Investment Highlights

• We maintain BUY on Sunway REIT (SREIT) with a higher DDM-based fair value of RM1.76/unit (from RM1.66/unit). Our DDM valuation assumptions are based on a WACC of 7.7% and a terminal growth rate of 2.5%. No changes to our 4-star ESG rating (Exhibit 11).

• We increase our distributable income estimates by 33% for FY22F and 8% for FY23F. This is after factoring in: (i) lower Covid-19 rental rebates for retail malls; (ii) higher borrowing costs amid rising interest rates; and (iii) improved occupancy rates for hotel properties due to the expectation of a steady pick-up in the hospitality industry after the reopening of international borders. We also raise our estimate of average daily rates for Sunway Resort Hotel & Spa.

• The group reported a distributable income of RM83mil in 1QFY22, including the reversal of an impairment loss of trade receivables of RM2mil (Exhibit 2). It came in above our and consensus' projection, accounting for 42% of ours and 32% of streets’ full-year estimates. The key variance to our estimate was mainly due to higher-than expectedrental income and lower-than-projected rental support given to tenants amid a strong pick-up in the retail sector after the relaxation of movement restrictions.

• SREIT’s 1QFY22 gross revenue surged 48% YoY to RM154mil while net property income (NPI) jumped 77% YoY to RM119mil (Exhibit 2). The improvement was driven by higher rental income for the retail (+194% YoY) and hotel segments (+36% YoY), reduced provisions for doubtful debt as well as lower rental assistance to tenants. Elsewhere, the reported net investment income rocketed more than 100% YoY to RM137mil. This is mainly due to changes in the fair values of investment properties after the group revalued most of its properties, including the newly added Kompleks Dato’ Shaari Jihin.

• The debt-to-asset ratio inched up 1.3% points to 35%, well below the statutory threshold of 60%. The mix of debt with floating rates increased 2% points to 68% in 1QFY22. Our forecasts have imputed higher borrowing costs of 4.5% in FY22F and 5.0% in FY23F on the back of the rising interest rate environment. A total of RM1.2bil debts are due to mature in FY22F and RM505mil in FY23F.

• The group did not declare DPU for this quarter as the distribution frequency of Sunway REIT has been changed to a semi-annual of basis from CY20 onwards.

• Despite the average occupancy rate for the hotel segment rising 8.2% points QoQ to 35.3% in 1QFY22, it was below the pre-pandemic level of 71.5% in 2019 (Exhibit 7). Meanwhile, the average vacancy rates for the retail and office segments remained stable (Exhibits 6 & 8).

• Management has provided updates during the analyst briefing. The following are the key highlights:

1. On 26 January 2022, Sunway REIT completed the acquisition of Kompleks Dato’ Shaari Jihin, a commercial building in Port Klang. The property was acquired for a cash consideration of RM34.1mil and is slated for redevelopment into a retail-focused property targeting mainly domestic and foreign tourists. The estimated timeline for the redevelopment is 2 to 3 years
2. The expansion of Sunway Carnival Shopping Mall is scheduled to be completed in 2QCY22. Management has secured an occupancy rate of nearly 90% for the mall.
3. Management alluded that for every 25bps increase in interest rate, the group’s finance cost will be raised by RM8mil.
4. Management reported a slight positive rental reversion for the tenancy renewed in Sunway Pyramid Shopping Mall and is expecting a positive rental reversion for tenancies expiring in the remaining months of 2022 amidst the robust recovery in retail footfalls and tenant sales (Exhibit 1).

• With the reopening of international borders and further relaxation of SOPs, we expect a gradual recovery in the average occupancy rate for hotel properties to 48% in FY22F and 58% in FY23F. The hotel’s average occupancy rate was 27.2% in FY2021 and 71.5% in FY2019 (pre-pandemic levels) (Exhibit 7). This was largely due to business and leisure travel restrictions in the last 2 years amid multiple lockdowns for Covid-19. However, we do not expect a significant recovery in the vacancy rate as rising interest rates and inflationary pressure could weaken consumer spending for leisure travel.

• Moving forward, we foresee the discontinuation of Covid-19-related rental rebates offered to tenants as all businesses are allowed to fully operate after the reopening of the economy and borders. This will lead to a normalisation of rental income in the retail, hotel and office segment.

• Sunway REIT is our top buy for the REIT sector underpinned by its well-diversified income base, which could cushion it against the potential downside risks. Its portfolio encompasses retail malls, offices, hotels, universities, hospitals and industrial property across Malaysia. We remain bullish about the outlook of Sunway eMall, which offers delivery and in-store collection for online shopping across its physical malls. Also, the group is recognized 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.

• The downside risks are: (i) a lower-than-expected tenancy renewal and occupancy rate; (ii) further contraction in yield spread against 10-year MGS amid a greater-than-expected increase in interest rate; and (iii) rental rebates reinstated if a lockdown is implemented again due to the emergence of more harmful Covid-19 variants.

Source: AmInvest Research - 19 May 2022