Investment Highlights

• We maintain our OVERWEIGHT recommendation on the REIT sector. We believe the worst is over for REITs. We expect the sector to be broadly on its recovery path as consumers spending and footfall pick up, following the relaxed restrictions on the movement control order (MCO), as well as the upcoming Hari Raya festive season in 2Q. While we are aware that before Malaysia achieves herd immunity (which is expected to be by the end of 2021), any further outbreaks of Covid-19 might still cause bumps to the recovery, earnings visibility of the REITs has been improving following the wide rollout of vaccines globally.

• We take comfort that the occupancy rate at the anchor malls of the retail REITs under our coverage remains healthy at above 95% (on average, only a slight decline of 1%–2% was recorded as compared to pre-pandemic levels). While we observed that the pandemic has accelerated the consolidation of departmental stores and causing them to move out from the lifestyle malls, we believe this could be a blessing in disguise as the malls are replacing the anchor tenants (which usually enjoys lower rental rates by taking up large lettable area) with higher average rental rates specialty stores. Already, the departmental stores that have shut down during the pandemic under our radar include Robinsons in Mid Valley Mall (in 4QFY20) and Parkson in Da Men Mall (in 2QFY21), the second closure of a Parkson outlet since 2019 after the first moved out from Suria KLCC.

• This trend is in line with the performance in the retail subsector as published in Retail Group Malaysia’s (RGM) Malaysia Retail Sales Report (Exhibit 2), where in 2020, departmental stores-cum-supermarkets are one of the hardest hit sector (with a decline of -20.2% recorded in sales), while specialty retailers were the least impacted sub-sector, recording the smallest decline in sales of 11.7% in 2020. RGM is expecting a similar trend to persist moving forward. It is also forecasting the retail sales to grow by 4.1% for 2021, after declining by 13.4% in 1Q21 before it returns to its growth path from 2Q onwards. This is largely in line with our assumption of rental recovery from 2Q onwards.

• Apart from that, we also take comfort that there have been no major losses recorded for the commercial property assets owned by the REITs under our coverage. Property consultancy Knight Frank said it is anticipating the values of the prime grade retail assets to remain relatively stable despite the rental decline, supported by the more resilient tenant and lease profiles, as well as the existing low interest rate environment which will cushion the yields of the properties.

• Knight Frank also highlighted that it is expecting some good quality prime assets to trade in 2021, which is in line with our expectations. It believes the prices of Malaysian hotels might be trading at 10%–30% discount as compared to the pre-Covid values. In view of that, we do not rule out the chances of potential acquisitions to happen in the next 12–18 months for the REITs under our coverage, taking cue from their strong financial ability and debt headroom of 23%–42% debt-to asset ratio vs. 60% of the regulatory threshold (temporarily raised from 50% up to 31 December 2022 by the Securities Commission as a Covid-19 relief measure), which allows the REITs to gear up for further acquisitions. We view this as a good opportunity for the REITs to acquire yield-accretive assets to drive its medium to long-term growth despite of the short-term earnings pressures.

• Already, Pavilion REIT (fair value RM1.75) has just obtained its shareholders’ approval in the AGM for a potential issue of new units of up to 20% (we believe will be via a private placement if it happens) and a potential rights issue of up to 50%, which we believe is to prepare for potential fund raising for asset injections. Projects in the pipeline for a potential acquisition include Pavilion Bukit Jalil, and we believe there might also be hotel acquisitions if valuations are attractive. Apart from that, YTL REIT (FV RM1.26) also indicated that it will be looking into hotel acquisitions if there are attractively valued assets

• Our top picks for the sector are IGB REIT (FV RM2.03) and Sunway REIT (FV RM1.64). We like IGB REIT for its more balanced footfall profile (i.e. only moderate exposure to tourists compared with Pavilion REIT), enabling it to capitalise on the recovery in domestic consumption while waiting for Malaysia’s borders to reopen. We also favour Sunway REIT for its diversified investment portfolio (which includes retail malls, hotels, offices, university, hospital, etc.) and the large pipeline of potential assets for future injection.

• We maintain our OVERWEIGHT recommendation for the REIT sector. Based on our estimates, the REITs under our coverage provide distribution yields of more than 4.7% for FY22 and beyond compared to the current low interest environment rate. We like the sector as a recovery play sector, which we believe is poised to benefit from the growth in Malaysia's economy post-pandemic.

• We may downgrade our OVERWEIGHT stance to NEUTRAL if: (1) footfall recovery is weaker than expected; (2) there is a massive decline in occupancy rate due to increased competition from oversupply of retail spaces; and (3) consumer spending/sentiment is to deteriorate further or recovers slower than expected.

Source: AmInvest Research - 30 Mar 2021