1H17 core earnings of RM329m came in slightly below both our and market expectations, at 44%. 1H17 NDPS of 16.1 sen was also below our FY17E NDPS of 37.1 sen (43%). We lower FY17-18E core NP by 7-6% to RM700-719m. Downgrade to MP (from OP) and lower TP to RM7.80 (from RM8.30) on a lower FY18E GDPS/NDPS of 37.5 sen/35.4 sen on a +0.85ppt to our 10-year MGS target.

1H17 RDI slightly below our and markets’ expectations at 44%. 1H17 realized distributable income (RDI) of 329m came in slightly below both our and consensus estimates at 44%. 2Q17 GDPS of 8.60 sen, (3.16 sen single tier dividend plus 5.44 sen subject to 10% withholding tax), translate to NDPS of 8.06 sen, brought 1H17 NDPS to 16.1 sen which is also below expectations at 43% of our FY17E NDPS of 37.1 sen. Top-line and net profit were considered within our expectations at 47%, but we believe results missed due to a lower ratio of RDI to net profit, which was at 93% in 1H17 (vs. our bullish expectations of 100%).

Results highlights. QoQ, RDI declined marginally, (-2%) on the back of a flattish top-line on marginal improvements on all segments save for the hotel segment (-6.5%) likely due to fewer banqueting events in 2Q17. EBITDA and PBT margins remained fairly stable at 75.6% and 68.2%, respectively, but RDI declined by 2% likely from lower distributable income from the REIT portion. YoY-Ytd, top-line was up slightly (+1%) on: (i) improvements from the hotel segment (+6.4%) on better occupancy at 46.7% (from 42.8% in 2Q16), and (ii) management services segment (5.6%), but higher operating cost (+6%) and lower interest income (-30%) dragged down PBT margins (-1.5ppt). All in, RDI declined by 3%.

Outlook. The Group remains on the lookout to acquire assets, and has renewed its shareholders’ approval for a 10% placement in Apr-17. Management has renewed Menara ExxonMobil’s lease (expiring end Jan 2017) for 9+3+3+3 years with ExxonMobil retaining 60% of the building while management has already identified a tenant for the remaining 40%, which was completed in 2Q17, contributing fully from 3Q17 onwards. Lower earnings in FY17-18E by 7-6% to RM700-719m as we lower our RDI assumptions closer to management’s current RDI pay-out levels in 1H17, which is c.93% of net profit. FY17-18E NDPS of 34.5- 35.4 sen implies 4.4-4.5% yields.

Lower call to MARKET PERFORM (from OP) and TP to RM7.80 (from RM8.30) post lowering earnings estimates. Our TP is based on an unchanged target gross/net yield of 4.9%/4.5% but lower FY18E GDPS/NDPS of 37.5 sen /35.4 sen (from 40.3 sen/37.7 sen) on a +0.85ppt to our 10-year MGS target of 4.00%. We like KLCC for its strong asset stability as most office assets are on long-term leases (i.e.15 years) and on a TNL basis, while gearing remains low, allowing for sizeable acquisition potential. Further clarity on its acquisition pipeline will be a positive re-rating catalyst. However, at current levels, KLCC’s FY18E net yield of 4.5% (gross: 4.8%) is slightly below MREITs’ average of 5.1% (gross: 5.7%), prompting us to lower our call.

Downside risks to our call include: (i) bond yield expansions, (ii) flattish to negative rental reversions, and (iii) weaker-than-expected occupancy rates.

Source: Kenanga Research - 16 Aug 2017