Investment Highlights

• We maintain BUY on UOA REIT with a lower fair value (FV) of RM1.32/unit (from RM1.42/unit previously) based on our revised dividend discount model (DDM). Our FV has incorporated a neutral 3-star ESG rating (Exhibits 8 & 9) and implies a FY24F distribution yield of 7%, at parity with its 5- year median.

• The lower FV stems from the cut to FY23F/FY24F/FY25F distributable income by 8% to reflect lower occupancy rate assumptions in Wisma UOA II and Wisma UOA Damansara II. As at 30 June 2023, the occupancy rates in Wisma UOA II and Wisma UOA Damansara II were 61%/76%, lower than our earlier FY23F assumptions of 73%/86%.

• UOA REIT’s 1HFY23 distributable income of RM29mil was below our expectation and consensus’. It accounted for 44% of our earlier FY23F earnings and consensus’.

• The variance was mainly due to slower-than-expected recovery of occupancy rates in Wisma UOA II and Wisma UOA Damansara II (Exhibit 3).

• In 1HFY23, UOA REIT’s gross revenue slid 1% YoY while net property income (NPI) fell 4% 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 fell marginally by 1% while NPI was flattish at RM21mil. The slight improvement in the NPI margin was mainly attributed to lower direct operating expenses incurred in both Wisma UOA Damansara II and Parcel B - Menara UOA Bangsar.

• QoQ, UOA REIT’s average occupancy rate was flat at 81% in 2QFY23 (Exhibit 3).

• The occupancy rates in Wisma UOA II and UOA Damansara II have continued to be lower in 2QFY23. The rental income of both assets made up 25% of UOA REIT’s rental income in FY23F. Based on our sensitivity analysis, a 5% decline in the occupancy rate for both properties will result in a 1% drop in UOA REIT’s FY23F distributable income.

• Meanwhile, the weaker occupancies in Wisma UOA II and Wisma UOA Damansara II were mitigated by stronger performance in its other office assets. Notably, its major assets, UOA Corporate Tower and Parcel B - Menara UOA Bangsar which contributed 62% of gross rental income have achieved impressive occupancy rates of >96% in 2QFY23 amid rising demand for new and tech-enabled office spaces (Exhibits 2, 3).

• Management indicated that one of the anchor tenants in Parcel B – Menara UOA Bangsar, which constitutes 5% of the net lettable area (NLA) of the building, is expected to terminate the tenancy upon its expiration in 2HFY23, as the tenant will be relocating to its own newly completed building.

• Nevertheless, we remain confident that UOA REIT will be able to secure replacement tenants given the building’s prime location with direct connectivity to Bangsar LRT station. Parcel B – Menara UOA Bangsar was highly sought after and boasted a high occupancy rate of 98% as at 2QFY23.

• As at 30 June 2023, 16%-20% out of the 57% of the floor space or NLA occupied by tenancies which will be expiring on FY23 were renewed. Apart from the upcoming termination of tenancy in Parcel B – Menara UOA Bangsar, management is confident that 80% of its tenants that are set to expire in FY23 (mainly coming from new buildings such as UOA Corporate Tower) will be renewed, as most of the existing tenants have expressed interest in renewing tenancies (Exhibit 4).

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

• UOA REIT declared a gross distribution per unit (DPU) of 4 sen in 2QFY23 (-8% YoY), which represents a distribution payout ratio of 95%.

• Our in-house economist anticipates the Fed fund rate to peak between 5.5%-5.75% by 3QCY23 from current levels of 5%-5.25%. As such, we expect the uptrend in 10-year US Treasury yield to be tapering off with the expectation that the Federal Reserve may pause the rate hike after 3QCY23.

• With the expectation of the end of global monetary policy tightening, our economist forecasts 10-year MGS to be lower at 3.75% (from current level of 3.8%) 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.

• From FY23F onwards, we anticipate UOA REIT’s distribution yield spread against 10-year MGS to widen to 4% vs. a 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 FY23F-FY25F distribution yield of 8%; 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 3.8%.

Source: AmInvest Research - 25 Jul 2023