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Morningstar | 2Q Result in Line for CapitaLand and City Development; CapitaLand Remains the Preferred Pick

CapitaLand and City Development reported second-quarter results in line with expectations. The latter bounced back from a weak first quarter with a stronger second-quarter result underpinned by revenue recognition of three residential projects and a decent performance for its hotel operation, Millennium and Copthorne. Quarterly operating profit after tax and minority interest for CapitaLand was resilient despite a slight decline of 5% to SGD 605 million on lower contribution from its residential units development business. In our earlier expectation, the market over-reacted to the restrictive measures in residential property in July, CapitaLand's share price has recovered to a level prior to the announcement as the property conglomerate has prudently lowered exposure to residential real estate development in recent years. However, value in CapitaLand remains, in our opinion.

Both CapitaLand and City Development are trading at similar discounts of close to 20% to our unchanged fair values for both companies. We reiterate our preference for CapitaLand over City Development on a quality basis. This is reflected in our narrow economic moat rating for CapitaLand, as its investment properties in malls and offices benefit from efficient scale. We see the investment portfolio as more established and high-quality, with a balance between offices and large mall portfolios, underpinning the group's recurring cash flow. Some properties are mixed-use as the office component above underpins foot traffic for the malls below. The portfolio is also geographically diversified with a concentration in Singapore and China. While CapitaLand's expansion in geographies away from Singapore and China comes with added risk, the group is prudently, in our view, targeting properties in gateway cities in developed countries.

For City Development, recurring income is currently supported by investment properties and its hotel operation, Millennium and Copthorne, or M&C. The group is targeting recurring EBITDA of SGD 900 million in 10 years. This consists of M&C, additional investment properties and management fee from its fund management platform. Fiscal 2017 EBITDA was SGD 600 million and the 10-year target represents compound annual growth of 4%. Management is exploring multiple avenues to achieve the target from direct acquisitions of investment properties, to an expansion of its fund management. An office in Shanghai was acquire for RMB 148 million and management also flagged the acquisition of another office asset at value over SGD 300 million is pending. Fund management remains a work in progress and the company is looking to reach USD 5 billion in assets under management by 2023. Partnering with institutional investors is an option while acquisition of an existing real estate platform is a possibility but management noted a good track record and culture fit are criteria. Real estate platform includes listed and unlisted entities.