SINGAPORE (Apr 13): CIMB is downgrading Lippo Malls Indonesia Retail Trust (LMIRT) to “reduce” from “hold” with a lower target price of 33 cents.

The downgrade followed amendments made by the Indonesian government to rules regarding payment of income tax on income received or earned from land and building leases in Indonesia from Jan 2.

See: New tax regulations in Indonesia could impact LMIRT

The new rules state that all income earned from building and land leases in Indonesia will be hit by a 10% income tax of the total value of the building lease that now includes service charges and utilities recovery charges.

Property owners previously were not subjected to pay income tax on such charges. They are paid by tenants to a third party operator appointed to manage and maintain the property. Following this, tenants are required to withhold income tax on such charges.

Based on the trust’s pro-forma assessment, it indicated that its FY17 distributable income could drop by about 7.2% to 3.19 cents, instead of 3.44 cents. This situation is also assuming that the new regulations were in effect on Jan 1 instead.

After this change, the trust will no longer outsource the operational management of the mall to a third party vendor.

In a Thursday report, analyst Lock Mun Yee says, “While LMRT will take time to put the system in place, we anticipate this change to take place in FY18. Hence, we tweak our projected revenue to reflect the inclusion of service/utilities recovery charges from 2H18 onwards as well as adjust our DPU to take into account the additional tax expense.”

In addition, the analyst lowers her IDR to SGD exchange rate assumption to 10,300, compared to 9,450 previously. Since Dec 2016, the IDR has depreciated against the SGD by about 12%.

Currently, the trust uses currency option contracts to hedge 85% of its IDR quarterly cashflow. It put in place two-year currency hedges in Feb 2017 and as the hedges roll off, the analyst believes that the continued weakness in the IDR could likely have an adverse effect when the trust converts its distributions into SGD.

Nonetheless, Lock has lowered her FY18/19 DPU projections by 26.3%/26.6% to factor in the higher tax expense and weaker rupiah assumptions.

“We continue to find LMRT’s long-term growth story of exposure to the rising urbanisation and growing middle-class consumption still intact. However, in the near term, this earnings erosion from higher taxes is likely to be a drag on its share price performance,” says Lock.

As at 12.41pm, units in LMIRT are trading 3 cents or 8.22% lower at 34 cents, giving it a FY18 price-to-book ratio of 1.15, with a dividend yield of 6.80%.