We revise our call on HEKTAR to Not Rated (from Trading Buy) with an Ex-Rights TP of RM1.25 on FY18E, in light of challenging times ahead. Consistent with sectorial trends, rental reversions have been tough, but more so for smaller town-based malls under HEKTAR’s portfolio, while its recent acquisitions are unlikely to be DPU-accretive in the near term. All in, we expect FY17-18E RNI of RM38.4- 39.9m, on 6.5-6.6% yields.

Proposed acquisition of 1Segamat accretive in the long run, post FY18. It has proposed the acquisition of 1Segamat Mall, Johor (on 10th June 16), for RM104m, along with a proposed renounceable rights issue (indicative entitlement of 3 rights units for 20 existing units), to raise gross proceeds of up to RM75m (RM71m net proceeds). The remaining financing sum of RM33m will be raised via borrowings. The SPA is yet to be completed pending fulfillment of the conditions precedent (CP’s). We expect the exercise to be completed by 3Q17. Post the acquisition, we estimate 1Segamat to add RM4- 10m to topline in FY17-18E (2-6% of topline), but we expect it to be DPU-accretive only in the longer run post FY18 after accounting for higher operating and financing costs, and dilution from the rights issue.

Stable occupancy, but negative reversions in FY16A. HEKTAR has maintained stable occupancy in FY16A at 96.2% vs. 96.6% in FY15. However, rental reversions were dampened in FY16 at -9% vs. +3% in FY15, on minimal lease expiries of 19% of NLA. Notably, FY16 saw declining shoppers traffic of 2% YoY to 30.2m, mostly at Subang Parade (-6.2%) and Landmark Central (-6.3%), and as such we believe HEKTAR is working to prioritise occupancy over rental during tough times.

Unexciting outlook for FY17-18E. Looking ahead, FY17 is a major rental reversion year with 59% of NLA expiring (representing c.56% of rental income), which may face headwinds due to tough retail market conditions, putting more downward pressure on reversions and earnings. Furthermore, HEKTAR’s malls are smaller town malls which may find it tougher to acclimatise to weaker shopper traffic and tenant sales vs. the larger and more established city-based malls. As such, we estimate -7% reversion in FY17 and -3% in FY18, but the negative impact to top-line will be partially offset by the acquisition of 1Segamat Mall (by 3Q17), while we are assuming flattish occupancy in FY17-18 for now. All in, we estimate FY17-18E RNI of RM38.4-39.9m due to higher expenses and financing costs for the new asset in FY17.

FY17-18E DPU of 9.4-9.6 sen (ex-rights 8.2-8.3 sen). HEKTAR has maintained DPU at 10.5 sen, with a 94.0-97.5% pay-out ratio for the past 3 years. Going forward, we believe the Group will try to maintain above 95% pay-out. Our FY17-18E DPU implies 6.5-6.6% yields.

Not Rated (from Trading Buy) as we believe HEKTAR is fairly valued at an ex-rights TP of RM1.25 (previous cum/ex-rights TP RM1.57/RM1.37 based on report dated 24th Jun 2015). Although HEKTAR provides above average yields of 6.5-6.6% in FY17-18 vs. MREITs under our coverage of 5.2-5.8%, we believe earnings and DPU risks call for caution. As a result, we are applying the higher spread of +2.6ppt to our MGS target of 4.0%, (vs. other MREITs of +0.8ppt to +2.0ppt), which is also HEKTAR’s 1-year average spread. As such, we are bringing a closure to our Trading Buy position as we turn more conservative on the company’s future prospects

Source: Kenanga Research - 20 Jun 2017