We upgrade KLCC to BUY (from HOLD) with a higher SOP-derived price target of RM8.55 after incorporating a lower discount rate of 7.4% in anticipation of stronger investor demand for defensive assets, especially those with sustainable yields during an economic downturn. Backed by triple net leases, high occupancy and low gearing, we believe KLCC can continue to grow its dividend over 2019-21E. Our price target implies a fair 2020E yield of 4.7%, -1SD from KLCC’s 5-year average of 5.0% and comparable to its peak valuation of 4.4%-4.7% during 4Q16-2017.

An Ideal Bond Proxy; Sustainable Yield, Reputable Tenants

We view KLCC as an ideal bond proxy for investors seeking sustainable yield, given the defensive rental income from reputable tenants and high occupancy at its iconic Suria KLCC. In line with the defensive stance from our house view for 2H19 (Malaysia Strategy: a shift into defensive names) and the sustainable yield approach recommended by our alliance partner, we expect KLCC to re-rate on the back of higher demand for defensive assets and solid earnings delivery (higher DPS yoy).

Rain or Shine, KLCC’s Earnings Are Defensive, Yield Is Sustainable

KLCC has one of the most defensive earnings profiles among the MREITs, given: (i) c.74% of its 2018 net profit was contributed by triple net and longterm leases with reputable companies. In addition, the rentals for these triple net leases are subject to 10% increment every 3 years; (ii) the highly successful Suria KLCC Shopping Mall has consistently maintained its occupancy rate between 96%-99% and continues to grow its base rent; (iii) KLCC has a strong balance sheet and its gearing ratio of 12.7% is the lowest among MREITs; and (iv) KLCC has continually grown its dividend - KLCC has raised its dividend per share by 1-3% pa since 2014.

Upgrade to BUY, Demand for Sustainable Yield Should Lift Share Price

We upgrade KLCC to BUY (from HOLD) with a higher price target of RM8.55 after lowering our discount rate to 7.4% (from 7.6%) in anticipation of strong investor demand for defensive assets with sustainable yield. We have revised our 2019-21 earnings forecasts to account for the ongoing reconfiguration exercise at Suria KLCC that should weaken 2019E retail earnings but lift 2020-21E retail income. Overall, our price target implies a fair 2020E yield of 4.7% (-1 SD from 5-year average), comparable to its peak valuation of 4.4%-4.7% during 4Q16-2017. Key risk to our positive view: a reversal in the global yield trend.

Source: Affin Hwang Research - 9 Jul 2019