Hektar REIT (OSK Research), reiterates ‘buy’, target price upgraded to RM1.37

1QFY2010 Results Review: A pleasant surprise indeed

The 1QFY2010 earnings surpassed our and market expectations by ?9%. Turnover and net profit nudged up by 6% and 4% y-o-y respectively on higher turnover rent and implementation of FRS 117. Consequently, the 2.5 sen dividend (vs 2.4 sen previously) was also slightly higher than expected. Upon revising upwards our earnings forecast given the improving retail market outlook and gradual positive rerating on M-REITs, we are upgrading our TP on Hektar to RM1.37. Maintain BUY.

Beating expectations. Hektar’s 1Q10 earnings surpassed our expectation by close to 9% on an annualised basis. This was mainly as a result of: (i) higher turnover rent due to much improved retail sales by its tenants, which reflects improved consumer spending during the quarter; (ii) implementation of FRS 117 which required Hektar to recognise rental income receivable under tenancy agreements with provisions for step-up rent on an average basis over the period of the tenancy, thus giving rise to an additional earnings contribution of RM0.4 million in 1Q10; and (iii) lower than expected borrowing costs in 1Q10.

Earnings upgrade. After adjusting for our assumptions, particularly on borrowing cost, weare upgrading our earnings forecast for FY10 by 6%. Consequently, we are upgrading ourdividend forecast for FY10 slightly to 11.0 sen (from 10.8 sen previously).

But not all was rosy in 1Q10. Despite the much-improved consumer spending, which contributed to higher turnover rent collected in 1Q10, all was not that rosy, particularly for Mahkota Parade (Melaka). Rental reversion for Mahkota Parade in 1Q10 fell 16% over the previous rental rates, Subang Parade reported flat rental reversion (-2%) and Wetex Parade saw a slightly higher rental reversion (+6%). As we highlighted previously, the weakness in Mahkota Parade was to be expected due to: (i) stiff competition from numerous newer malls in the vicinity; and (ii) slight impact from refurbishment works to upgrade the mall during the quarter. We expect the mall’s performance to stabilise, if not improve, in 2H10 as refurbishment works would have completed in May 2010. A refurbished mall would ensure that: (i) Mahkota Parade stands a better chance of competing against its competitors; and (ii) there will no longer be any disruption to its tenants’ business.

Reiterate BUY. Although its share price has appreciated by as much as 12% since our lastupgrade in target price in 10 Feb, we continue to reiterate our BUY call on Hektar based on its still attractive dividend yield of 8.9%. The target price is upgraded further to RM1.37(from RM1.29) to reflect our slight earnings upgrade as well as the ongoing positive reratingon M-REITs. M-REITs are now trading at an average forward dividend yield of about8.0% (vs about 8.4% previously).

Competition heats up in Subang Jaya too? The recent opening of the 600,000 sq ft Empire Shopping Gallery (ESG) is likely to destabilise the retail market in Subang Jaya in the short term as the market would have to absorb the sudden influx of retail space. An example would be the recent relocation of Toys’ R’ Us from Subang Parade, which used to contribute marginally to Hektar’s earnings (2.3% of the mall’s monthly income in FY09 only), to the ESG as part of its expansion plans despite the higher rental rate. As the ESG is marketing itself as a ‘lifestyle’ shopping mall with focus on the mid-high to high-end market, it will continue to attract certain tenants in the region which are able to fit into the mall’s business model. Such tenants, who already occupy some of the older malls in the region, however, are few in numbers. The malls that offer a similar concept in the immediate vicinity such as the ESG, however, are even fewer, if any. Therefore, we believe the destabilisation is likely to be short-lived and have minimal impact on the region’s retail market.

We will get a clearer picture if we were to compare the tenant mix between Subang Parade and ESG. While the ESG features the higher-end Tangs and Charles & Keith department stores, Subang Parade offers the more affordable Parkson. In terms of food & beverage outlets, the ESG offers the higher-end Italiannies and Chili’s while Subang Parade has the more affordable TGI Friday’s, Nando’s and Dave’s Deli, just to name a few. Subang Parade has the Cold Storage supermarket while we have yet to see any supermarkets in ESG. In conclusion, as it appears for now, ESG focuses primarily on a ‘lifestyle’ shopping experience while Subang Parade continues to promote itself as a convenient place for the residents in the neighbourhoods to purchase their daily/weekly necessities. Over the mid- to longer term, older shopping malls such as Subang Parade will naturally complement the ESG rather than compete against it. Therefore, we are quite unperturbed by the impact from the emergence of the ESG on the prospects of Subang Parade, at least in the mid- to long term.