KLCC Property Stapled Group (KLCCPSG) reported weaker earnings in 1Q17 (though within consensus and our expectations), affected by marginal declines in mainstream income from the office and retail portfolio. Nonetheless, we are of the view that earnings will recover from 2Q17 with an improvement in overall occupancy rates and rental rates. 1Q17 DPS of 8.6 sen. Maintain Hold, PT of RM8.00.

1Q17 Earnings Within Street and Our Expectations

KLCCPSG reported 1Q17 PATAMI of RM176.7m (-3.3% yoy), due to marginally weaker results for the office and retail portfolio, with operating profit down by 1.5% yoy and 1.7% yoy, respectively. Nonetheless, we are of the view that the earnings outlook will gradually recover from 2Q17 onwards on an expected improvement in overall occupancy rates and rental rates for both the office and retail assets. Despite the temporary disruption to rental income arising from a dip in ExxonMobil’s occupancy rate to 60% (from 100% in 1Q16) and the repositioning of tenants at Suria KLCC (occupancy dipped to 97% from 98% in 1Q16), KLCCPSG’s overall EBIT declined by a marginal 2.0% yoy and 2.7% qoq. The stable office portfolio as well as the retail segment together underpinned 93% of EBIT. We maintain our FY17-19E earnings.

Differentiation Strategies for Hotel Operation Bearing Fruit

Though the profit contribution from the hotel segment was insignificant in 1Q17, management indicated that the shift in target markets other than the primary oil & gas sector is bearing fruit, implied by an increase in occupancy per available room to 72% (1Q17) from 52% in 1Q16 and 63% in 4Q16.

Maintain HOLD, Price Target Unchanged at RM8.00

We maintain our HOLD rating on KLCCPSG with a 12-month dividend discount model-derived Price Target of RM8.00 (including RM0.26 from the redevelopment of Dayabumi and RM0.24 from the potential development of Lot D1). We think KLCCCP’s longer-term potential is underpinned by an asset-injection pipeline of approximately RM5.8bn (backed by its strong parent company) and attractiveness as a Shariahcompliant stock. Earnings should remain relatively stable for both the office (triple net leases – next rental reversion in Dec17 for Menara 3 and Oct18 for Petronas Twin Towers) and the retail portfolio in 2017 (steady rental rate of RM30.50psf).

Medium- to Long-term AEI and Asset Injection Plans

KLCCPSG’s long-term (up to 2019) AEI as well as asset-injection plans should be driven by: i) growth from a in-built pipeline (redevelopment of Citypoint Podium at Kompleks Dayabumi into a 200,000 sq ft retail area, 600,000 sq ft office, and a 500-room hotel [2015-2019]); and ii) the potential development of an office tower in Lot D1 (1.3m sq ft GFA).

Key Risks – Slowdown in Expansion, Upcoming Supply of Space

Downside risks: i) economic downturn; ii) inflationary pressure; iii) decline in tenancy rates; iv) incoming supply, 16m sq ft from the retail and 11.7m sq ft from the office markets (2017-21); v) higher debt-refinancing rates; and vi) correction in asset prices. Upside risks: i) rebound in tourist arrivals and ii) improvement in consumer and business sentiment.

Source: Affin Hwang Research - 23 May 2017