Investment Highlights

• Following the recent Federal Open Market Committee (FOMC) meeting in June 2023, regulators have indicated an upward revision in the projected terminal fed funds rate to 5.6% from 5.1% in Mar 2023. In the recent meeting in June 2023, the FOMC held the benchmark rate unchanged at 5%-5.25% while raising its CY23F terminal rate to 5.6% from 5.1%. This implies another 2 more US interest rate hikes by 0.25% each, bringing the Fed fund rate to the range of 5.5%-5.75% over the remaining months of CY23.

• Fed fund rate to peak by 3QCY23. Our in-house economist anticipates the Fed fund rate to peak between 5.5%-5.75% (from 5.25%-5.5% previously) by 3QCY23. Based on Bloomberg’s most recent world interest rate probability (WIRP), market consensus is expecting the US rate cut to occur earliest in 1QCY24.

• A further decline in the 10-year MGS yield may not be ruled out. With the expectation of the end of global monetary policy tightening, our economist forecasts 10-year MGS to be lower at 3.75% (from previous forecast of 3.8%-4%) in 4QCY23 with a gradual decline to 3.5% by 4Q2024. However, we do not rule out the possibility that the 10-year MGS yield could be lower than our projection of 3.75% in 2023 should there be a change in Fed’s hawkishness on rate hikes.

• Bursa Malaysia REIT index outperformed the Bursa Malaysia KLCI Index in the previous rate cut cycle. In July 2019, the 10-years MGS yield declined to 3.6% in July 2019 from 4.1%. This coincided with the first interest rate cut in the US after the 2015-2018 rate hike cycle (Exhibit 2). During this period, Bursa Malaysia REIT index registered a 10% gain compared to a 1% drop in Bursa Malaysia KLCI Index with higher investor interest in REIT stocks supported by the widening of yield spreads.

• Maintain OVERWEIGHT. We believe CY23F will mark a turnaround year for REIT counters after 2 years of hardship, supported by the recovery in retail and hotel segments. Meanwhile, the arrivals of international tourists may support consumption spending. Hence, with a potential end to Fed rate hikes in 2HCY23, we see buying opportunities in Malaysian REIT stocks given widening yield spreads against 10-year MGS yield (Exhibit 5) with appealing distribution yields of 6%- 10% (Exhibits 6).

• We like REITs with high-quality assets situated in strategic locations and strong dividend yields. Also, we favour REITs with exposures in retail and hotel assets, both of which are anticipated to further recover in CY23F.

• Our top Buys are Pavilion REIT (FV: RM1.62/unit), Hektar REIT (FV: RM0.81/unit) and YTL REIT (FV: RM1.10/unit). For Pavilion REIT, we foresee its earnings to be resilient, mainly underpinned by the prime location of key assets, Pavilion Kuala Lumpur and Elite Pavilion Mall, which are hotspots that will benefit from the return of international tourists. Also, we expect stronger earnings growth from the Pavilion Bukit Jalil from 3QCY23 onwards. We like Hektar due to its attractive FY24F distribution yield of 9% vs. average yield (excluding Hektar) of 8%. YTLREIT is another of our top picks due to stable recurring rental income and minimal occupancy risks for its hotel properties in Malaysia and Japan, which are secured by master lease agreements. The stock also offers an impressive FY24F yield of 10%.
   
• Downside risks to our forecasts are: (i) higher-than-expected interest rate hikes in the US that could weaken the Malaysian ringgit, narrow the yield spreads against 10-year MGS; and (ii) stagflationary risks, which could substantively dampen revenue and earnings prospects due to lower occupancy rates for REIT assets, negative rental reversions and the likelihood of rental rebates to be offered to tenants.

Source: AmInvest Research - 26 Jun 2023