Investment Highlights

• We maintain BUY on Sunway REIT (SREIT) with an unchanged fair value (FV) of RM1.84/unit based on our dividend discount model (DDM), which incorporates a 4-star ESG rating (Exhibits 11 & 12). The FV implies a FY24F distribution yield of 6%, at parity to its 5-year median.

• We make no changes to our earnings forecasts as SREIT’s 1QFY23 distributable income of RM92mil came in within our expectations and consensus'. It accounted for 29% of our FY23F earnings and 25% of consensus.

• In 1QFY23, SREIT’s gross revenue grew 19% YoY while net property income (NPI) improved 16% YoY. This was mainly driven by improved performance of its retail segments, particularly, Sunway Pyramid and Sunway Carnival.

• On a QoQ comparison, SREIT’s 1QFY23 gross revenue fell 2% while NPI dropped 5%. This was mainly attributed to lower income from its hotel segments in 1QFY23 following a strong result in 4QFY22 because of increased demand for holiday vacations during the year-end holiday season.

• QoQ, average occupancy rate for overall segments rose steadily to 79% in 1QFY23 from 77% in 4QFY22 (Exhibits 4, 5 & 7).

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

• For its retail malls, we foresee a positive rental reversion of 5% in FY23F/FY24F. SREIT’s tenant sales in 1QFY23 were 10% higher than pre-pandemic level (1Q2019) on the back of the festive season and strong demand for out of home dining. Stronger tenant sales are anticipated to provide the group with the opportunity to negotiate for higher rentals in subsequent years.

• While a significant percentage of leases for retail malls (particularly Sunway Pyramid and Sunway Carnival) are expiring in FY23 (Exhibit 9), we believe that the majority of leases will be renewed. This is in view of the substantial improvement in tenant sales and footfalls in retail malls.

• Notably, SREIT does not intend to extend the lease with Sunway Pyramid’s anchor tenant, AEON that is due to expire in September 2023. The reason being is that SREIT plans to convert the current AEON-lease space into smaller specialty stores which carry higher rental rates. The asset enhancement initiative (AEI) is expected to commence in October 2023 and result in an 11% decline in Sunway Pyramid’s occupancy rate for 12 months. However, the shortterm impact of the AEI to SREIT’s FY23F/FY24F earnings is immaterial as it only accounts for <1% of SREIT’s FY22 total revenue.

• For its industrial segment, SREIT is still in the midst of negotiation with prospective tenants to lease out its newly acquired industrial property in Sungei Way, Petaling Jaya. Based on the current negotiation progress, SREIT anticipates renting out at least 1 out of the 2 buildings in Sungei Way by end of FY23.

• With the gradual recovery of Malaysia’s domestic travelling and influx of foreign tourists, 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). Riding on the recovery of hotel segments, the full reopening of hotel rooms in Sunway Resort Hotel (100 out of 477 were closed for refurbishment previously) in 2QFY23 will provide further upside to SREIT’s earnings in subsequent quarters.

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

• Given the weaker economic data and softening inflation in United States (US), we anticipate the US Fed Funds rate to peak at 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 forecast 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 SREIT’s distribution yield spread against 10-year MGS to widen to 2% vs. 5- year median of 1%. Hence, we expect SREIT to be appealing to yield-seeking investors with its higher distribution 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, hospitals 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 16x vs. its 4-year average PE of 20x. Meanwhile, distribution yield for FY24F of 6% is attractive vs. current 10-year MGS yield of 3.7%.

Source: AmInvest Research - 5 May 2023