Defying industry trends

Retail spending at Mid Valley Megamall and The Gardens Mall (under IGB REIT) continues to defy industry trends and competition (from new malls and the online market). Occupancy rates are close to 100% and tenancy renewals remain a non-issue to continue supporting DPU payout in FY16-18E. Reiterate BUY and TP of RM1.70.

Cautious remains the word, but retail spending is improving

Although 2016 has been hit by weak business sentiment and the deterioration of the Ringgit, the nation’s consumer sentiment has gradually improved compared to 2015. GDP data are showing a more positive trend emerging in 2016, with key drivers being a growing population, a young demographic trend, a healthy employment market and sustained income levels in urban areas, among others. The Malaysia Retail Group expects retail sales growth of 3.0% yoy in 2016 and 5.0% in 2017, with stronger growth from specialty stores.

IGBREIT’s retail sales growth likely above industry

Management’s feedback remains positive on retail sales growth at Mid Valley Megamall (MVM) and The Gardens Mall (TGM), likely to be in the high single digits in 2016. This is underpinned by: i) the malls’ strategic locations (flanked by affluent neighbourhoods and being a super-regional malls to suburban neighbourhoods around Kuala Lumpur); and iii) a diverse tenant mix and management’s experience in managing mass market and upper-class retail expectations.

Reiterate BUY, with Price Target at RM1.70

We reiterate our BUY rating and DDM-derived 12-month target price of

RM1.70. We expect IGBREIT’s earnings to remain resilient on: (i) stable occupancy rates (c.100%); (ii) an experienced management team; and (iii) more efficient cost management. We think 2016-18E DPU yields remain attractive at 5.6-6.3% vis-à-vis the peer averages of 5.3-5.8%. The likelihood of sustained renewals in 2017 (with 40% of MVM’s and 42% of TGM’s net lettable areas due for renewal) and positive rental reversions continue to justify the higher DPU payouts in FY17-18E, in our view.

Key risks – slowdown in expansion, upcoming supply of space

Risks: i) Slowdown in consumer spending; ii) competition from new supply and online websites; and iii) higher debt-refinancing rates.

Recovery in retail sentiment

Cautious remains the word, but retail-spending is improving

Although 2016 has been hit by weak business sentiment and the deterioration of the Ringgit (which has lost 25% of its value since 2 Jan15), the nation’s consumer sentiment has gradually improved compared to 2015 (Fig 1) and we note that the Goods and Services Tax (GST) impact on consumers is gradually tapering off though the cost of living is constantly under inflationary pressure (to recap, the GST affected retail goods such as IT/computers, timepieces, processed food, F&B outlets, luxury goods and beauty & health). We do hear the initial response of the word “cautious” from most consumers when asked about retail spending. However, data are showing otherwise, with a more positive trend emerging in 2016 vs. 2015. Testament to this, based on the latest GDP data published, consumption spending in Malaysia grew by a robust 6.4% yoy in 3Q16, i.e. higher than 6.3% in 2Q16 and 5.3% in 1Q16.

We believe that the key drivers to consumer spending in the country include a growing population, a young demographic trend (with 65% below 39 years of age), a healthy employment market, sustained income levels in urban areas, government handouts through BR1M/special assistance programs, expansion of total employment during 3Q16 (net gain of 45,000 jobs, mainly in service sub-sectors), the emergence of new retail trends/ideas and the availability of lower-priced products as a result of competition (driven by online shopping).

RGM forecasts rebound in 4Q16 retail sales growth; 3% in 2016

The Retail Group Malaysia (RGM) (according to StarBiz, 13 Dec16) has guided that retailers are expecting a rebound in 4Q16 growth to 5.5% yoy in 4Q16 from 1.9% yoy in 3Q16. We believe that the less robust retail performance in 3Q16 was attributable to stronger seasonal sales in 2Q16 as the Hari Raya celebration fell in early July 2016. For 2016, RGM is anticipating annual retail sales growth of 3.0% yoy to RM99.1bn (revised down from 4.0% originally owing to poor performance in the department store sub-sector year-to-date).

The retail sub-sectors that are expected to perform strongly in 2016 include the pharmacy and personal care and fashion and fashion accessories. RGM attributed the modest retail performance to the weakening of the Ringgit as it has affected the cost of retail goods as well as a partial impact from the GST (implemented in April 2015), which have both led to higher retail prices. In our view, retailers are again expected to pass on higher prices to consumers during the next six months of 2017; hence the country’s overall consumer sentiment is not expected to see significant improvement in 1H2017. RGM currently forecasts 5% yoy retail sales growth in 2017.

Mid Valley City – still a crowd-puller

IGB REIT sees retail sales growth sustained at high single digits

Based on our recent meeting, management’s feedback remains positive on retail sales growth at Mid Valley Megamall (MVM) and The Gardens Mall (TGM), likely to be in the high-single-digits growth in 2016 and defy industry trends. The strongest factors underpinning this trend are: i) the malls’ strategic location, flanked by affluent neighbourhoods such as Bangsar, Seputeh, and Damansara Heights; ii) being super-regional malls with easy road and transportation access for urban dwellers from Petaling Jaya and other suburban neighbourhoods around Kuala Lumpur; and iii) a diverse tenant mix and management’s experience in understanding retail trends and offering a retail concept suitable for the Malaysian lifestyle. Traditionally, the fourth quarter of the year has always been the strongest quarter for MVM and TGM, given the year-end festive seasons and holidays, while expected higher tourist arrivals (due to the attractive Ringgit) would spur retail spending.

Management well experienced in managing sustainable growth

In fact, from our on-the-ground checks, we note that management takes into account strongly the fact that the mass-market crowds are largely affected by the higher cost of living, and as such, there are an affordable range of products at MVM (ranging from food, fashion, and IT to household items) for price-sensitive shoppers. In addition, the retail concepts for the mass-affluent to the upper class shoppers are also improving at TGM, and international fashion names such as Balenciaga, Sacoor Brothers, Bell & Ross, and Diane Von Furstenberg opened their doors in late 2015 while Bvlgari and Rebecca Minkoff opened in 2016. The Golden Screen Cinemas (GSC) also added four new screens in 2Q16 and is currently the largest GSC outlet in Malaysia. New outlets which will be opening soon include Village Grocer and Lord’s, coupled with the expansion of the existing Din Tai Fung restaurant and a Michael Kors outlet. We think LV, which is one of the outlets with the highest sales growth on a yoy basis, and the expansion of the Hermes outlet in TGM are testaments to the sustainability of high-end retail sales at TGM, even during challenging times.

Renewals have not been an issue; occupancy rates close to 100%

One of IGB REIT’s key strengths is its long waiting list of potential tenants (>100) and track record of high renewal rates, even during challenging economic times. Most of the key tenants, especially the anchor tenants (AEON, AEON Big, Metrojaya, Isetan, Robinsons, GSC Cinemas) and specialty stores such as G2000, MNG, Zara and Madam Kwan’s have been with the group since the malls commenced operations. Based on management’s guidance, MVM and TGM have occupancy rates of 99.5% and 98.3% respectively as at 3Q16. The occupancy rates have remained consistent and close to 100% based on historical trends.

Tenancy renewals at MVM and TGM continue to sustain DPU payout

For 2016, tenancies up for renewal accounted for 21.2% of MVM’s NetLetable-Area (NLA) of 1.8m sq ft (2015: 32% of NLA) and 38% of TGM NLA of 830,035 sq ft (2015: 15% of NLA). Rental reversions of tenancies renewed were in the range of the low to mid-teens. The year 2017 is

expected to see a higher percentage of NLA up for renewal – 40% of MVM’s NLA and 42% of TGM’s NLA. The likelihood of sustained renewals and positive rental reversions continue to justify the higher DPU payouts in FY17-18E, in our view. In our forecasts, we have factored in a rental reversion of +15% at both MVM and TGM for 2016 and 2017 as well. Our rental reversion assumptions are based on the expectation that the malls still have the potential to catch up with other city-centre malls’ rental rates, which are currently between RM20-30psf. Based on management’s guidance, the rental rate at MVM is currently going at RM13.30psf while TGM is going at RM12.40psf.

Valuation

Reiterate BUY and TP of RM1.70; above-peer 2016-17E DPU yields

We reiterate our BUY rating with a DDM-derived 12-month target price of RM1.70 based on the following underlying assumptions: 8.3% cost of equity, risk-free rate at 4.0% (adjusted up from 3.5%), 6% market risk premium and a 3.0% terminal growth rate remain unchanged. At RM1.57, IGB REIT is trading at FY16-18E yields of 5.6-6.3% which are higher compared to sector’s 5.3-5.8% over the same period. There were some fine-tunings done to FY16-18 forecasts on tenancy renewals, but they are very minor. In our view, despite the risk of weaker consumer sentiment (due to repercussions of higher retail prices) as well as incoming supply of new retail space in suburban neighbourhoods, we expect IGBREIT’s earnings to remain resilient on: (i) stable occupancy rates of close to 100% and a long tenant waiting list; (ii) an experienced management team in sustaining the shopping mall yields amidst stiff competition; (iii) more efficient cost management; and (iv) both Mid Valley Megamall and The Gardens Mall being key suburban shopping destinations. Longer-term key catalysts include the potential injection of the Southkey Megamall (1.5m sq ft NLA) in the Iskandar Development Region by 2021-22.

Upside for rental rates, future asset injection, yield-accretion

Our conviction on IGBREIT is driven by: i) the sustainability of IGB REIT’s existing tenancies; and ii) potential yield-accretion by increasing leverage given its low gearing ratio of 24% (ability to gear up by another RM1.3bn) for future acquisitions.

Premium valuation warranted, in our view

Our TP of RM1.70 translates into a P/NAV premium of 1.6x vs. IGB REIT’s current P/NAV of 1.48x and the retail peer average of 1.15x. Though higher than the peer average, we believe that this reflects IGB REIT’s dominance in the retail sector, underpinned by its strategically located assets in Mid Valley City, which is a 50-acre integrated development project sustained by a high foot traffic from fully occupied offices, service apartments and hotels.

Source: Affin Hwang Research - 20 Dec 2016