Post briefing, we find WCT to be on a tough footing given: (i) weaker construction margins, (ii) poorer occupancies at malls and hotels, (iii) high rebates given to entice mall tenants to stay on, and (iv) the fact that the RM822m perpetual sukuk cost so much more than a traditional loan. Reduce earnings on higher tax given non-tax deductible perps. Downgrade to UP (from MP) with a lower TP of RM0.46 (from RM0.48).

1QFY20 breakeven bottom-line was supported by a land sale gain of RM16m. While management has targeted to further monetise RM55m worth of land this year, there are still no firm buyers at this juncture. Hence, on the back of the slowdown caused by the pandemic, subsequent quarters’ profitability would be more challenging with no land sales in the horizon.

Weaker construction margins. Management has guided for lower EBIT margin of 8% (vs. the previous 9%) for infrastructure-related jobs due to additional prolongation costs. Infrastructure jobs make up 34% of their total construction order-book (of RM6b which has 4x cover) while building jobs makes up the remaining 66%. On a brighter note, collection of payment has been smooth so far.

Full rental rebates for mall tenants worth RM8m/month during the peak of MCO (Mar – Apr 20). Currently, WCT is providing rebates of up to 50% during the RMCO (June 10th – Aug 31st). Gauging from the current footfalls (of 50-60% of normal level) during RMCO, we project traffic for the remainder of the year to remain tepid. Thus, we would not be surprised if the rental rebates to support tenants last beyond RMCO until year end.

Mall tenancy contracts due for renewals could see some exits especially from Paradigm JB which will see a bulk of it expiring in Sep/Nov 2020. While occupancy at all malls is expected to drop, management is cautiously optimistic for all malls to maintain >90% occupancy – but on flat reversions.

Hotels currently at 10% occupancy rate after reopening on June 10th. Prior to the pandemic, WCT’s two hotels – New World and Premiere Hotel were already loss-making with 40-50% occupancy levels. Thus, we expect losses to widen post Covid-19. Perpetual sukuk might look better on net gearing and allows for flexibility, but the real cost is substantial. On the surface, net gearing fell to 0.58x (from 0.98x) when WCT refinanced RM800m of medium-term notes (MTN) with perpetual sukuk. That said, for cost comparison, the perps effectively cost an additional c.RM19.3m/annum (+2.4ppt) more than the MTN it replaces due to: (i) higher rate of 5.9% vs. 4.6% and (ii) non-tax deductible nature of the perps. (refer Table 2)

Reduce FY20/21E earnings on higher tax due to non-tax deductible nature of the perps as we had previously assumed the perps distribution were tax deductible. Hence, FY20E earnings are reduced to a loss of RM6m (from CNP of RM8m) and FY21E earnings reduced by 34% to RM43m. Downgrade to UNDERPERFORM (from MP) with reduced TP of RM0.46 (from RM0.48) from lower BV based on unchanged PBV valuations to 0.2x (-2SD below 2-year mean) given its high financial leverage which could amplify the severity of the current downturn.

Source: Kenanga Research - 29 Jun 2020