CapitaLand is on track to deliver ROE target of 8-12% in the next 3-5 years.

Streamlining of operations will enhance CapitaLand’s competitive strengths in integrated developments and increase its financial flexibility and scale, thus narrowing the holding company discount. Management remains long-term positive on residential demand although it still expects private residential demand and pricing to moderate further in 2H14. Maintain BUY with a raised target price of S$4.08, pegged at a 20% discount (25% previously) to our RNAV of S$5.11/share.

Results below expectations. CapitaLand reported 2Q14 net profit of S$438.7m, up 14.5% yoy, bringing 1H14 PATMI to S$621.5, up 9.2% yoy. Excluding the portfolio gains of S$13.8m, revaluation gains of S$306.2m and impairment writeback of S$9.3m, operating PATMI increased 30.7% yoy to S$136.5m due to lower finance costs, higher development profits from China residential and higher contribution from shopping malls business. The results are below our expectations, accounting for 40% of our full-year forecast mainly due to timing differences in the recognition of residential developments in China and Singapore.

STOCK IMPACT
• Holding company discount to narrow with the streamlining of operations. The-CMA transaction (groups CMA stake is 98.4% as of 30 Jun 2014) simplifies CapitaLand’s organisational structure with all group development activities undertaken under a single listed entity (61% of CapitaLand value). The group has a stable income stream with ~75% investment properties and ~25% residential properties which will help to mitigate residential market headwinds faced in Singapore and China. The streamlining of operations would help to enhance CapitaLand’s competitive strengths in integrated developments, and also increase financial flexibility and scale. The group intends to improve capital productivity by reducing financing costs, extending debt maturities, recycling matured or non-core assets and redeploying capital to higher return projects. CapitaLand is on track to deliver ROE target of 8-12% in the next 3-5 years.

• Derisking the Singapore residential portfolio in the near term but remain long-term positive. Management remains long-term positive on residential demand although it expects private residential demand and pricing to further moderate in 2H14 due the impact of the Total Debt Servicing Ratio and concerns over interest rate hikes. The group sold 161 residential units (2Q 2013: 139 units), bringing the total number of residential units sold in 1H14 to 195 units (1H 2013: 683 units) with a sales value of
$340m (1H2013: $1.6b). Sky Habitat accounted for the bulk sales as price discounts of 8-15% attracted demand. The exposure to residential segtment is limited with the residential inventory of 1,400 units at ~10% of CapitaLand’s total assets. The group plans to launch Marine Blue project in 2H14.

• Management expects Chinese government to maintain its policies to ensure stability, citing the policy easing in certain cities as inventory build-up poses heightend risks. Management plans to strengthen its presence in the key five clusters – Beijing, Shanghai, Chengdu-Chongqing, Guangzhou-Shenzhen and Wuhan. The residential units handed over in 1H14 increased 41% to 5,540 units with a sales value of Rmb5.28b, up 20% yoy. Expect strong performance in 2H14 with about 1,990 Units (~Rmb5b) that are on track for completion in 2H14, of which 68% have been sold. Upcoming launches for 2H14 include Lotus Mansion and New Horizon in Shanghai, Riverfront in Hangzhou and Vermont Hills in Beijing, which will collectively yield about 7,500 units.

• Improving outlook for Ascott with overall RevPAU increasing 6% yoy as China, Japan and Europe continued to perform strongly. The 24,000 operational units contributed ~S$126m to fee income while 11,800 pipeline units are expected to uplift fee Income by another S$45m, of which ~2,000 units will be opened in 2H14. Management continues to seek investment opportunities in key gateway cities in Asia and Europe and will focus on active asset enhancement initiatives (AEI) to reposition and upgrade its residences by reconfiguring layout of public space and rooms to maximise returns and enhance travellers’ experience.

EARNINGS REVISION/RISK
• We have adjusted our FY14-16 earnings by -5 to 0% mainly to defer the recognition of residential development projects.

VALUATION/RECOMMENDATION
• Maintain BUY with a raised target price of S$4.08 (from S$3.83), pegged at a 20% discount (from 25% previously) to our RNAV of S$5.11/share. The discount has been reduced by 5ppt to factor in the narrowing of the holding company discount. The stock is currently trading at a deep 32% discount to its RNAV.

SHARE PRICE CATALYST
• Acquisition of mixed development sites, relaxation of property measures and improving sentiment in core markets of Singapore and China.