S P Setia shores up balance sheet amid slowdown

S P Setia Bhd does not fit the profile of a company in search of funding on the open market, not with the strength of its balance sheet and cash flow.

So, it would have surprised many that it sought to raise up to RM1.07 billion for working capital (RM300 million) and to support future landbanking efforts (RM768 million) through a proposed rights issue of 1.07 billion new Islamic Redeemable Convertible Preference Shares (iRCPS). Based on S P Setia’s announcement to Bursa Malaysia, the cash call involves the issuance of 1.07 billion iRCPS at an issue price of RM1 on the basis of two iRCPS for every five S P Setia shares held. The iRCPS’s preferential dividend rate is set at 6.49% per annum with a 1% step-up above the initial rate per annum as long as the iRCPS dividend does not exceed 20% payout.

The iRCPS are convertible at any time at the ratio of two new S P Setia shares for seven iRCPS. The conversion price is RM3.50. The iRCPS are redeemable on or after the 15th anniversary of the issue date.

The proposal will require shareholders’ approval and it would be hard not to be swayed by what is being offered. The iRCPS’ dividend rate of 6.49% is most tempting. Kenanga Research notes that the iRCPS offers a yield above S P Setia’s dividend yield of 5.5% for FY2016. “iRCPS yield at conversion price and assuming 1% step-up per annum implies a yield of 6.1% yield versus S P Setia’s yield of 4.9% at RM3.50,” says the research house.

But subscribing to the iRCPS is also the only way to minimise the dilution impact on the value of existing shares when the exercise is completed by the end of this year.

S P Setia’s largest shareholder, Permodalan Nasional Bhd, which has 51.04% equity interest — likely to be the largest beneficiary of this cash call — has given an irrevocable undertaking to subscribe in full for its entitlement of the iRCPS. Still, glaring questions over this proposal are not likely to escape the scrutiny of minority shareholders at the extraordinary general meeting.

As a pure property developer, S P Setia does not have recurring income. The sustainability of its earnings is driven primarily by its ability to build and sell properties. Such a business model is capital intensive, particularly so for a company that is growing its brand presence abroad.

Apart from its many township developments in Malaysia, the group has projects in the UK, Australia, Singapore and Vietnam. The difference in accounting practice in Malaysia and other markets means sales and profit thereof can only be recognised upon completion, and not progressively. As a result, substantial capital outlay is constantly required.

Shareholders will be eager to find out whether balancing the need for S P Setia’s future capital expenditure needs for ongoing projects with a long-term high dividend rate of 6.49% for the iRCPS might be a stretch for its financials.

The company already has a dividend payout policy of 50% of its profits, which is unusually high for a property developer. In FY2015, shareholders saw a payout ratio of 65.8%. The analyst says the iRCPS dividend rate pushes the company’s dividend payout ratio policy closer to 60%, which is unsustainable.

Moreover, analysts say S P Setia has shown no signs it is in need of a cash call. The group’s earnings have been growing steadily , and it recorded revenue of RM6.75 billion in FY2015. Net profit during the period rose to RM918.26 million, a record high, largely due to the delivery of its maiden Australian project, Fulton Lane. This, though, was over a 14-month period after a change in the company’s financial reporting year.

During the period, it also had free cash flow of some RM1.27 billion and healthy unbilled sales of RM8.6 billion as at end-March. It aims to achieve an ambitious RM4 billion sales target for FY2016.

With the delivery of Phase 1 of the Battersea Power Station development in London slated from 4Q2016 to 1Q2017, S P Setia is expecting a profit recognition of RM280 million in 2016 and 2017. Proceeds from Battersea will be reinvested for Phase 2 and Phase 3 of the development.

Meanwhile, the company had a healthy gearing of 0.2 times as at end-FY2015 and can afford to gear up. With its average borrowing costs standing at 4.21% in FY2015, the issuance of iRCPs and the promise of 6.49% dividend rate is a significantly more expensive way of financing. CIMB Research, in a June 6 note, estimates that the exercise will cost S P Setia a payout of RM69 million per annum if none of the iRCPS is converted. This, Kenanga says, could reduce S P Setia’s distributable profit to ordinary shareholders by 4% to 5% from FY2016 to FY2018.

A straightforward rights issue may dilute existing shares’ value immediately but would have spared the company from hefty dividend payments.

When asked why a cash call is being made under such circumstances and the options available, S P Setia’s president and CEO Datuk Khor Chap Jen tells The Edge, “We believe the time is right to further strengthen our equity to match long-term funding with long-term objectives such as landbanking activities.”

“This fundraising exercise will provide us with the war chest for future land acquisitions and in the meantime to support our 10:90 programme, which has been progressively launched throughout this year.”

It will be interesting to see whether minorities will demand more information at the EGM to approve the exercise.

This article first appeared in The Edge Malaysia on June 13, 2016. Subscribe here for your personal copy.