CapitaLand - Cold realities present opportunities; upgrade to Buy,

We upgrade CapitaLand to Buy (from Neutral) and add it to our Conviction List as we see its wide discount to NAV of 38% vs. City Dev of 21% (Sell) as attractive given its diversified business model and strong balance sheet (better positioned today than during the 1998 down-cycle when its gearing was 0.95X vs. 0.27X currently). Moreover, its decision to step up efforts to dispose investment assets (S$7bn in two yrs) to raise cash has positioned it well to reinvest for the next cycle. We believe CapitaLand could look at potential acquisitions once macro conditions improve, enabling it to generate above-sector NAV growth in the next 3 years.

Our stress tested valuation (further 10ppt below 1998 prices) shows that the stock has moderate downside, at 7% below current prices. Also, stressed tangible BVPS post write downs and provisions is S$2.36 (-16% erosion). While we expect news flow on the sector to be dominated by DPS risk, this should be offset by CapitaLand's defensive mix. We identify the following share price drivers: 1) a war chest of S$6bn, and allocation of cash would be a catalyst when markets stabilize; 2) provisions on its residential land bank, as early as 1H09 results. Any kitchen sinking would accelerate the earnings adjustment process, leading to potential share price recovery (similar to 2001); 3) good take up of CapitaMall’s (Neutral) rights issue would free up capital commitments; 4) China’s property market stabilizing by late 2009E, before Singapore in mid ‘10.

38% disc to NAV is at the low end of its historical range. We cut our 09E-NAV 5% to S$3.35 and write down Ascott. We cut our 12-m TP to S$2.68 from S$2.81; we maintain our 20% disc to RNAV. We cut ‘09-10E core EPS by 5-25% on weaker prices and raise ‘11E by 12% on a pick up in residential contribution. Residential cycle bottoms out earlier than our expectations (of mid 2010).

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