We attended KLCC’s 2Q14 results briefing and came away feeling comforted over its prospects. Their assets remain stable with the office segment chalking 100% occupancy while retail and hotel segments are showing improvements in occupancy and rental rates. KLCC has secured a tenant for Complex Dayabumi and is focusing on developing Phase 3 beginning FY15, with completion targeted by FY19. Quarterly results RDI declined by 10% due to a one-off finance cost from the accretion premium of the Sukuk Musharakah in April 2014. Going forward, it is no surprise that asset acquisition is tough to come by, but we still believe KLCC has an advantage due to its low effective cap rates and gearing especially given their placement mandate. Maintain OUTPERFORM and TP of RM6.90 based on an unchanged target gross/net yield of 5.00% / 4.72% on average FY15E GDPS/NDPS of 34.5 sen / 32.6 sen (+1.2ppt spread to the 10-year MGS target of 3.80%)

Operationally sound. We believe KLCC’s office segment, which contributes the most (44%) to the Group’s topline, is extremely stable as it has been constantly chalking close to 100% occupancy thanks to strong anchor tenants and long-term leases of 15 years. The retapil segment is also strong, recording an average of 98.0% occupancy on positive rental reversions, while the hotel segment also showed an improvement in occupancy to 65% (from 62% for 1H13). This was mainly due to the completion of refurbishment works of Mandarin Oriental (MO)’s lobby, main area, restaurant and ballroom, which reduced the revenue from F&B, events and room occupancy in FY13. We expect continued improvement for MO’s occupancy going forward as there is on-going refurbishment for guest rooms and corridors, with the full completion expected by FY16.

Phase 1 and 2 of Complex Dayabumi refurbishment completed, focussing on Phase 3. Phase 1 and Phase 2 of Complex Dayabumi’s refurbishment has been completed and management has been successful in securing a tenant on a TNL basis as they have already obtained an FID on the asset. Management is currently looking at Phase 3, which involves the redevelopment of City Point podium. Phase 3 will comprise a 60-storey tower of mixed development, consisting of retail, office and hotel portion and we estimate that this may cost close to RM0.5b; it will likely be financed by their new Sukuk Murabahah program (refer overleaf).

Acquisitions in the horizon? The group has obtained shareholders’ approval at the last AGM (17-Apr) for up to 10% placement, which should raise funds of between RM1.1b-RM1.2b for a potential asset acquisition and it may target assets within KL’s Golden Triangle (GT). Post yesterday’s briefing, we understand that the Group is still on the prowl for assets, but this may be tough considering the low cap rate environment at present. However, we still believe KLCC has an added advantage as the Group’s effective cap rates is one of the lowest at 5.5%, while its gearing is low at 0.16x; the lowest among MREITs under our coverage (safe for PAVREIT of 0.16x), implying lower financing cost and greater acquisition power. As such, we believe KLCC remains in an extremely favourable position for an asset acquisition should it choose to do so.

We make no changes to our FY14E and FY15E earnings estimates of RM638m and RM656m We also do not expect any significant earnings risk from KLCC due to its stable assets profile. Impact from refinancing its debt will result in a 0.3ppt decline in their effective rates which results in 1.0% increase in earnings, which is not significant, thus our estimate is unchanged. KLCC’s fixed rate debt portion has increased to 85% from 70% (refer overleaf).

Maintain CALL and TP of RM6.90 based on an unchanged target gross / net yield of 5.00% / 4.72% on average FY15E GDPS/NDPS of 34.5 sen / 32.6 sen (+1.2ppt spread to the 10-year MGS target of 3.80%). Our call is sector driven as we expect a possible European QE to have a positive effect on MREITs, and we believe the stock may also see further excitement as newsflow of potential acquisition unfolds.

Source: Kenanga