Investment Highlights

• We maintain BUY on YTL Hospitality REIT (YTL REIT) with an unchanged fair value (FV) of RM1.10/unit based on our dividend discount model (DDM), which incorporates a neutral 3-star ESG rating (Exhibits 9 & 10).

• The FV implies a FY24F distribution yield (excluding deferred repayment) of 6%, at parity to its 5-year median. Recall that a portion of the rental income for its Malaysian and Japanese properties (except The Green Leaf Niseko Village) were deferred for 24 months commencing 1 July 2020 until 30 June 2022. The deferred rental will be repaid over the next 7 years (Exhibit 3).

• We make no changes to our earnings forecast as YTL REIT’s 1HFY23 distributable income of RM58mil came in within our expectation and consensus'. It accounted for 52% of our earnings (without taking into account the deferred repayment of RM16mil) and 55% of street’s number.

• In 1HFY23, YTL REIT’s gross revenue rose 35% YoY, mainly contributed by higher revenue (+68% YoY) from the Australian portfolio. However, its net property income (NPI) improved by only 10% YoY due to higher operating expenses incurred during the reopening period of its hotels (Exhibit 2).

• On a QoQ comparison, YTL REIT’s gross revenue grew 16% while NPI rose 14% in 2QFY23. This was mainly contributed by higher revenue (+26% QoQ) from the Australian hotel portfolio, which saw an increase in its revenue per available room by 30% QoQ to A$237 from A$183 (Exhibit 4).

• On the Australian hotel portfolio, we have seen an improvement in average occupancy and average daily rates since 2QFY22. Notably, its 2QFY23 average daily rate has reached its historical high at A$311 vs. pre-Covid (2019) level of A$271. Meanwhile, its 2QFY23 average occupancy rate of 76% was still lower than the pre-Covid level of 85% (Exhibit 4).

• YTL REIT declared its gross distribution per unit (DPU) of 3 sen in 2QFY23, which represents a distribution yield of 3%. Notably, the FY23F deferred payment of 1 sen will be distributed in 4QFY23 (Exhibit 6).

• The portion of the repayment of rental deferrals account for 11%/29%/13% of total distributable income in FY23F/24F/25F (Exhibit 3).

• As at 31 December 2022, YTL REIT has 51% of borrowings denominated in AUD, 40% in MYR and the remainder in JPY. As 83% of its borrowing is in floating rates, the interest rate hikes in Malaysia and Australia are expected to result in higher borrowing costs in AUD and MYR (Exhibit 7). Nevertheless, we believe that the interest rate hike cycle in Malaysia has reached its tail-end with the expectation of another 0.25% increase to 3% in 2023. Meanwhile, Bloomberg consensus estimates has shown that the Australian cash rate is expected to peak at 3.95% on 3QCY23 from its current level of 3.35%.

• In light of the stronger-than-expected economic data as well as stickier inflation readings in January 2023, our inhouse economist projects a more aggressive 0.75% hike (from 0.5%) in the Fed rate in 1HCY23 from the current level of 4.5%-4.75% to tackle persistently high inflation. Meanwhile, the likelihood of a US rate cut in this year is dwindling. This means that the Fed Funds Rate is likely to stay at 5.25%-5.5% towards the end of this year. Pending more clarity from the upcoming Federal Open Market Committee and Bank Negara Malaysia Monetary Policy Statement meetings, we anticipate that the 10-year MGS yield could remain fluid in the near future.

• Nevertheless, we expect to see the impact from the rate hike to be manifested in 2HFY22 with more signs of tapering inflation as well as US wage growth. This could result in the stabilisation of Fed rate as well as 10-year MGS in 2HFY22. Hence, our in-house forecast on 10-year MGS yield is maintained at 3.8%-4% by the end of 2023.

• We like YTL REIT for its stable recurring rental income and minimal occupancy risk for its hotel properties in Malaysia and Japan, secured by master lease agreements. Meanwhile, we anticipate the yield spread from FY23F onwards to widen to 6% vs. 5-year median of 2% with the normalisation of lease rentals for its Malaysian and Japanese properties and repayment of rental deferral accounts, which will translate into higher distribution yields of 8%-10% in FY23F- 25F vs. 5% in FY22. We expect YTL REIT to be appealing to yield-seeking investors with its higher yield spread against 10-year MGS (Exhibit 8).

• YTL REIT currently trades at a compelling FY24F PE of 10x vs. 2-year pre-pandemic (FY18-19) average of 13x. Meanwhile, FY24F distribution yield of 10% is attractive as compared to its 2-year pre-pandemic (FY18-19) average of 8%. It also offers the highest distribution yield among REITs under our coverage.

• The downside risks are:
  (i) lower-than-expected occupancy and average daily rates for hotels in Australia;
  (ii) reintroduction of lockdowns due to the outbreak of a more harmful Covid-19 variant; and
  (iii) declining yield spread against 10Y MGS.

Source: AmInvest Research - 24 Feb 2023