2015

Dear Valued Unitholders,

On behalf of the Board of Directors, I would like to share with you the achievements and activities that have occurred in the financial year ended 31 December 2015 (“FY2015”). I am pleased that Hektar REIT has maintained its strong and stable performance.

Chairman's Letter to Unitholders from Hektar REIT's 2015 Annual Report.

On behalf of the Board of Directors, I would like to share with you the achievements and activities that have occurred in the financial year ended 31 December 2015 (“FY2015”). I am pleased that Hektar REIT has maintained its strong and stable performance.

2015 – A year of economic decline

2015 proved to be a difficult year for Malaysians. Initially, the introduction of goods and services tax (“GST”) in April discouraged retail spending. Later, the oil crisis and its accompanying currency crisis further dampened retail sentiment as thousands of people from the oil and gas and banking sectors were laid off, vastly decreasing the number of spending shoppers. As a result, numerous retailers have decided to consolidate instead of expanding their business.

To aggravate matters, the weak ringgit has affected many retailers’ cost of doing business, putting a squeeze on their profit margin. With reduced consumer spending and increased cost, retailers are facing a very real challenge in their business, not seen since 1997. As a consequence, our negotiating leverage with them is severely tested.

Fortunately, we have managed to weather this economic turbulence intact in 2015, with realised earnings registering RM44.7 million, higher than the previous year. This bears testimony to our strategy of geographical diversification, where the performance of a mall in one location has helped another mall in a separate location facing challenges.

Our history illustrates the efficacy of this strategy; in 2014, our mall in Sungai Petani, Central Square experienced a significant dip in revenue due to the ongoing asset enhancement initiative (“AEI”). Central Square’s reduced revenue was mitigated by higher revenues in other malls.

In 2015, it is the turn of Mahkota Parade to suffer dips in revenue as domestic competition heats up, and this time, it was Central Square’s much-improved revenue post-AEI that had mostly helped out.

Though shopping mall performance is premised on sound management, sometimes external factors like rent competition from neighbouring malls, GST and the economic condition play an equally crucial part. Our strategy against these external factors is diversification. We find that shopping malls in smaller towns, though not entirely insulated, are affected less by the prevailing economy than shopping malls in bigger towns.

Operating environment and market update

Based on Bank Negara’s third quarter 2015 report, Malaysia’s economy grew by 4.7% in 3Q2015, the key driver being private sector expenditure, mainly manufacturing and services sector. This growth is markedly lower than the corresponding period of the previous year, which was 5.6%. Meanwhile, private consumption growth moderated to 4.1% in the same quarter due to household adjustment to GST (2Q2015 : 6.4%). Following this, Bank Negara projects growth to be between 4% to 5% in 2016.

Due to weak retail figures, Retail Group Malaysia downgraded its forecast in September 2015 for the fifth consecutive time to 2.0% for 2015, from 3.1% earlier – down 11.9% y-o-y. The association also said in their recent report that confusion such as that involving service charges for the food and beverage industry, telecommunications top-up cards, last minutes’ announcement of products to be exempt from tax, and sudden increase in taxi fares, also contributed to the drop in retail sales. Consumers were confused by the conflicting messages by the different authorities, causing them to delay their purchases.

Market researcher Nielsen found that consumer confidence in Malaysia fell to 78 points over the July to September period, down 11 percentage points on the quarter, marking a record low since the survey began in 2005, as well as Southeast Asia’s worst reading for the quarter.

Financial performance

Continuing stability

Gross revenue of RM125.5 million for FY2015 was a 2.9% increase from the financial year ended 31 December 2014 (“FY2014”), the main contributor being casual leasing and car park income. However, percentage rent dropped due to lower retailer sales.

Despite the overall increase in the cost of doing business, our operations team has managed to rein in operating expenses via astute negotiations with service providers, energy-saving initiatives as well as seeking sponsors to subsidise our promotional activities.

As a result, Net Property Income (“NPI”) FY2015 went up by 4.4% to RM76.5 million compared to FY2014. Meanwhile, realised income increased from RM44.3 million to RM44.7 million.

However, our net income fell from RM50.4 million in FY2014 to RM4.8 million in FY2015 due to fair value loss arising from revaluation of our properties (non-cash item). The revaluation loss arose mainly from timing issue; we need a longer time to crystallise the returns to our investment, where:

  1. At Mahkota Parade, we acquired individual lots and embarked on an AEI to increase the number of screens for our cinema. The ultimate objective of incurring these capital expenses is to increase the value of our mall. While these capital expenses were incurred and recognised upfront in our books, it will take longer than a year for them to generate additional income that will improve Mahkota Parade’s overall market value. Hence the revaluation deficit.

  2. Similarly for Central Square, a major AEI was undertaken primarily to revitalise a 16-year old mall. Unfortunately, there was no space to create new net lettable area (“NLA”) that would immediately increase the value of the mall. This means income returns would require several rental cycles to improve the overall market value of the mall.

  3. Finally, the overall weak outlook of the retail and property industry has influenced the valuers to be more conservative in their method of computation.

Please be reminded that the revaluation deficit does not affect our ability to pay dividends as it is a non-cash item. In 2015, despite the revaluation deficit and poor market conditions, our total dividend payment to investors remain the same as 2014.

Income distribution and accounting policy

Hektar REIT announced a distribution per unit (“DPU”) of 10.50 sen for FY2015 maintaining the distribution made in FY2014. Since its initial public offering (“IPO”) in 2006, Hektar REIT has maintained its uninterrupted track record of making quarterly distributions to its unitholders, providing unitholders a stable distribution track.

We have maintained a policy of paying out at least 90% of our distributable net income in four quarterly distribution payments throughout the year. We should clarify that distributable net income is net income excluding non-cash items, such as fair value adjustments (usually attributed to property value increases) and items under MFRS 117, an accounting standard implemented in FY2010 (see the notes to the accounts for more details). As a result, the FY2015 distributable income is higher than the net income. After paying 90% of the distributable net income, Hektar REIT retains the remaining 10% for future asset enhancements of the properties and potential acquisitions of sold lots throughout the Hektar REIT portfolio.

Stable distributions and capital growth

Hektar REIT’s unit price closed the year at RM1.52, increased by 3 sen as compared to the opening price in the beginning of the financial year. Hektar REIT’s net asset value at 31 December 2015 stood at RM1.46 per unit.

If you have invested in Hektar REIT units in the beginning of 2015 at RM1.49 and remained a unitholder till the year end, you would have received four distributions totalling 10.5 sen per unit, representing a dividend yield of 6.9% (based on a closing price of RM1.52 on 31 December 2015). Your total return on Hektar REIT for FY2015 would be approximately 8.9%.

At the end of 2015, Hektar REIT units had been traded at a spread of 295 basis points to the 10-year Malaysian Government Securities (“MGS”) yield. Previously, the spread against MGS yield was recorded at 287 basis points in 2014. The premium over the MGS yield had increased by 8 basis points due to lower MGS rates.

Financing in 2015

Hektar REIT’s financing is secured by Al-Murabahah overdraft facilities with 6 tranches worth RM184 million, RM150 million, RM15 million, RM87 million, RM65 million and RM30 million expiring in 2016, 2017, 2021, 2016/17, 2019 and 2018 respectively. Hektar REIT’s FY2015 gearing ratio had increased to 44.3% (FY2014: 40.9%) of gross asset value which is still within the 50% limit set by the authorities whilst its weighted average cost of financing as at the year ended FY2015 was maintained at 4.9%.

We were reliably informed by our banker that despite Bank Negara maintaining the Overnight Policy Rate of 3.25%, commercial rate has started creeping up since 3Q2015 due to Bank Negara’s phased implementation of Basel III. In a nutshell, Basel III aims to promote a more resilient banking system and further strengthen global capital and liquidity regulations. Banks are basically asked to increase their capital requirements as a buffer. Key changes in Basel III include the introduction of a counter-cyclical buffer and a leverage ratio. It also introduced the liquidity coverage ratio and the net stable funding ratio. Ultimately, this has increased cost of borrowings.

More than 60% of Hektar’s borrowings remain hedged but its remaining borrowings are now exposed to increasing interest rates. We are currently exploring options to pare down our loans to limit our exposure.

Portfolio performance

The shopping centre experience

Hektar REIT’s 5 malls stretch across the west coast of Peninsula Malaysia: Subang Parade in Subang Jaya, Selangor, Mahkota Parade in Melaka, Wetex Parade in Muar, Johor, and Central Square in Sungai Petani and Landmark Central in Kulim, both in Kedah. Collectively our NLA is 1.8 million square feet with a market catchment of 3.0 million. We aim to bring best practices across all locations of our malls and strive to give shoppers the same enjoyable shopping experience.

Subang Parade

An iconic and historical mall, Subang Parade is located in the heart of Subang Jaya’s commercial centre. Subang Parade continues to be Hektar REIT’s flagship mall. Its close proximity to the train station, the soon-to-be-completed LRT and main road links afford it great accessibility. Subang Parade sits on an enclave of several shopping centres located within a short walking distance of each other.

In 2015, we recalibrated a significant number of retail lots to offer improved retail experience to the shoppers. Larger lots were subdivided to increase tenancy mix; for instance, part of MPH was carved out to bring in several beauty and healthcare service providers – the hitherto low traffic area is now designated as a beauty and healthcare corner.

We have also increased food and beverage (“F&B”) offerings to diversify our shoppers’ culinary options. NY Steak Shack, Papparich, Ah Cheng Laksa, and Mozer’s are the latest food outlets that have joined Subang Parade.

From our analysis, compared to our other malls, retailers at Subang Parade suffered the strongest impact from weak consumer spending. Mass layoffs occasioned by the world economy affect Subang Parade the most as these workers reside in Klang Valley.

Mahkota Parade

Located at the heart of the city of Melaka, Mahkota Parade was Melaka’s first regional shopping mall when it opened way back in 1994. It celebrated its 20th anniversary in 2014. Mahkota Parade was positioned and is still one of Melaka’s premier shopping destinations as it is strategically located in the tourist belt of the historical city of Melaka. The city is inscribed on UNESCO’s World Heritage List as part of UNESCO’s preservation of historical sites across the globe. In this part of the city, there are other shopping malls such as Dataran Pahlawan and Hatten City shopping complexes which, due to their proximity to one another has created a vibrant, though highly competitive retail precinct.

In 2015, we expanded our cinema from 4 screens to 10 screens. To celebrate this expansion, the cinema re-launched glamourously with the attendance of the international movie star from Hong Kong, Donnie Yen. Tens of thousands of fans and shoppers thronged Mahkota Parade that day which benefited our retailers.

As explained earlier, Mahkota Parade’s performance dipped in 2015 due to very stiff domestic competition as well as the general economy. In the face of this great challenge, Mahkota Parade differentiated itself with colourful events held throughout the year to boost shopper traffic and retailer sales. Amongst the events include “Balloon Wonderland Campaign” during school break, “AA Bazaar” – a bazaar bringing together many online retailers, “Hari Belia Sukan” organised with Jabatan Belia dan Sukan Negeri Melaka, in conjunction with the nationwide sports day, “Save a Life” campaign in collaboration with WWF, where stage activities were held to create awareness on turtle and marine life preservation.

Wetex Parade’s leading position in Muar

Wetex Parade is an integrated retail complex located in the midst of Muar town’s commercial area. It enjoys a prominent position as a premier retail destination for the local community as Wetex Parade is the only purpose built shopping mall in the thriving town of Muar.

Wetex Parade continues to be the epitome of stability for Hektar REIT as it weathered the economic storm with minimal impact. In 2015, we introduced several new offerings and new retail concept like: Big Apple Donuts & Coffee, Focus Point, Bonita (first in Johor), and Lolita – a fashion café.

The upcoming expiry of Classic Hotel’s long term lease gives us a good opportunity to explore the recalibration of the retail and hotel area to increase the overall NLA of the mall.

Central Square

Central Square is situated in the middle of Sungai Petani town, which is located 35km north of the state of Penang. It is a thriving industrial township with a sizeable population of more than 400,000 residents. The township is also about 25km away from another growing industrial district known as Gurun, a heavy industry zone. Sungai Petani’s retail environment is thriving and is increasingly competitive as the town boasts several shopping malls and hypermarkets.

Central Square’s AEI was fully completed in 2015. Following this, a major promotional relaunch was conducted, officiated by the former Menteri Besar, Datuk Seri Mukhriz Mahathir. The relaunch also reintroduced the cinema in Central Square, which previously had ceased operations. Other promotional events that were attached to this relaunch included the launching of Super Kids Squad to attract family patrons.

Central Square’s revenue has dramatically increased since the completion of the AEI, despite the gloomy economic backdrop. We hope that Central Square can continue to contribute positively to Hektar’s portfolio in the coming years.

The revitalised mall has attracted several new retailers like Apple Store, OPPO, Panbowling, and Sushi World.

Landmark Central

Landmark Central is situated in Kulim town, which is regarded as the feeder to the successful Kulim Hi-Tech Park that resides many of the global technology companies. Landmark Central is the only purpose built shopping mall in Kulim town serving the immediate catchment of more than 250,000 residents. The closest competitors are two other malls located in the neighbouring Bukit Mertajam town. Landmark Central was officially launched in 2009 and since then Landmark Central has been a catalyst to the town attracting more commercial development towards the vicinity.

Landmark Central has demonstrated the fastest growth in terms of revenue amongst the other malls in Hektar’s portfolio in 2015. It recorded very healthy reversion rates (average about 10% for FY2015). Additional fashion offerings like Factory Direct and Scarfsecret were added to improve the tenancy mix at the mall.

We are now looking into plans for AEI to increase the retail space at Landmark Central.

Moving forward into 2016

We expect 2016 to be Hektar REIT’s toughest year over its 10-year history. To reiterate, the oil crisis, the currency crisis, mass layoffs and hike in interest rates from the implementation of Bank Negara’s Basel III are not doing Hektar REIT and retailers any favours. The retail outlook in 2016 is very lacklustre and retailers continue to be skittish. A significant number of our loyal retailers are seeking our support to reduce their rent until the tide is turned. These are not fly-by-night retailers. They have been with us for many years and have never objected to rent increases before. I feel it is now time for us to demonstrate our loyalty to them during this extremely trying period. Bear in mind though, that by acceding to these rent reduction, Hektar REIT may experience dips in revenue in 2016.

However, every cloud has a silver lining. We now expect more opportunities for acquisition as we are now in a better position to negotiate with vendors, who we feel are more willing to accept our high-yield requirement.

Acknowledgements

On behalf of the Board of Directors, I wish to thank our team for their commitment and dedication to their work. Our appreciation is also extended to our retailers, vendors and business partners. Your contributions and support ensure that Hektar REIT remains a defensible, safe and preferred investment for our investors.

Dato’ Jaafar bin Abdul Hamid
Chairman & Chief Executive Officer