IGB Real Estate Investment Trust (Dec 29, RM1.80)

Maintain hold with a lower target price (TP) of RM1.63: Klang Valley retail mall operators are in a tough time, facing a cocktail of weak retail sentiment, increased competition (new malls and e-commerce) and possible overnight policy rate hikes.

Backed by its strategic location (good accessibility and a large captive market) and diverse tenant mix, IGB Real Estate Investment Trust’s (REIT) Mid Valley Megamall and The Gardens have fared relatively well.

These assets have enjoyed 100% occupancy (as at end-December 2016), the highest among Klang Valley peers. IGB REIT has delivered uninterrupted year-on-year growth in revenue, a commendable feat under prevailing market conditions.

IGB REIT, in our view, is ahead of its peers in preparation for possible rate hikes. The REIT has one of the lowest gearing ratios among retail peers. Importantly, IGB REIT in August 2017 set up a medium-term notes programme of up to RM5 billion, with a tenure of 20 years.

The first tranche (RM1.2 billion) was given the highest rating by RAM, with a “stable” outlook, signifying the quality of IGB REIT’s assets.

The construction of the SouthKey Megamall (a joint-venture project between IGB Corp Bhd and a Johor-based company) is ongoing, and on track for its soft launch on Aug 8, 2018. The project has a large net lettable area (NLA) of 1.5 million sq ft (about 56% of IGB REIT’s current NLA).

We are fairly upbeat on the project, in view of IGB Corp’s strong project track record and pent-up demand from Johorians. Nonetheless, an acquisition, if it were to happen, may only materialise in 2020 to 2021.

We recently met up with several retail mall operators. Broadly, most managers cited weak consumer sentiment as their main concern and are cautious about the 2018 market outlook. We concur. For IGB REIT, we now expect a lower rental growth of 3% per year (from 4%) and cut our 2017 to 2019 earnings per unit forecasts by 2% to 3%.

In tandem with our earnings cuts, we trim our dividend discount model (DDM) derived-TP by 3% to RM1.63. We reiterate our “hold” rating on IGB REIT. While we like IGB REIT for its first-class assets and strong balance sheet, the weak retail mall market and possible rate hikes should weigh on investor sentiment. At a 5.6% yield, valuation is within its historical trading range, comparable to peers and and looks fair.

Upside risks include a change in market expectations from rising rates to a rate cut, and a strong recovery in consumer sentiment. A downside risk is further deterioration in the retail mall market, leading to weaker-than-expected earnings. We derived our fair value (FV) using a DDM model. We estimate that every 25-basis- point (bps) increase in cost of equity (from 8.2%) would lower our FV by 4%, while every 50bps change in our long-term growth assumption (3%) will increase/decrease our FV by 7%. — Affin Hwang Capital, Dec 29

This article first appeared in The Edge Financial Daily, on Jan 2, 2018.

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