KLCC Stapled Securities - A Slow Recovery Ahead

Date: 07/08/2020

Source  :  HLG
Stock  :  KLCC       Price Target  :  8.05      |      Price Call  :  HOLD
        Last Price  :  7.60      |      Upside/Downside  :  +0.45 (5.92%)

KLCCSS’s office portfolio remains stable backed by its long-term leases (which forms the foundation of its cash flow). However, we remain cautious on its hotel segment in light of Covid-19 and restricted movement. For retail segment, we believe the worst is over as Suria KLCC has been operating close to 100%. However, the retail industry is facing a challenging time ahead, amid potential changes in consumer behaviour, hence suggesting a slow recovery in 2H. We increase FY20 earnings by 7% but maintain FY21-22 forecasts. Maintain HOLD, with an unchanged of TP: RM8.05.

Below are the key takeaways from KLCCSS’s analysts briefing:

Office. KLCCSS’s office segment continues to deliver a stable showing, underpinned by its full occupancy. One of its tenants, PETRONAS (which occupies 40% of Menara ExxonMobil) has successfully renewed its leases in Apr 2020 for the next 3-year term of the 18-year lease tenure (with an unchanged rental reversion). We believe their office segment (which accounted for 48% of total revenue as of 2Q20) will continue to have stable revenue backed by its triple net lease agreements and long-term leases.

Retail. Revenue for retail segment has been hit due to the rental assistance granted to tenants coupled with lower internal digital advertising income. For 2H, management will be extending their rental assistance (in the form of rebates, deferment and marketing advertising) on a case-to-case basis in order to retain occupancy. We expect retail segment to recover gradually as big chunk of rental rebates have been recognised in 2Q and moving forward, the quantum of rental assistance will be lesser compared to 2Q20. Other than that, management has observed steady pick up in footfall despite the surrounding offices have yet to return to work at full strength (e.g. Petronas still enforcing their employees to work from home until further notice and their workplace occupancy shall not exceed 35%). With the absence of tourists (accounting of 20-30% of footfalls) and lesser workforce from surrounding offices, we believe their tenants sales growth recovery will be slow. However, Suria KLCC’s rent structure weighs more on fixed base rent rather than variable turnover sales, hence suggesting a gradual recovery for their retail segment.

Hotel. Mandarin Oriental (MO) has been hard hit by the profound Covid-19 outbreak and the implementation of MCO. Occupancy in 2Q20 deteriorated to 24% from 44% in 1Q20 as a result of the pandemic, with corporates and leisure restricting travel during the MCO and CMCO period. Post RMCO (Jun 2020 vs May 2020), management saw slow recovery in corporate demand whilst leisure saw an uptick in rooms booking arising from domestic tourism (32% increase in room revenue). Furthermore, F&B outlets saw significant pick up in revenue covers, particularly Mosaic & Lai Po Heen, operating at full capacity with social distancing protocols in place. MO has been stepping up promotional offerings with enticing packages to take advantage of domestic tourism. However, we believe MO will continue to deliver subdued occupancy due to the bleak hospitality and tourism outlook from absence of tourists as borders remained closed.

Outlook. Slow recovery is expected for KLCCSS’s hotel segment as the tourism and hospitality industry remains challenging with growth confined to domestic and driveleisure markets until regional and international travel becomes easily available. For retail segment, we believe the worst is over as Suria KLCC has been operating close to 100% (with the exception of reconfiguration exercise). However, the retail industry is still facing a challenging times ahead, amid potential changes in consumer behaviour and sentiment upon the uplift of restricted movement, hence suggesting a tepid recovery in 2H. For office segment, we believe it will remain stable on the back of long-term tenancies and their triple net lease agreement that forms a healthy cash flow foundation, and we believe it will be sufficient to sustain their income for the rest of the year as their office segment contributed to almost half of their revenue.

Forecast. We increase FY20 earnings by 7% as the negative impact from MCO/CMCO was less severe than we initially thought to be. To recap, KLCCSS’s 1H20 core net profit of RM317.3m (-12.9%) came in at 53% of our full year forecast, which is above our expectations as we believe 2H will likely be stronger than 1H which bore the brunt of the MCO impact. However, our FY21-22 forecast remains unchanged as we have factored in a gradual recovery in the previous forecast.

Maintain HOLD, with an unchanged of TP: RM8.05. Although we increase our earnings in FY20, our TP remains unchanged as our valuation is pegged on FY21 forward DPS on targeted yield of 4.3%, derived from 2 years historical average yield spread of KLCCSS and MAGY10YR. While we like KLCCCS given its resilient office segment, prime location retail and Shariah compliant scarcity amongst REITs, we remain cautious on a likely slow recovery for the retail and hotel segment due to Covid-19.

ESG Updates

Environment. KLCCSS will continue to uphold ESG practices with stakeholderfocused and business sustainability in the face of the pandemic . During restricted movement, KLCCSS has (i) switched off all electricity for unused floors in their office buildings resulting in reduction in energy consumption during the MCO, (ii) closed down certain floors not in operation and maintained minimum room temperature where needed throughout the hotel to conserve energy, and (iii) used operational equipment at their offices and hotel only on actual loads to reduce energy consumption.

Social. In term of social, KLCCSS has prioritised the safety & wellbeing of stakeholder group that includes providing (i) complimentary Covid-19 test, face masks & sanitizers for employees returning to work post MCO, (ii) self-directed learning platform for employees via Harvard ManageMentor during the MCO, (iii) Covid-19 tailored content through social media to keep shoppers & guests updated and engaged, and (iv) connected with investors via virtual meetings to provide transparent & credible communication in the face of a fluid ongoing crisis

Governance. KLCCSS has demonstrated positive reaction towards the pandemic while limiting damage to company’s performance by (i) establishing KLCC Pandemic Response Team (KPRT) to coordinate efforts in ensuring business continuity and sustainability whilst prioritising health and safety of all employees, (ii) mobilising robust risk management process quickly and effectively to protect facilities and maintain critical operations, and (iii) activating the Business Continuity Plan throughout the MCO in accordance with the directive on the Special Working Arrangement.

Source: Hong Leong Investment Bank Research - 7 Aug 2020

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