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 2.7 sen) 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).

• YTL REIT’s FY23 adjusted distributable income of RM155mil came in above our expectation and consensus'. It was 10% above our FY23F earnings and 22% above street’s estimate.

• The variance to our forecast was mainly driven by betterthan-expected average daily rate (ADR) from its Australian portfolio. The surge in travel demand and labour shortages in FY23 led to a record high ADR of AUD293 in FY23, which was 8% higher than the prepandemic level of AUD271 in FY19 (Exhibit 4).

• Hence, we raised our FY24F/25F revenue by 18%/12% to reflect the higher ADR from its Australian portfolio. We also lower our FY24F/25F net property income margin to 49%/50% from 58%/56% to reflect the higher operating expenses incurred in its Australian portfolio.

• We also take the opportunity to introduce FY26F distributable income with a growth of 4%, driven by the expectation of higher rental rates for its Malaysian and Japan portfolios upon renewal in FY26.

• In FY23, YTL REIT’s gross revenue rose 34% YoY to RM487mil, mainly contributed by higher revenue (+66% YoY) from the Australian portfolio. However, its net property income (NPI) improved only by 17% 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 fell 7% while NPI dropped 11% in 4QFY23. The decline in both occupancy rates (-5.5% QoQ) and average daily rate (-10% QoQ) of its Australian portfolio was attributed to the winter seasonal factor.  

• Historically, 1Q and 4Q have been the weakest quarters for its Australian portfolio, with ADR ranging from 9% to 17% lower compared to peak quarters (2Q and 3Q) (Exhibit 6). Moving forward, we anticipate 1QFY24 ADR to be weak, with a potential rebound in 2QFY24, supported by the festive and summer holiday seasons following the similar trend of previous financial years.  

• Despite the QoQ decline in gross revenue and NPI in 4QFY23, its distributable income improved 12% QoQ due to the distribution of deferred rental repayments totaling RM16mil.  

• YTL REIT declared its gross distribution per unit (DPU) of 4.38 sen in 4QFY23, resulting in a FY23 DPU of 7.4 sen. This represents a FY23 distribution yield of 7.6%.  

• The portion of the repayment of rental deferrals account for 29%/13%/13% of total distributable income in FY24F/25F/26F.  

• The master lease for JW Marriott Hotel Kuala Lumpur is set to expire on 31 December 2023 (Exhibit 5). Nevertheless, the lessee, Star Hill Hotel has exercised its option to extend the lease term for another 15 years.  

• As at 30 June 2023, YTL REIT has 52% of borrowings denominated in AUD, 39% in MYR and the remainder in JPY. As 96% of its borrowing is in floating rates, the interest rate hikes in Malaysia and Australia are expected to result in higher borrowing costs in MYR and AUD (Exhibit 7). Nevertheless, we expect no further increase in OPR given that our in-house economist’s full-year expectation of OPR at 3% has already materialised. Meanwhile, we anticipate that the interest rate hike cycle in Australia has reached its tail-end. Bloomberg consensus estimates has shown that the Australian cash rate is expected to peak at 4.35% on 1QCY24 from its current level of 4.1%.  

• Based on the information shared during the Federal Open Market Committee's post-meeting press conference, we understand that there is no certainty that another 0.25% rate hike will take place in the next meeting on 19th- 20th September 2023. The decision to implement another 0.25% rate hike appears to hinge on incoming data, particularly related to labour market and inflation expectations. While awaiting economic data updates, our inhouse economists maintain their forecast, anticipating that the Fed fund rate to peak between 5.5%-5.75% by 3QCY23 from current levels of 5.25%-5.5%.  

• The recent less-hawkish interest rate guidance delivered by the Federal Reserve (Fed) may suggest that we are approaching the end of global monetary policy tightening. 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 rate hikes after 3QCY23. Besides, 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% in 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.  

• 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 9%-10% in FY24F-26F. 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 P/E 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 - 1 Aug 2023