KLCC Property Holdings Berhad

Investing Ideas: Defensive earnings make KLCCP appealing

KLCC Property Holdings Bhd (KLCCP) is among the very few bright spots in the property sector, which is being hit by growing inflationary pressure, expectation of interest rate hikes and consumer-spending cuts. The group's beauty lies in its defensive income stream that made it appealing at a time when most companies' earnings are vulnerable to unfavourable economic conditions.

Thanks to steady rental income, KLCCP will be less affected by a slowdown in the property sector where developers are facing a squeeze in margins caused by rising building material costs and slow sale growth or contraction in sales. According to HwangDBS Vickers Research, KLCCP's earnings are the "most defensive" in the property sector.

STEADY INCOME
KLCCP derives the bulk of its earnings from rental incomes that have been secured by long-term leases with anchor tenants such as Petroliam Nasional Bhd (Petronas) and Maxis Communications Bhd, which are presumably good paymasters.

Rental incomes from these long-term lease agreements generate RM179 million in annual operating profit, or 43%, of KLCCP's earnings before interest, taxes, depreciation and amortisation (Ebitda). The agreements also offer guaranteed rental increase of 3% (year-on-year), which is adjustable for inflation.

KLCCP owns the 88-storey Petronas Twin Tower and its shopping mall podium (Suria KLCC), Menara Maxis, Menara ExxonMobil, Mandarin Oriental Hotel and Kompleks Dayabumi. The group also holds vacant commercial land surrounding the twin towers.

Petronas Twin Towers and Menara Maxis, both of which contribute 41% to the group's rental income, are on triple-net-leases. According to HwangDBS, under triple-net-leases, tenants will fully bear all property taxes, insurance and maintenance costs. The leases will shield KLCCP from rising operating costs.

PRIME LOCATION
With consumers expected to tighten their purse strings amid rising inflationary pressure, there are concerns that the occupancy and rental rates in Suria KLCC may not be sustainable. But again, analysts say the retail space is rented out on three-to-five year agreements. This guarantees stable income for KLCCP.

Given its prime location, Suria KLCC stands out strongly among the retail shopping malls in the Klang Valley. The mall currently enjoys 100% occupancy rate. It is not surprising that KLCCP has a long list of prospective tenants wanting to move in to capture the high-end domestic shoppers and international tourists, who have deep pockets to spend.

HwangDBS says it expects rental growth for Suria KLCC to moderate to a y-o-y increase of 10% from 15% previously. Citi Investment Research forecasts commercial property values and rental rates to increase by between 5% and 10% annually in KLCC areas.

GROWTH POTENTIAL
KLCCP's prime landbank, located around the Twin Towers, is another jewel in its crown. Analysts say future developments on the current vacant commercial land will be the catalyst for stronger earnings growth.

The group is developing a parcel of land called Lot C, which is to be completed in phases starting from 2010. Upon completion, the project will provide an additional 1.4 million sq ft of gross floor area, with a combination of retail and office space.

KLCCP also plans to commence, within the current FY2009 ending March 31, a commercial development project on another parcel of land called LotD1 (next to Lot C), comprising both serviced apartments and office space.

HwangDBS estimates the two new projects to fetch annual rental revenue of RM197 million. "We expect earnings to increase from FY2012 onwards, with y-o-y growth of between 9% and 19%, upon completion of the Lot C and Lot D1 projects," it says.

For FY2008 ended March 31, KLCCP achieved higher revenue of RM843 million against RM781 million in FY2007. Its net profit was RM442 million versus RM982.8 million the year before, while earnings per share was 47.27 sen compared with RM1.05 previously.

The fall in realised net profit is due to the adoption of the fair value adjustment scheme in accordance with the Financial Reporting Standard 140. The group reported a RM1.68 billion valuation gains in FY2007 compared with only RM427 million in FY2008.

APPRECIATING ASSET VALUES
Prime land is getting scarce in the city, particularly in the Golden Triangle. This suggests that the value of KLCCP's property assets, including its landbank, will remain on an uptrend. Being an asset-based company, KLCCP's share price is bound to benefit from the appreciation of its property and land values.

Rising building materials costs may slow down construction activities, and result in tighter supply of commercial buildings, but this development may augur well for existing property owners like KLCCP.

The market value of office space in the Golden Triangle has more than doubled to RM1,230 psf in 1Q2008 from RM550 psf in 2006. The land price near KLCCP has also gone up substantially to between RM2,000 and RM2,600 psf from RM1,000 psf in 2006, according to HwangDBS.

KLCCP's single largest shareholder, KLCC Holdings Sdn Bhd, owns several properties in the KLCC vicinity, including KL Convention Centre, Prince Court Medical Centre and Traders Hotel. Hence, some are also betting on possible asset injection by the parent company.

But asset injections can be a cost-burden if the assets are not profitable.

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