The Motley Fool

Tug-of-Fools: CapitaLand – The Bear Argument

250px-Bulle_und_Bär_FrankfurtShopping is arguably one of the favourite pastimes of Singaporeans. If that is true, then it’s hard for local shoppers to not have seen CapitaLand (SGX: C31) in action.

Malls like ION Orchard, Plaza Singapura, Raffles City and Bugis Junction are all, in one way or another, connected to CapitaLand through the company’s other listed entities like CapitaMalls Asia (SGX: JS8) and CapitaMall Trust (SGX: C38U).

Lest you think that shopping malls are all that CapitaLand does, think again. The company is a real-estate juggernaut in Asia, and holds in its portfolio a huge mix of homes, offices, shopping malls and serviced residences, among others.

In any case, while shoppers might find great shopping bargains at CapitaLand’s malls, the company’s shares might not turn out to be such a bargain.

Building buildings, flat-lined earnings

With CapitaLand, we are seeing a company whose revenue and earnings have been essentially flat since 2006 as seen in the chart below, with 2007 being an exception.

Being a company that has more than S$3b a year in revenues, it’s fair to say that CapitaLand is likely to be a mature business that shows either no or low growth, rewarding shareholders instead, through dividends.

Unfortunately, CapitaLand’s dividends are anything but fat. Last year, dividends were 7 cents per share, giving its shares a trailing dividend yield of 2.2% at the current price of $3.19. That is low when compared to the Straits Times Index’s (SGX: ^STI) yield of 2.5%.

And, without any history of sustained dividend increases, it seems unlikely that investors could achieve a better yield-on-cost over time.


Building buildings, returns declining

CapitaLand has also been earning poor returns on equity (ROE) of 8.7% to 6.2% since 2009, as seen from the chart above. For a company with a small ROE and wanting to boost its earnings, it could simply take on additional leverage. But, even that avenue has failed CapitaLand.

Its leverage – defined as Net Debt / Equity – has increased steadily from 2009 to 2012. But its ROE has continued falling, leading to a decrease in earnings.

This is important for investors because it might mean that CapitaLand’s on-going business activities might just be earning smaller returns on each dollar of capital that it employs.

Theoretically, for the company to maintain current earnings, it has to pump in even more capital, indicating the need for even more debt, or for a fresh injection of shareholder’s money. Both options aren’t good choices.

The first option carries with it more risk due to the possibility of rising interest rates stemming from a possible pull-back in US’s stimulus efforts, making debt more expensive. The second option is doing a disservice to shareholders as any newly supplied funds could be used to earn higher returns elsewhere.

Building buildings, we’re concluding

In summary, it seems that the business of real-estate development that CapitaLand knows so well, might not be generating the returns that it used to. And when businesses earn lower returns over time…. the results generally aren’t pretty.

That concludes the bear argument. You can read Sudhan’s bull case here.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.