Property Majors: Capitaland and City Developments

Introduction

Capitaland and City Developments are two of the largest property developers listed on the SGX. Capitaland is a Temasek controlled GLC, while City Developments is controlled by Kwek Leng Beng and family.

Juxtaposing the 1H07 income statements of the two companies will reveal the differences in the sources of income of the two companies. Even though the two groups have a similar top line, Capitaland gets a significant portion of its net profit from “Other operating income”, “Share of Associates” and “Share of Jointly Controlled Entities” (see red arrows). This is due to the fact that apart from its development operations, Capitaland has significant investments in property-related assets. A further inquiry into the balance sheet information will reveal more:

As we can see, associates and joint ventures comprise a much bigger proportion of the non-current assets of Capitaland compared to City Developments. This will be an important distinction to consider when comparing the valuations of the two companies.

In order to contrast the operating profitability and risk ratios of the two companies, some adjustments have to be made. This is because CapitaLand seems to classify as part of “cost of sales” items that City Developments classifies as “other expenses.”

Also, CDL and CapitaLand have different accounting policies with regards to reporting revaluations in investment properties. Capitaland includes “fair value gain of investment properties” in its “other operating income,” however CDL does not take into account revaluation of its investment properties, because it says that “companies can reflect unrealized revaluation surpluses or deficits in the income statement which may significantly inflate or deflate the balance sheet and can cause volatile fluctuations in core earnings depending on market conditions.”(Extracted from Note 8)

I personally prefer this approach to conservative accounting because fair value changes are only real when properties are divested or sold, and it is always easy to get carried away by ‘paper gains’ before the market collapses and the value of the assets plummets back to earth.

In any case, to get around the differences in accounting policy, I have chosen to use “Operating Profit excluding other income,” and this is arrived at by deducting the “other operating income” from the operating profit item. The ratio is much more comparable, and in this case Capitaland appears to be doing slightly better than City Developments.

This appears to be the only comparable ratio between the two companies. The ROE of Capitaland is inflated because of the upward revaluation in properties. The revenue/assets for capitaland is much lower because it has a lot of investment properties which have rentals which are very small compared to assets. In a sense, it is better to think of Capitaland as a property developer + REIT under one house, whereas CDL is closer to a pure developer.

Also, it is very difficult to compare the P/E ratios because CDL has not accounted for asset revaluations; perhaps the only feasible way to compare the two is by looking at the P/B ratio, where CDL pips Capitaland, 2.68 compared to 2.34. But again, this must be tampered by the fact that CDL's book value would be higher if it revalues its properties to market value.

Conclusion

Based on this comparison, it’s hard to say whether either company is fairly valued by the market. Capitaland's practice of amalgamating the fair value revaluations into its operating profit, along with its large amount of investment assets, associates and joint ventures make it difficult to analyse vis-a-vis City Developments. I will get a better idea once I have gone through a few more property developers and REITs and then I’ll come back and see if my understanding is changed.

In the meantime, leave a comment if you have tips on how to interpret the numbers.