APAC Realty vs PropNex – Singapore Real Estate Agencies

Introduction

APAC Realty (SGX:CLN) and PropNex (SGX:OYY) are listed real estate brokerages in Singapore. Both businesses are asset-light and service-based.

PropNex has over 7,395 agents while APAC Realty is following behind with over 6,000 agents.

PropNex became the largest after the merger with DWG. DWG transferred over >1,000 salespeople to PropNex. They compete with Huttons Asia, OrangeTee.com, and Edmund Tie & Company Property network. PropNex International, one of the subsidiaries of PropNex, is 28.17% owned by JLL.

A service-based company is able to grow and shrink itself relatively easier. It does not have huge manufacturing plants to manage. During bad times, it’d be able to shed some of its work force to lower costs. Likewise, during good times, hire some of the work force back. These companies tend to be cash rich because they are not required to spend huge capital expenditure to maintain the competitiveness of their services. The key is continuous training to ensure the competency level of their staff. Some other service-based companies are Accenture, HRNetGroup, MSCI, Moody’s, and Japan-listed DIP Corporation.

Cooling Measures by the Singapore Government

Singapore Government raised the additional buyer’s stamp duty rates and tightening loan to value (LTV) limits. It raised fears of property transactions slowdown and these two companies dropped roughly 20%.

Comparison of PropNex and APAC Realty

While it may seem that PropNex has a lesser geographical presence in the region, APAC Realty derives 99.9% of its revenue in Singapore as of FY2016. This could indicate APAC Realty’s agents aren’t active however the risk to APAC Realty is low because it collects royalty fees instead (FY2017: 416k). In its latest 1H results, there is no mention of any traction in its overseas operations. It is far more important to bring back the focus in Singapore.

Gross Profit Margin

How is gross profits derived? It takes commissions earned from the developer, then deducting up to 90% of commissions to its agents. It is known as “cost of services”.

 (source: APAC Realty prospectus)

(source: PropNex prospectus)

While from an investor’s perspective, lower gross margins could show weakness. I disagree. APAC Realty takes 10-12% while PropNex takes 7-9%. I suppose PropNex’s margins are lower because it pays a higher override (up to 5%) to its team managers/team leaders. If I’m an agent, I would be more keen to join PropNex for better payouts. I do think this could work better for the long term because of stronger economic incentive. The lower gross profit margin may not be as bad as it seems.

In the first seven months, PropNex had led in the sales performance for 12 out of 15 of the projected launches, having closed the most number of units ahead of the other joint marketing agencies.

source: 1H FY2018 Press Release

I believe this could be a result of training and better economic incentive for agents to perform.

Net Profit Margin

For APAC Reality,

the 1H PBT margin is 7.6%. [(16,382+809) / 224,913] and gross margin is 11.8%.

The SGA cost of the business was 11.8% – 7.6% = 4.2%.

For PropNex, the 1H PBT margin is 6.7%. [(13,912+1,113+15) / 224,364] and gross margins is 8.9%.

The SGA cost of the business was 8.9% – 6.7% = 2.2%.

This shows that PropNex is far more efficient in controlling their costs.

Valuation

I realized that APAC Realty has an intangible asset value of $99.9m and net assets of $139.5m. 71.6% of its net assets are in intangible value. Is the intangible value being assessed on a yearly basis? PropNex’s trademark is valued at $203k. Is the value accurate? It’s a big question mark for me.

APAC Realty is buying a property at 450 Lorong 6 Toa Payoh for their new HQ. It has 51 years of lease left. The purchase consideration agreed was $72.8m. As its existing cash balance is $61.65m, it is likely that APAC would borrow the shortfall of $7.15m or so. As much as possible, I prefer asset-light companies to operate on a rental model.

From PropNex’s balance sheet, it suggests that they do not own any property. The current offices at HDB level 10 and 11 should be on a rental basis. They moved there in the year 2004 and it has a size 24,000 sq. ft.

We will use enterprise value to find the price we are paying.

Let us ignore the purchase for the time being.

Enterprise Value = Market Capitalisation + Debt – Cash.

For PropNex and APAC Reality, you’ll get 147.8m and $149.7m respectively.

PropNex has been mandated for another 20 upcoming New Project Launches with approximately 10,800 units for 2H2018/2019. Within the next 5 months, PropNex is expected to launch 15 projects, totaling 5,462 units, which will present more opportunities for PropNex’s salespersons.

CONTRAST WITH APAC REALTY (ERA)

To date, ERA has launched 15 projects in the first 7 months of 2018, or a total of 8,625 units. Another 10 projects, or 4,383 units, are due to launch in the next 5 months which signifies growth potential for the Group and more opportunities for ERA salespersons in the second half of 2018.

Source: SGX Announcements

Given there were 15 project launches in 1H FY2018/19, PropNex earned $11.487m. Knowing there are another 20 projects for 2H FY2018/19, it is likely that PropNex is able to earn $22.97m minimally.

$22.97m is derived by multiplying $11.487m by two.

Taking EV/Profits (147.8m / 22.97m), the price multiple is 6.3x. 

For APAC Realty, there were 15 project launches in 1H FY2018 and 10 projects launches in 2H FY2018. We are going to do a simple estimation of $27.22m for the full year. There is going to be a drop in projects, by right, we should not annualise profits of 1H. But I’m keeping it really simple.

Taking EV/Profits (149.7m / 27.22) = the price multiple is 5.5x. 

At a simple glance, PropNex is 14.5% more expensive than APAC Realty (6.3/5.5-1).

I believe PropNex deliberately chose to reward its agent more generously and this resulted in the lower profits, hence, higher valuation. PropNex has strength in an efficient cost structure. If PropNex adopts the similar payout as ERA and earns the same gross margins as ERA, its earnings are likely to see a lift of 32.5% based on 1H FY2018 numbers.

I view Propnex’s higher valuation to be justified because of their self-imposed margins suppression, market leadership status and access to more quality projects from reputable developers.

Risks

These are companies that would not become multi-baggers because the market size is limited in Singapore. For example, PropNex is the largest real estate brokerage in Singapore already. I do not see a possibility where they can double or triple their profits if they operate in Singapore only. They have to seek overseas growth engines.

Such companies are also affected by policies set by the government. A further tightening by our Singapore government had caused share prices to drop further. This is one big uncertainty when one chooses to invest in either of these businesses.

These stocks are still considered cyclical because they are tied towards their industry.

It is not easy to value a service-based company with fluctuating and volatile earnings. But if we were to do so, a price-multiple of 7x should not be too demanding, this indicates an upside of 11%. But we need to be aware of a huge earnings decline, should there be a drop in property transactions.

Since we are unable to classify this company as a growth stock, the key is to buy them when their shares are depressed. I will buy PropNex during a crisis and not now.