We attended KLCC’s 1H15 results briefing and came away unexcited. Its organic growth appears to be hampered by its weak hotel segment but is expected to improve in 2H15. Lot D1 development remains quiet as management is still trying to secure a tenant. The 10% placement mandate was renewed in April-15 and valid up to a year, but there are no clear acquisition targets as yet. The group will concentrate on the redevelopment of City Point podium @ Dayabumi. No changes to earnings. Reiterate MARKET PERFORM with a higher TP of RM7.27 (from RM7.06) after rolling valuation base forward to FY16E GDPS of 37.1 sen (NDPS: 34.9 sen). While we like the stock for its prime asset positioning and operational stability, upsides are limited as FY16E net dividend yield of 5.0% is less compelling vs. sizeable peers’ average of 5.5%.

Operationally stable, despite a weaker hotel segment. The Office segment is the biggest driver for the group and continues to provide steady earnings visibility given its long-term leases. Its Retail driver, Suria KLCC, continues to buck the weak retail trend thanks to its iconic landmark status. However, the Hotel segment saw declining PBT (-134%) to losses of RM4.7m, but this was mainly due to lower occupancy (44% vs. 65% in 1H14) and slightly lower ARR YoY (refer overleaf). Based on its operating margins in the past, we reckon the group’s operating breakeven level is around 50%-55%, which explains its 1H15 pre-tax losses of RM4.7m which would be a first since its listing. Going forward, we believe the hotel segment may improve in 2H15, to close to FY14 levels, although the hotel segment’s full-year contributions are still likely to be marginal for FY15 (refer overleaf). We have already built-in the weak hotel performance in our estimates and thus, keeping our FY15-16E earnings unchanged for now.

Phase 3 of Dayabumi on track. To date, KLCC has completed refurbishment of Phase 1 and 2 of Complex Dayabumi, and has already demolished City Point podium. Management has yet to secure a tenant but is eyeing a TNL agreement for the asset. To recap, 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 Sukuk Murabahah program. Management has indicated that they will not be providing guidance on CAPEX going forward due to sensitivity of contract pricings. For now, we are assuming RM50.0m for FY15E while significant earnings contributions will only be post completion in FY19.

Strong acquisition capabilities. The group renewed its 10% placement mandate at the recent AGM on 16-Apr-2015 which will only be valid up to April-2016. The placement is meant to raise funds of RM1.1b-RM1.2b for a potential asset acquisition and it may target assets within KL’s Golden Triangle. Note that KLCCSS’ parent owns the KLCC Convention Centre, Traders Hotel and Impiana Hotel in the KL Golden Triangle. Management has not targeted any suitable assets for acquisition as yet, but note that KLCC has strong acquisition capabilities from large placement size and low net gearing of 0.12x.

Reiterate MARKET PERFORM and a higher TP of RM7.27 (from RM7.06) as we fully roll our valuation base to FY16E. Our TP is based on a target gross yield of 5.1% (net: 4.9%) on FY16E GDPS (from FY15E) of 37.1 sen (NDPS: 34.9 sen). Our target gross yield is based on +1.20ppt spread to our target 10-year MGS of 3.90%. We like the stock for its prime asset positioning, and as the two major segments; Office and Retail, are extremely stable, while Hotel is likely to improve in 2H15. The stock carries a premium being one of the few sizeable Syariah compliant MREITs. However, upsides are limited as its FY16E net yield of 5.0% is already slightly lower than sizeable MREIT peers’ average of 5.5%.

Office and retail segments remain stable. The Office segment is the main driver (45% to topline), and is extremely stable as it has been constantly chalking close to 100% occupancy thanks to strong anchor tenants (e.g. PETRONAS group as one of the largest) and long-term leases of 15 years, recording solid 12.1% YoY-Ytd PBT growth. The Retail segment, namely Suria KLCC was resilient YoY-Ytd, maintaining an average 98.0% occupancy on 5%-10% rental reversions for 50% of leases up for expiry, and recording 3.7% YoY-Ytd PBT growth.

Hotel segment to see a better 2H15? The hotel segment saw declining PBT (-134%), but this was mainly due to lower occupancy (44% vs. 65% in 1H14) and slightly lower ARR YoY from: (i) Mandarin Oriental’s (MO) renovations of the ballrooms and 2nd and 3rd floors, which include meeting rooms, swimming pool area, spa and gym, which completed on 15th July 2015, and (ii) overall weaker traveller and consumer sentiment. We expect Hotel PBT to pick up in 2H15 as: (i) ARR and occupancy should pick up in 2H15, post refurbishment completion in July-15, (ii) there also a new restaurant (AQUA) operational in July-15, (iii) we believe favourable USD-MYR rates and the weakening Ringgit will attract tourists arrival in coming quarters, and (iv) management has guided that there is a pick-up in hotel events in 3Q15 unlike 1H15 (i.e. ASEAN Summit, meetings, and F&B promotion events). All in, we also do not expect any significant earnings risk from KLCC due to its stable assets profile.

Lot D1 which was earmarked by management to be a mixed development of office and retail space (GFA: 1.3m sf has yet to secure an anchor tenant). The development is still at the planning stage and management is still searching for a major anchor tenant as it will only proceed with development upon securing one.

Source: Kenanga Research - 11 Aug 2015