Thursday, August 3, 2017

Guest Post by CK - Accounting For Development Properties Using Bukit Sembawang As Case Study

One of the many favoured investment options is to buy properties for capital gains and rent it to receive passive rental income. Such properties are classified as developed or development properties in the balance sheet of the Company. Put it simply, these properties are built to be resold to end users.

In this post, I hope to let readers have a better understanding on how these development properties are being accounted for and also to shed some lights on a developer illustrated and how we can appreciate the value within using Bukit Sembawang as case study.

The Financial information below is extracted from the annual report of Bukit Sembawang for the financial year ended 31 March 2016.

Development property
Cash and cash equivalent
Total assets
Trade and other payables
Total liabilities
Net asset

Cost of sales
Gross profit
Total profit
GP margin

How are development properties being accounted?

Accounting for development property is set out in page 56 of the annual report: “Development properties are measured at the lower of cost and net realisable value.” In another words such properties will be held at cost and will only take into account any downside movement but not the appreciation that has taken place.
Trading at around $4.50 per share during March 2016, would give the Company a market capitalisation of about 1.16 billion (number of shares of 258,511,000 multiply by $4.5). Relative to the net asset of $1.29 billion, the share was traded at a discount of about 10%.
But given the manner of accounting at lower of cost and net realisable value,  is there more value to the Company than the net asset reflected on the balance sheet? Some history on Bukit Sembawang will shed some light to it.
Bukit Sembawang started off as a leading rubber company in 1911. Arising from the legacy, the Company “inherited” a substantial potion of freehold land which they have successfully developed into landed housing over the years which the most recent ones being Luxus Hills off Ang Mo Kio.
Lack of detailed information, one shortcut method to compute the estimated market value of the development properties is to regross the development properties using the gross profit margin using the gross margin of 40%.
Taking development property of $941,883 yielding a gross margin of 40% would result in an implied development property value of about $1.57 billion. ($941,883/60%) which is an uplift of 0.63 billion of its net asset of 1.29 billion to about 1.9 billion.
The discount of market capitalisation to revised net asset? A cool $0.74 billion or about 40%.
Another plus point to highlight is that the Company is debt free and is probably biding its time to launch its projects at a suitable time.

Investment considerations for such companies
Unlike REITs whereby there is a requirement to distribute 90% of its distributable income, the issue with investing in developers is the timing of return. Hence the track record on dividend payout (i.e. how willing is the Company is willing to reward its shareholders while waiting for the eventual upturn is important.

Bukit Sembawang is not too shabby in that respect. Below is a table on their dividend distribution history.

Dividend (S$)
Yield based on $4.50

Another consideration to take note is the sustainability of the Company’s dividend payout and more importantly how long can they capitalised on their low cost land bank before it runs out.

One metrics to look at is taking development properties balance divided by cost of sales which will yield a result of 5.54 years. This is a conservative metrics as it assumes the Company will not make new land acquisition which the Company will be able to do so given its net cash position and this metrics also have to be benchmark against the industry especially in land scarce country like Singapore.

The other more traditional metrics will be looking at dividend payout ratio which is a respectable 1.08 times for Bukit Sembawang. This means the Company is not dipping into its reserves to give back to its shareholders.

There are obvious value to it and personally, I have invested in Bukit Sembawang at around $4.50 in September 2016. Fast forward to today, lets recap the key concepts introduced and summarise the various value indicators based on the latest financial results and market capitalisation.

Value indicators
2017 (S$billion)
2016 (S$billion)
Estimated value of development properties #
Revised net asset value
Gross profit margin
Market capitalisation
1.76 billion based on share price of $6.80
1.16 billion based on share price of $4.50
Discount to RNAV
Development properties/Cost of sales
Dividend payout ratio
Dividend yield
Net cash
Net cash

# Estimated value of development properties for 2017 is uplifted on the basis of 40% gross margin as a conservative estimate although gross profit improved in 2017. 

Take note that the revenue recognised for 2017 is $143,395,000 compared to $281,997,000 recognised in 2016. This explains the increase in development properties to cost of sales ratio due to the lower denominator with a fixed numerator.

If adjusted by the revenue recognised, the ratio would be more comparable by taking 18.5/281,997*143,395 which would yield a result of about 9.4. Based on the above analysis, it suggest that the Company has been selling more of its units with a lower cost by observing a higher gross profit margin and also highlight the adequacy of land bank to sustain the Company’s operation with a higher development properties to cost of sales ratio after adjusting for revenue.

From a value investing standpoint, the discount to revised net asset value has narrowed considerably and dividend yield has compressed significantly. Realisation of the eventual market value of the land would entail the Company’s successful execution in development its land bank and more importantly overall market sentiments on the Singapore residential market.

For the record, I have disposed my shareholdings in Bukit Sembawang at around $6.10 or at around 20% of the discount to the revised net asset value of the Company.

Thanks for reading.

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