Investment Highlights

• Maintain our NEUTRAL stance on the REITs sector. Although 1Q2022 saw improvements in retail sales, footfalls and consumer sentiment, we expect a decline in consumer spending ahead due to higher interest rate and inflationary pressures. The spillover effect of a weakening consumer spending is envisaged to hold back the recovery in tenant sales. Hence, we expect rental reversion to stay flattish for malls in prime locations and possibly adverse reversion for less established malls. REIT distribution yields continue to be unattractive due to declining yield against the 10-year Malaysian Government Securities (MGS).

• Discontinued Covid-19 rental rebates to tenants of shopping malls. With all retail stores allowed to fully operate after the reopening of the economy and borders with no further lockdown expectations, Covid-19-related support offered to tenants will cease in the coming quarter. This will lead to a normalisation of rental income in the retail segment.

• Stronger recovery seen in malls in prime locations. According to the Department of Statistics Malaysia (DOSM), retail trade rose 10.8% YoY to RM49.9bil in March 2022, mainly contributed by an increase in e-commerce sales (Exhibit 4). Retail sales improved 9.4% YoY to RM148.6bil for 1Q2022. Based on the Malaysian Institute of Economic Research’s (MIER) survey, the consumer sentiment index rose to 108.9 points in 1QCY22 (Exhibit 3). This was marginally higher than the pre-pandemic 2019 level. Both retail footfall and tenant sales in prime malls such as Mid Valley Megamall, The Gardens Mall, Pavilion Kuala Lumpur and Sunway Pyramid have reached 90% of pre-Covid 19 levels in 1Q2022. The momentum is expected to continue into 2Q2022 with the Hari Raya Aidilfitri festive season as celebrations were dampened over the last 2 years due to strict Covid-19 SOPs and preventive measures.

• Expect lower consumer spending moving forward due to higher interest rates and inflationary pressure. The DOSM reported that the Consumer Price Index (CPI) rose 2.7% YoY while core inflation climbed 2% YoY in March 2022 (Exhibit 2). The MIER noted a shift in consumers’ spending behaviour to “moderate spending” from “revenge spending” amid concerns about rising prices of consumer goods. On 11 May 2022, Bank Negara Malaysia (BNM) raised the overnight policy rate (OPR) by 25bps to 2.0% to lower inflationary pressures following the trend of interest rate hikes in developed countries such as the US, UK and Australia. Our in-house economist is now forecasting another OPR hike of 25bps in July 2022. The higher OPR rate is estimated to support the ringgit from further weakening against the US dollar due to the differential in interest rates between the 2 countries.
  Higher interest rates and inflation are anticipated to weigh on personal consumption expenditure due to higher borrowing costs and prices for consumer goods. Hence, tenant sales ahead are likely to soften as consumers may turn cautious in spending on discretionary goods. Rental reversion is expected to remain flattish in prime malls but could turn negative in unpopular malls with low footfalls in order to retain existing and attract new tenants. Given that retail malls are only able to renew tenancy agreements with higher rental rates if tenant sales improve.

• Hawkish expectations of US Federal Reserve (Fed) rate hike triggered the surge in the 10-year US treasury yield (UST) which consequently led to an increase in the 10-year MGS yield. Last Wednesday, US Fed announced its second rate hike by another 50bps and alluded that it will reduce its US$9 trillion balance sheet from June 2022 onwards. Post-decision, the 10-year UST yield jumped to its highest at 3.14% (Exhibit 5). Elsewhere, the 10-year MGS yield rose to 4.5% on 6 May 2022 following the upward trend in the 10-year UST yield.
  On 11 May 2022, the US Bureau of Labor Statistics reported CPI rising 8.3% YoY in April 2022, higher than market expectations of 8.1%. While recent data showed some improvement in inflation, this was still at its 40-year high after the first rate hike in March 2022. Hence, we foresee more interest rate hikes ahead to curb the soaring cost of living. With higher interest rate expectations in the US, a further increase in the 10-year MGS and 10-year UST could result in a deeper contraction in the yield spread between REITs and the 10-year MGS. The yield spread of companies under our coverage is now mostly negative against the 10-year MGS (Exhibits 6, 7, 8 & 9). We believe that market sentiment on REITs will remain lackluster in the near term due to the unappealing offering to yield-seeking investors. The targeted average CY23F distribution yield for REITs under our coverage is 6.4%.

• Our top BUY is Sunway REIT (fair value RM1.66/share) underpinned by its well-diversified income base, which could provide a cushion against potential downside risks. Its portfolio encompasses retail malls, offices, hotels, universities, hospitals and an industrial property across Malaysia. We are also positive about the outlook of Sunway eMall, which offers delivery and in-store collection for online shopping across its physical malls. The group is recognised for its environmental, social and governance (ESG) practices. Specifically, Sunway REIT is the first amongst its local peers to incorporate sustainability financial consideration into its capital management strategy.

• Downside risks to our forecasts are: (i) a lower-than-expected tenancy renewal rate; (ii) extensive decline in yield spread against 10-year MGS due to higher-than-expected increase in interest rate; and (iii) reintroduction of rental rebates if lockdowns are implemented again due to the emergence of more harmful Covid-19 variants.

Source: AmInvest Research - 13 May 2022