Investment Highlights

• Maintain OVERWEIGHT. We believe FY22F/FY23F will mark the turnaround year for REIT counters after 2 years of hardship, supported by the recovery in retail and hotel segments. With the gradual recovery of retail footfalls and hotel occupancy rates, 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 REIT sector to appeal to yield-seeking investors with high distribution yields of 6%-11%.

• Retail sales to normalise in FY23F after strong rebound in FY22. Although the outlook on retail sales is improving, we anticipate the upside of domestic spending will be limited due to rising concerns on higher borrowing costs and inflation, which will subsequently result in lower consumer disposable income. Nevertheless, the rental reversion for malls situated in prime locations with strong market position and brand name (eg. Mid Valley Megamall, Pavilion Kuala Lumpur and Sunway Pyramid) is anticipated to be positive in FY23F, and gradually recover to pre-pandemic levels in FY24F. 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. Meanwhile, the return of foreign tourists will be another upside for prime malls that are close to tourist attractions (eg. Pavilion Kuala Lumpur and Sunway Pyramid).

• Occupancy and rental reversion rates in office segment expected to stabilise. Following a downtrend that began in FY20, the average occupancy rate for offices are showing signs of stabilisation in 3QCY22. 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 hospitality segment from resumption of leisure activities and reopening of international borders on 1 April 2022. We observed a reversal in the downtrend of the hotel occupancy rates 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 and Exhibitions) and business events. 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 Chinese 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 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 3). 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 widen from FY22F onwards with the gradual recovery of retail malls’ footfalls and hotel occupancy rates.

• Key risks for the sector: 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 and hotel occupancy rates are likely to soften if consumers turn cautious in spending on discretionary goods and leisure activities.

• 2 REITs with 4-star ESG rating on the FTSE4Good Bursa Malaysia Index (FTSE4Good). As one of our ESG top pick, Sunway REIT is targeting zero carbon emissions by 2050 and has incorporated sustainable financing consideration into capital management strategies via the issuance of sustainability-linked bond. Meanwhile, Hektar’s ESG rating on the FTSE4Good was upgraded to 4-star from 3-star in June 2022 due an improvement in governance pillar, reflecting its adoption of best practices for corporate governance and anti-corruption.
• Our top BUYs are Sunway REIT (FV: RM1.73/unit), Hektar (FV: RM0.81/unit) and YTL REIT (FV: RM1.01/unit). For Sunway REIT, we like its diversified investment portfolio which encompasses retail malls, hotels, offices, a university and hospitals across Malaysia, as well as strong occupancy rates which have exceeded 90% for retail assets. We also prefer Hektar due to its attractive FY23F distribution yield of 9% vs. average sector yield of 7% (excluding Hektar). YTLREIT is another of our top picks for REITs with an eye-watering FY23F yield of 11% due to stable recurring rental income and minimal occupancy risk for its hotel properties in Malaysia and Japan that are secured by master lease agreements.
• Sector valuation is attractive at an average yield spread of 2.2%. This compares to the 5-year median yield spread of 2% from 2017-2022. Meanwhile, the expectation of widening yield spread will provide further upside on REIT valuations (Exhibit 4).
• Key considerations for downgrading the sector to NEUTRAL: (i) a deeper contraction in dividend yield spread against 10-year MGS, compressed by a faster-than-expected interest rate hike to curb rising inflation; and (ii) stagflation risk which could substantively impact the company’s revenue and earnings with lower occupancy rates, negative rental reversions and extension of rental rebates offered to tenants.

Source: AmInvest Research - 22 Dec 2022