Initiating coverage with OUTPERFORM recommendation and TP of RM2.76. Despite its large Johor exposure which has been perceived to be overplayed due to rising incoming house supplies (especially high-rises), we like KSL given its exposure in the locally driven mass market segment coupled with its ability to price its product competitively due to their low land costs. That aside, one third of their income stream is derived from investment properties which offer earnings resiliency should property sales performed worse than expected; notably, KSL City Mall and Hotel is one of the larger malls and better managed hotel in Johor Bahru town centre. Hence, we are conservatively estimating FY15-16E earnings of RM310m (+6%, YoY) and RM348m (+12%, YoY), based on FY15-16E sales assumptions of RM988m- RM993m, respectively. Our TP of RM2.76 is based on 61% discount applied to its FD RNAV of RM7.07 which is within the discount range (60%-65%) pegged to Johor-based developers under our coverage i.e. CRESNDO and UEMS. At our TP, the implied FY14-15E PER of 7.4x-7.0x is still cheaper compared to its mid-cap peers which are trading at 8.2x-7.5x, respectively. We admit that the Malaysian property landscape will be challenging this year, particularly 6-9 months after GST implementation, so share price could be volatile. However, we reckon that the deep values of KSL should offer some valuation downside risks to current levels while we believe this year’s volatility in property share prices should offer good entry points for long-term positioning of the stock.

Low land cost = better margins and pricing flexibility. The group’s land cost is relatively low considering that the majority of its Johor landbanks were acquired back in 2002-07. This allows KSL better pricing flexibility which enables them to continue catering for the affordable market segment with different products while maintaining its decent margins. KSL’s 3-year operating income margins averaged at 42.2% which is far superior to the overall developers’ 3-year average operating margins of 25.2%.

Earnings diversification through strong recurring income stream. Its investment properties in Johor has done relatively well, reporting segmental operating profits of RM107m in FY13 or a 2-year CAGR of 85%. It makes up a third of their income and helps provide some earnings safety, cushioning the impact from slower sales, should the property market remains soft. Notably, their investment property assets are severely undervalued by RM1.55b considering FY15E operating income of RM144m and conservative 7% cap rate and FY15E operating income of RM144m yields a valuation of RM2.05b! If they do revalue their assets, it could raise their BV/sh by 104% to RM3.90, while further strengthening their balance sheet.

Deep pockets with more gearing headroom. As at 9M14, the company’s net gearing remains fairly low at 0.01x, providing ample flexibility to gear up by another RM750.0m for either further land banking activities in Klang Valley/Johor or to fund its CAPEX for property investment in Klang which is slated to be developed over 10 to 15 years. Going forward, we are estimating its net gearing to inch up to 0.03x levels post its recent acquisition of its Batu Pahat agriculture land for RM90.6m.

Potential dividend policy? Over FY11-13, the company held back dividend payment. Prior to this ‘quiet’ period, KSL’s dividend yield ranged between 4%-6%. In the recently concluded 9M14 results, the board has proposed an interim single-tier DPS of 5.0 sen post the 1-for-1 bonus entitlement. Dividend Reinvestment Plan (DRP) will apply to this interim dividend where shareholders will be given an option to elect to reinvest in whole or part of the electable portion. Following its maiden dividend payment and DRP, we believe that there is a high likelihood of a formalised dividend policy. For the full FY14, we are anticipating single-tier DPS of 11.2 sen (5.2%) based on a payout ratio of 30%.

Estimating FY14-15-16E core earnings growth of +66%, +6% and +12% YoY, respectively. Current record high property unbilled sales of RM1b provides up to 1 year visibility.

Attractive valuations vis-à-vis peers. KSL is currently trading at FY14-15E core PERs of 5.8x-5.4x which is attractive against its mid-cap peer average of 8.2x-7.5x, and not to mention that it is also the most undervalued developer amongst our list of mid-cap peers. We would also like to point out that: (i) KSL’s earnings growth is also stronger than its peers, (ii) developers that deliver close to RM300m core earnings annually are typically large cap developers with a minimum market cap of RM3.0b. 

Source: Kenanga