Oxley Holdings: Credit Update (8 Aug 18)

Background

After a strong start to 2018, credit markets turned sharply bearish in the second quarter, despite economic outlook remaining broadly benign worldwide. The negative sentiment originated initially from interest rate trajectory, as the US Federal Reserve hiked rates by 25bps in late March, and raised its median dot plot in the June meeting from three rate hikes this year to four.

Also, valuations had been rich prior to recent market corrections, with credit spreads at very tight levels. Therefore, when credit spreads, especially those of speculative issuers, widened significantly from their trough in January, the price swings were especially severe and investor sentiment took a big hit.

Chart 1 shows the indicative ask price of Oxley Holdings Limited’s OHLSP 6.375% ‘21s (USD) against the Bloomberg Barclays Asia USD HY Bond Index average OAS. As we can glean from the graph, the price weakness in the OHLSP bonds this year is much explained by the extensive spread widening in the Asian high-yield space, with divergence between the two starting only in July after the Singapore government announced new property cooling measures. We believe it also explains the performance divergence between high-quality (e.g. City Developments, CapitaLand) and speculative (e.g. Oxley, Aspial Corp) credits, as financially robust issuers have been largely insulated from the bond market selloff.

Chart 1: Credit spreads have widened significantly year-to-date

Credit Highlights

Weaker results YTD due to revenue recognition and compressed margins

Oxley’s revenue for the nine months ended March fell 15% YoY to S$955.6m (9MFY17: S$1.12 billion) due to the timing of revenue recognition and project completions. The company completed Oxley Tower in December 2016 and recognized revenue from the project in 9MFY17, whereas there were no such major project completions in the current financial year.

The margins on projects recognized YTD FY18 (The Royal Wharf Phase 1A and 1B) were also significantly thinner than those in 3QFY17 (The Flow and Floraville/Floraview/Floravista), as gross profit sank 54% YoY to S$157.7m, a decline that outpaced the fall in revenue. The weaker top line was partially offset by an increase in share of profits from joint venture (“JV”) and associates, which surged to S$73.4m (9MFY17: loss of S$1.6m). The Bridge (S$71.08m), a mixed development JV project in Cambodia, and Galliard (S$2.61m), a UK associate, contributed most of the profits from JV and associates.

As a result, Oxley’s profit before tax dropped 17% YoY to S$147.3m in 9MFY18 (9MFY17: S$176.6m).

Sales and unbilled contracts remained strong

Oxley has achieved strong sales for all its projects launched this year. The company has sold all the 170 units at Verandah Residences, 52 out of 60 units at Sixteen35, 21 out of 24 units at Sea Pavillion Residences, and 130 out of 300 units at Affinity Residences. Oxley has also managed to sell 575 out of 800 units at Riverfront Residences, which was launched on the same day when the property curbs were announced.

According to its corporate presentation slides released in July, Oxley has made S$1.4 billion of contracted sales from project launches in calendar year 2018. Total unbilled sales stood at S$3 billion, which provides decent income visibility for the next two years.

Credit metrics deteriorated and gearing is set to climb higher

We have warned in January (“Oxley Holdings: Credit Update and Potential New SGD Bond Issue”) that Oxley’s leverage may jump to an elevated level, following management guidance that they intend to take on incremental borrowings of up to S$1 billion to fund their acquisitions. Much of that additional borrowings have took place in 3QFY18, as the company’s total debt climbed to S$3.30 billion from S$2.55 billion as at 2QFY18. As a result, net gearing surged to 2.4x (2QFY18: 1.9x).

We think Oxley’s leverage is likely to continue to climb in the near term, upon settlements of major acquisitions such as Vista Park (S$418m) and Mayfair Gardens (S$311m). Nonetheless, the large amount of unbilled contracts mentioned above provides the company with the means to deleverage. We have seen such a deleveraging cycle took place in the past between FY14 and FY17, before management embarked on its aggressive land banking program in 2017.

As at 31 Mar 18, Oxley held S$218.4m of cash while its short-term debt was S$290.5m. Thus its liquidity position looks tight, especially if we consider the substantial amount of funds needed to settle its land purchases and finance project expenditures. This is partially mitigated by the company’s decent track record of access to capital markets and its sizeable asset base.

Oxley last tapped the bond market in January when it printed the S$150m OHLSP 5.700% 31Jan2022 Corp (SGD). It also issued 156.8m new shares in March via private placement, raising net proceeds of S$78.5m.

According to the company’s July corporate presentation slides, it still has S$954m of assets that could be pledged for more borrowings if needed, including the ungeared portion of Chevron House (valuation: S$660m), Novotel/Mercure Singapore (S$980m), and shares in the listed United Engineers Ltd (S$340m). Also, we think Oxley should be able to sell these assets with little difficulty should it run into a liquidity crunch.

Business outlook

Tighter curbs weigh on large Singapore land bank, although land costs are lower than competitors

After several years of diversifying its business overseas, Oxley returned to Singapore in 2017 in a big way through a series of en bloc acquisitions—setting off a wave of collective sales across the city-state. The company’s aggressive expansion left it with one of the largest domestic land bank, with 3,900 residential units in the pipeline and an estimated gross development value of S$5.2 billion (as at 31 Mar 18, less recognized billings and future progress billings).

With Singapore home prices risen more than 9% since mid-2017, Oxley was among the best positioned to ride on the strong upturn in the property market. Then the Singapore government had a sudden policy change in early July, when it announced cooling measures by raising Additional Buyer’s Stamp Duty rates and tightened loan-to-value limits.

Now Oxley is left with a huge residential pipeline to offload amid poorer market sentiment and likely weaker pricing power. The company intends to launch seven more projects in Singapore before the end of 2018, including the former Vista Park and Mayfair Gardens. Outside of Singapore, it has five projects targeted to launch in 2H18, including Deanston Wharf in UK and Oxley Towers KLCC in Malaysia.

Nonetheless, we note that the prices paid by Oxley provide it significant cost advantage relative to other developers. For instance, the company paid S$1,244 per square foot per plot ratio (“psf ppr”) for Mayfair Gardens, which is significantly cheaper than the average S$1,800 psf ppr paid by Allgreen Properties for nearby land parcels. Other examples include Serangoon Ville (S$835 psf ppr versus Serangoon North’s S$964.8 psf ppr paid by Keppel Land) and Rio Casa (S$669 psf ppr versus Florence Agency’s S$842 psf ppr paid by Logan Property).

Near-term outlook on Singapore’s property market remains good, but oversupply risk looms ahead

The near-term outlook for Singapore’s residential property market remains robust despite the recent cooling measures. Owners and tenants who have been displaced from the en bloc sales frenzy have to find replacement homes, which should support housing demand through at least 2H18.

The supply side also remains favorable, at least for the near future. Data from the Urban Redevelopment Authority (“URA”) shows that launched but unsold private residential units remained at a low level of 1,264 units in 2Q18, albeit higher than 1Q18’s 1,066 units.

The pipeline of upcoming supply suggests poorer prospects for 2019 and beyond, as 26,961 units with planning approvals remained unsold at the end of June, up from 24,193 units in the previous quarter. In addition, there is a potential supply of 19,500 units from Government Land Sales and en bloc sites that are still pending planning approval. URA noted that a large part of this new supply may be launch-ready in 2019, which exacerbates supply risk.

Our views and recommendation

Leverage is a two-edged sword magnifies both gains and losses. Therefore, highly leveraged property developers like Oxley and Aspial Corporation are more vulnerable to the negative impact from cooling measures. Weaker pricing power and slower sales would take a heavier toll on their financials, compared to developers with more robust balance sheet.

Developers with shaky credit metrics also have less financial power and maneuver room to delay project launches, if the housing market goes downhill. Moving forward, sales execution and quick monetization of the major projects will be crucial to alleviate the increasing pressure on Oxley’s credit profile. We took some comfort from the company’s good performance history in those areas, and will monitor closely its contracted sales numbers in the quarters ahead.

While we are negative on Oxley’s credit outlook, we think the price corrections this year in its bonds have brought valuations to a fair level. As such, we are neutral on the OHLSP curve (see Table 1).

Less adventurous investors who are keen on Oxley’s credit may opt for the OHLSP 5% ‘19s (SGD), due to better near-term cash flow visibility and relatively low short-term debt burden. The two longer OHLSP bonds—OHLSP 6.375% ‘21s (USD) and OHLSP 5.7% ‘22s (SGD)—have underperformed in the past month, and now provides decent compensation for their longer tenor.

Table 1: The OHLSP bonds (as at 7 Aug 18)

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in OHLSP 5.000% 05Nov2019 Corp (SGD) - Retail, OHLSP 5.150% 18May2020 Corp (SGD) - Retail, and OHLSP 6.375% 21Apr2021 Corp (USD). The analyst who produced this report holds a NIL position in the abovementioned securities.