KLCC Property Holdings - Priced-in for now

Raising TP to RM6.40 (from RM5.90) based on a more aggressive FY13E target net yield of 5.0% (from 6.0%) and KLCC Stapled REIT FY13E 90% payout of 33.2sen. Our TP also assumes Suria KLCC will be “REIT-ed” while new shares will be issued to fund the remaining 40% of the asset not owned by the company. We believe our target net yield of 5.0% (retail M-REITs under coverage are based on 4.0%-4.7%) is apt for KLCC Stapled REIT considering that is not a full-fledge M-REIT while  its free-float shares is the least amongst sizeable retail M-REITs. Since our new TP only implies <10% total return as the share price has run up 10% since the announcement, our call is downgraded to MARKET PERFORM (from OUTPERFORM). We also believe M-REITs are near its peak of the yield compression cycle given thin  risk-free-rate spreads while KLCC “REIT-able” office assets will be injected at peak 5.5% cap rates. 

Higher market cap, but share liquidity may remain unchanged. Post the exercise, PETRONAS-related  shareholding will increase to 75.5% from current 52.6%. They have obtained a GO waiver from SC, which could imply that PETRONAS may not pare down shareholding i.e. number of ‘free-float’ or MI shares are unchanged while MI shareholding is halved. So share liquidity may not improve albeit a larger market capitalisation of RM10b (from current RM5.8b). In terms of number of free-float shares, KLCC Stapled REIT has the lowest against sizeable retail M-REITs. 

Positioning KLCC Stapled REIT’s valuations. We are in the process of adjusting our M-REIT valuations, which are based on record low yield spreads to the 10-year MGS. We expect CY13E 10-year MGS to dip to 3.0% (3.3% previously) while sizeable retail M-REITs record low Fwd yield spreads are now +0.5ppt to +1.5ppt. Although KLCC Stapled REIT will have the highest market capitalisation amongst M-REITs, we have highlighted that number of free-float shares are likely to remain unchanged. Although the group has the “PETRONAS” premium, a bulk of their office income is based on fixed step-up rates, which translate to 3% p.a. organic growth rate vs. the more exciting retail M-REITs organic growth of 6%-8% p.a. Also, it is not fair to other M-REITs to view KLCC Stapled REIT as a full-fledge one; 1) although management intends to maintain a minimum of 90% payout overall, there are no guarantees of a consistent 90% payout for the non-REIT portion (32% of IP value); 2) the non-REIT portion is still liable for 25% corporate tax. Hence, we believe the group deserves a higher yield spread of +2.0ppt to CY13E 10-year MGS or a FY13E target net yield of 5.0% (6.0% previously). 

We have also reduced our FY12-13E earnings by due to PETRONAS Twin Towers (PTT) 3%-8% due to lower than assumed initial term rent base (refer overleaf). Assuming the KLCC Stapled REIT structure and overall 90% payout, we expect FY13E DPU of 30.8sen (refer to Base Case), implying a TP of RM6.16 (RM5.90 previously) based on FY13E target yield of 5.0%. However, we believe Suria KLCC could be REIT-ed, which will offer more upside to valuations. 

Suria KLCC maybe REIT-ed soon. Suria KLCC is only 60% owned by KLCC Property so remaining portion needs to be consolidated before injection into KLCC REIT. Post KLCC Stapled REIT, there is ample gearing room as net gearing is expected to be as low at 0.13x (0.17x based on REIT gearing). We see two scenarios: Assuming 100% gearing of Suria, we expect; 1) net gearing of 0.27x (0.30x based on REIT gearing) which is still comfortable; 2) DPU to increase by 8% to 33.2sen implying TP of RM6.65. However, if the remaining 40% of Suria is funded via new KLCC Stapled REIT shares, 1) FY13E DUP will only rise by 4% to 32.0sen implying TP of RM6.40; 2) net gearing will remain low at 0.11x (0.17x on REIT gearing).  Although the full-gearing scenario of Suria KLCC offers higher DPU and implied TPs, we prefer the equity scenario as it will help increase the group’s free-float by 65% to 0.7b shares which would help liquidity.  

Source: Kenanga