Investment Highlights

• We maintain BUY on Sunway REIT (SREIT) with a higher fair value (FV) of RM1.76/unit (from RM1.72/unit) based on our revised dividend discount model (DDM), which incorporates a 4-star ESG rating (Exhibits 11 & 12).

• We have imputed a lower risk-free rate (10-year Malaysian Government Securities (MGS) yield) assumption of 4% compared to 4.3% previously. The FV implies a FY24F distribution yield of 5%, at parity to its 5-year median.

• We make no changes to our earnings forecast as SREIT’s FY22 distributable income of RM312mil came in within our and consensus' expectations. Earnings were almost on the dot of our forecast and 2% below street’s.

• We also take the opportunity to introduce our FY25F earnings with a growth of 5% on expectation of further recovery in hotel occupancy rates to the pre-pandemic levels of 74%.

• In FY22, SREIT’s gross revenue surged 38% YoY while net property income (NPI) climbed 55% YoY. This was mainly driven by the improved performance of retail and hotel segments.

• On a QoQ comparison, SREIT’s 4QFY22 gross revenue improved 18% while NPI rose 19%. This was mainly attributed to the stronger contributions from Sunway Pyramid and Sunway Resort Hotel.

• SREIT declared its gross distribution per unit (DPU) of 5 sen in 4QFY22. The FY22 DPU of 9.2 sen represents a distribution yield of 6%.

• QoQ, the average occupancy rate for overall segments inched up to 77% in 4QFY22 from 76% in 3QFY22. The slight decline in the occupancy rate of retail and office segments was mitigated by the stronger performance in most of its hotels (Exhibit 6).

• For its retail malls, we foresee a positive rental reversion of 5% in FY23F/FY24F. Stronger tenant sales as compared to the pandemic level are anticipated to provide the group with the opportunity to negotiate for higher rentals in subsequent years.

• With China’s travel revival and gradual recovery of Malaysia’s domestic travelling, we expect the average occupancy rate of the group’s hotel properties to gradually improve in FY23F/24F and fully recover to pre-Covid levels in FY25F (Exhibit 6). Meanwhile, Chinese tourist arrivals are expected to be supported by the resumption of China’s group tour services, which will also create the spill-over effect of spending on retail outlets.

• For its office segment, we foresee a minor drop in its average occupancy rate in 1QFY23 following the exit of one of its tenants in Sunway Putra Tower with a NLA of 16,000 sq ft. Nevertheless, we believe this could be mitigated by the opening of its newly completed office space, Corporate Suite@19 with a NLA of 30,000 sq ft., which is already fully occupied.

• Meanwhile, given Wisma Sunway’s resilient tenant base (of whom 97% are government agencies), we are confident on the renewal of its tenants despite having 78% of floor space or NLA occupied by tenancies expiring on FY2023. (Exhibits 8, 9).

• We anticipate the Fed rate to peak in 1HFY23 as a result of weaker economic data and softening inflation. Our in-house economist projects another 0.75% hike in the Fed rate in 1HCY23 from the current level of 4.25%-4.5%. Meanwhile, the 10-year MGS yield is forecasted to be lower by the end of 2023 at 3.8%-4%. However, we do not rule out the possibility of a further decline in 10-year MGS yield if there are any signals pointing towards a shift in the Fed’s hawkish tone, which may potentially expedite the end of the rate hike cycle.

• We also foresee the yield spread from FY23F onwards to widen to 2% vs. 5-year median of 1%. Hence, we expect SREIT to be appealing to yield-seeking investors with its higher dividend spread against 10-year MGS (Exhibit 10).

• We like SREIT for its well-diversified income base which could cushion potential downside risks. Its portfolio encompasses retail malls, offices, hotels, universities and industrial properties across Malaysia. Also, the group is recognised for its environmental, social and governance (ESG) practices. Specifically, SREIT is the first amongst its local peers to incorporate sustainability financial considerations into its capital management strategies.

• SREIT currently trades at a compelling FY24F PE of 17x vs. its 4-year average PE of 20x. Meanwhile, distribution yield for FY24F of 6% is attractive vs. current 10-year MGS yield of 3.8%.

• The downside risks are:
  (i) a lower-than-expected tenancy renewal and occupancy rate; and
  (ii) further contraction in yield spread against the 10-year MGS if the loosening of Fed’s monetary policy is slower-than-expected.

Source: AmInvest Research - 31 Jan 2023