Investment Highlights

• 9MCY22 results were largely above our expectation. Out of the 6 companies under our coverage, 4 exceeded our expectations and 2 were in line. Most of the REITs posted stronger 9MCY22 results YoY except UOA REIT which registered a minor decline (-0.1%) in bottom line (Exhibit 2). The following are the salient highlights of the companies’ 9MCY22 performance:
  • The outperformers are retail-focused REITs, including IGB REIT, Sunway REIT, Pavilion REIT and Hektar REIT, which reported better-than-expected 9MCY22 earnings. The retail segments of these REITs benefited from stronger than-expected rental revenue as compared to a lower base in CY21. Besides, their earnings were further boosted by minimal rental assistance offered to tenants in CY22.
  • The distributable income of commercial and hospitality REITs, YTL REIT and UOA REIT came in within expectations.
  • QoQ, all of the REITs posted stronger results (except IGB REIT) as a result of higher tenants’ sales as well as write back of impairment losses of trade receivable amid the improvement in footfall traffic. The average occupancy rate for retail REITs has decreased slightly, but it is still stable at above 90% (Exhibit 4). Meanwhile, for the hospitality players, 3QCY22 saw a stronger hotel occupancy rate following the reopening of international border and relaxation of social and economy activities in April 2022. IGB REIT recorded a slight decline (-0.2%) QoQ in distributable income as a result of the higher maintenance expenses in 3QCY22.
• A significant uptick in tenants’ sales in 9MCY22. We gather that the tenants’ sales of majority of the malls that fall under our coverage have rebounded to 90%-110% of the pre-covid level in 9MCY22 with the improvement in footfall traffic. As such, we anticipate the rental reversion in FY22F to be mildly positive especially for the malls situated in prime locations (eg. Mid Valley Megamall, Pavilion Kuala Lumpur, Sunway Pyramid). However, the rental reversions for less established malls are likely to remain flattish or slightly negative. For these smaller malls, increasing occupancy rates through attractive rents will be imperative. Nevertheless, we expect the footfall and tenant sales will continue to be strong in 4QCY22 on the back of the holidays and festive seasons.

• Occupancy and rental reversion rates in the office segment are expected to stabilize. Following a downtrend that began in FY20, the average occupancy rate for offices are showing sign of stabilization in 3QCY22 (Exhibit 4). However, we expect a flattish rental reversion in FY22F/FY23F, particularly for older office buildings in Kuala Lumpur city centre, given the growing oversupply of office spaces on the back of office decentralisation and flexible working arrangement trends.

• Gradual recovery in the hospitality segment from the resumption of leisure activities and reopening of international borders on 1 April 2022. We observed a reversal in the downtrend of the hotel occupancy rate since 2QCY22 along with a recovery in average daily rate (ADR) brought on by the arrival of domestic and foreign tourists as well as the return of MICE (Meetings, Incentives, Conferences, Exhibitions) and business events (Exhibit 4). Given that we are approaching the year-end holiday season, we believe that the hotel segment will continue to have encouraging growth in 4QCY22. Another positive catalyst will be the potential return of China tourists, which made up 12% of Malaysia’s foreign tourist arrivals in 2019.

• Federal Reserve may ease off aggressive rate hikes. The recent aggressive policy rate hikes in the United States (US) has caused the US treasury yield to rise and this in turn has spilled over and resulted in an increase in 10-year MGS yield (Exhibit 6). However, we anticipate that the uptrend in 10-year US Treasury yield to be tapering off with the expectation that the Federal Reserve may ease off aggressive rate hikes after the end of 2022 as a result of weaker economic data. Meanwhile, we anticipate the yield spread to be widening from FY22F onwards with the gradual recovery of retail footfalls and hotel occupancy rates (Exhibit 7).

• We upgrade the REITs sector to OVERWEIGHT from NEUTRAL. We believe FY22F/FY23F will mark the turnaround year for REITs counter after 2 years of hardship, supported by the recovery in both retail and hotel segment. With the gradual recovery of retail footfalls and hotel occupancy, coupled with potential easing of aggressive rate hikes by Federal Reserve, we are seeing a widening yield spread for REITs against the 10-year MGS yield and expect REITs sector to be appealing to yield-seeking investors with its high distribution yield of 6%-11%.

• Selective criteria. We like REITs with high-quality assets situated at strategic location and offering a decent dividend yield. We also favour REITs with exposure in retail and hotel segments, both of which are anticipated to further recover in FY23F.

• Our top Buy are Sunway REIT (FV: RM1.73/unit), Hektar (FV: RM0.81/unit) and YTL REIT (FV: RM1.01/unit). On Sunway REIT, our BUY call is underpinned by its diversified investment portfolio which encompasses retail malls, hotels, offices, a university, and hospitals that spread across Malaysia, as well as its strong occupancy rates which have exceeded 90% in retail assets. We like Hektar due to its attractive FY23F distribution yield of 9% vs. average yield (excluding Hektar) of 7%. YTLREIT is another of our top picks for REITs due to its stable recurring rental income and minimal occupancy risk for its hotel properties in Malaysia and Japan, secured by master lease agreements. It also offers an attractive FY23F yield of 11%.

• Downside risks to our forecasts are: (i) a deeper contraction in yield spread of DPU against the 10-year MGS with a faster-than-expected interest rate hike to curb rising inflation; and (ii) stagflation risk which could substantively deteriorate the company’s revenue and earnings due to lower occupancy rates, negative rental reversions and extension of rental rebates offered to tenants.

Source: AmInvest Research - 8 Dec 2022