%). City Dev was subsequently added to our Conviction Sell list on August 29, 2008 and removed on February 12, 2009, during which time the share price fell 47% vs. a 37% drop for the STI. We note that underperformance vs. the STI during both periods came amid an increasingly difficult operating environment for residential developers and negative headwinds for Millennium & Copthorne’s global hotel business. We believe that the risk/reward trade-off in the residential market has improved, justifying our upgrade to Buy.

We set our 12-month target price of S$10.0 at a 10% discount to our reset end-2010E NAV vs. a 30% discount previously as we think the residential sector is likely to lead the recovery. The key risk to our target price is the potentially negative news flow from City Dev’s S$1.69bn South Beach project which its Middle Eastern partners, El-Ad group and Istithmar, reportedly want to exit. We estimate that should City Dev acquire their stakes at a 25% discount, the all-in cost would raise the company’s gearing to 62% from 49% currently, which is not excessive in our view.

On its 1Q09 results, City Dev posted net profits of S$83m, down from S$165mn a year ago, mainly due to weaker contributions from property development and hotels. Results came in below expectations, registering 21% of full-year estimates (GS estimates are at the low end of consensus). The 1Q09 miss aside, the tone of the results was positive on the residential space, with the group announcing it would “fast track” its mass market project at the former Hong Leong Gardens condominium for launch in 4Q09. The results however continued to cast a shadow over the commercial space, in line with our more cautious tone for that segment, with office occupancy down to 91% compared to 94% as at the end of 2008.

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