Investment Highlights

• We maintain BUY on UOA REIT with an unchanged fair value (FV) of RM1.42/unit based on dividend discount model (DDM), which incorporates a neutral 3-star ESG rating (Exhibits 8 & 9). This implies a FY24F distribution yield of 7%, at parity with its 5-year median.

• We make no changes to our earnings forecast as UOA REIT’s 1QFY23 distributable income of RM15mil was within our expectation and consensus’. It accounted for 22% of both our and consensus’ FY23F earnings.

• In 1QFY23, UOA REIT’s gross revenue declined 2% while net property income (NPI) fell 5% YoY. The lower NPI was mainly attributed to an increase of electricity tariff surcharge from 3.7 sen to 20 sen per kilowatt hour (kWh) from 1 January 2023 onwards.

• QoQ, UOA REIT’s revenue rose 2% while NPI was flattish at RM21mil. Property operating expenses rose 9% QoQ mainly from the increased electricity tariff surcharge.

• QoQ, UOA REIT’s average occupancy rate inched up to 81% in 1QFY23 from 80% in 4QFY22. The decline in occupancy rates of Wisma UOA II and UOA Corporate Tower office segments were mitigated by stronger performance in its other office assets (Exhibit 3).

• Despite having 56% of floor space or NLA occupied by tenancies which will be expiring on FY23 (mainly coming from new buildings such as UOA Corporate Tower), management is confident that at least 80% of its tenants will be renewed, as most of the existing tenants have expressed interest in renewal (Exhibit 4).

• Nevertheless, we expect rental reversion to be flattish upon the renewal of tenancies given the growing oversupply of office spaces, coupled with heightening inflationary pressures on tenant sales.

• There was no income distribution declared in 1QFY23 due to its semi-annual distribution policy.

• Given weaker economic data and softening inflation in United States (US), we anticipate the US Fed Funds rate to peak at the current level of 5%-5.25% after the recent 0.25% hike in May 2023. If US inflation rate continues to decline over the subsequent months, we may see a pause in US monetary tightening cycle.

• As such, we do not rule out the possibility that the 10-year MGS yield could ease further (from our 2023F yield of 3.8%-4%) if there are signals affirming a less hawkish tone by the US Federal Reserve, resulting in a pause in the Fed Funds rate hikes, as well as the tapering of inflation rates globally which will reduce pressures on central banks, including BNM, to continue raising interest rates.

• From FY23F onwards, we anticipate UOA REIT’s distribution yield spread against 10-year MGS to widen to 4% vs. 5-year median of 2%. Hence, we expect UOA REIT to be appealing to yield-seeking investors with its higher distribution spread against 10-year MGS (Exhibit 7).

• We like UOA REIT’s long-term prospects, bolstered by its:
  (i) strategically located properties which are well-connected in neighbourhoods via bridges, major highways and public transportation;
  (ii) diverse tenant mix, which could mitigate potential rental collection risks during economic downturns (Exhibit 5);
  (iii) excellent track record of distributing at least 96% of net income to unitholders with a strong distribution yield of 8% from FY23F to FY25F; and
  (iv) large pipeline of potential asset injections from its sponsor – UOA Development (Exhibit 6).

• UOA REIT currently trades at a compelling FY24F PE of 12x vs. 4-year average of 17x. Meanwhile, FY24F distribution yield of 8% is attractive vs. 10-year MGS yield of 3.7%.

Source: AmInvest Research - 5 May 2023