· Good return with deep value. Since our first recommendation on KSL six months ago, KSL has registered a decent total return of 13.4% (from RM1.94) outperforming KLCI’s negative return of 3.7% in the same time period. We reckon that the steady share price performance was well supported by its earnings growth trajectory coupled with its attractive share price valuation. That aside, the stock is also gradually regaining investors’ confidence through a bonus issue exercise and resumption of dividends. To recap, KSL has completed a 1-for-1 bonus issue and also resumed its dividend payment by paying out a 5.0 sen (ex-bonus) interim dividend to its shareholders in the past six months.

· Commencing core coverage on KSL. While KSL’s share price performance might not be as impressive compared to other OR stocks under our stable, we believe this would be the right time to collect this stock in the property sector. We view KSL as a cheaper and safer entry to the property sector due to: (i) its superior margins and pricing flexibility, (ii) earnings diversification through strong recurring incomes, (iii) severely undervalued investment properties, and (iv) compelling valuation vis-à-vis its peers. Hence, we are initiating coverage on KSL with an OUTPERFORM call and Target Price of RM2.76 based on 61% discount on its FD RNAV of RM7.07. (Kindly refer to our Initiation Report dated 17/02/15)

· Superior margins and pricing flexibility. The group’s land cost is relatively low as most of its Johor landbanks are acquired back in 2002- 07, allowing KSL better pricing flexibility to position themselves comfortably in 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 have 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.

· Deeply undervalued investment properties. KSL’s investment property assets are deeply undervalued by RM1.55b considering FY15E operating income of RM144m and conservative 7% cap rate which 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.

· Attractive valuations vis-à-vis peers. KSL is currently trading at FY14-15E core PERs of 5.8-5.4x which is attractive against its mid-cap peer average of 8.2-7.5x, 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