Investment Highlights

• We downgrade our recommendation on the REIT sector to NEUTRAL from OVERWEIGHT. Our valuation of REITs under our coverage is based on a target yield of 5% over FY23F distribution income. For 4QCY22, most of the REIT’s earnings were above our expectations. Out of the 4 companies that we cover, one met expectations while the other two were above expectations. IGB REIT’s FY21 distribution income of RM399.5mil was within our forecast, accounting for 99% of our full-year estimate (Exhibits 2 & 3). Meanwhile, YTL Hospitality REIT is due to release its 2QFY22 results in this month.
  Pavilion REIT and Sunway REIT’s earnings came in above expectations, accounting for 107% and 119% of our full-year estimates respectively. The key variance to our projection was mainly due to: (i) higher-than-expected gross rental income and car park income with a stronger recovery in the retail footfall and sales; and (ii) lower-than-expected rental rebates given to tenants (Exhibit 2).

• Nonetheless, we have turned cautious on the recovery of the retail and hotel segment for the upcoming quarters in FY22. This is due to: (i) the emergence of a new wave of Covid-19 with higher Omicron cases domestically, which may slow down the retail footfall and domestic tourism recovery; (ii) the rental reversion could slightly negative as some tenants may still require rental support in the immediate term; (iii) a slower recovery for the occupancy rate in the hotel segment with the hike in Covid-19 cases; and (iv) the declining yield spread between REITs under our coverage and the 10-year Malaysian Government Securities (MGS). 
  Retail segment. The retail footfall and sales picked up strongly in 4QCY21 to circa 80–90% of pre-pandemic levels in 4QCY21 after the economic reopening and year-end holiday season. However, we expect the rental reversion of retail malls unlikely to recover to the pre-pandemic levels in FY22F. Instead, it is likely to turn slightly negative YoY in order to retain good tenants. Meanwhile, we foresee the rental assistance to persist in 2022 but at a lower quantum than 2021, assuming no full lockdowns in 2022. Certain tenants, especially those in travel-related businesses, will still require rental rebates in the near term. 
  Hospitality segment. In 4QCY21, the occupancy rate of hotels improved slightly amidst the boost in domestic tourism during the holiday seasons (Exhibit 10). However, we expect the outlook to be bumpy in the near term due to the spike of Covid-19 cases which could impact domestic tourism activities. 
  Office segment. The overall average occupancy rate of offices under our coverage remains stable in 4QCY21 (Exhibit 10). For the office segment, we expect the rental reversion to remain flattish due to the oversupply of office spaces in the central region. 
  Industrial segment. Industrial assets under our coverage continue to provide a steadier rental income compared to other segments during and post-MCO. We are positive on the outlook of this segment due to the increasing demand for logistics warehouses and data centres with the rising online sales. Also, more REIT players are eyeing to acquire industrial assets to mitigate the potential downside risk of rental for retail and hotel segments.
• Net gearing ratio well below the regulatory threshold. All REITs under our coverage maintain net gearing ratios of 26%–48%, well below the 60% regulatory threshold of the Securities Commission (Exhibit 5).
• Higher borrowing cost with the potential hikes of interest rates. For companies under our coverage, YTL Hospitality REIT is more sensitive to interest rates hikes as 80% of its borrowings are floating-rate loans. This is followed by Sunway REIT and Pavilion REIT at 62% and 58% respectively (Exhibit 5). On a positive note, IGB REIT will experience minimal impact on its borrowing cost as their loans are mostly in fixed rates.

• The declining yield spread between REITs and the 10-year Malaysian Government Securities (MGS) in a rising interest rate environment (Exhibit 6 to 9). Our in-house economists expect 1–2 rate hikes in 2H2022 and will continue to 3.0%–3.50% in 2023–24. Hence, we expect the yield spread between REIT and 10Y MGS to shrink further. Presently, the average distribution yield under our coverage is at 4.1% (Exhibit 1).

• Our top pick is Sunway REIT (fair value RM1.66) underpinned by: (i) its diversified investment portfolio which encompasses retail malls, hotels, offices, a university and hospitals that spread across Malaysia; (ii) strong occupancy rates, which have exceeded 90% for its retail malls; and (iii) profitable rental income generated from the services and industrial segments, which mitigate the downside risk of the hotel and retail segment. The group is also innovative in its reaction towards the e-commerce disruption. It has launched Sunway E-mall, which offers online shopping options for the convenience of shoppers.

• The downside risk to our assumptions are: (i) yields spread turning more negative against the 10Y MGS with a faster-than-expected interest rate hike than expected; (ii) lower-than-expected tenancy renewal rates; and (iii) the potential reintroduction of MCOs due to the spike in Covid-19 infection cases which may result in lower occupancy rates for assets in retail and hotel segments.

Source: AmInvest Research - 10 Feb 2022