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 12 & 13). The FV implies a FY24F distribution yield of 6%, at parity to its 5-year median.

• We make no changes to earnings forecasts as SREIT’s 1HFY23 distributable income of RM159mil came in within our expectations and consensus'. It accounted for 51% of our FY23F earnings and 46% of consensus.

• In 1HFY23, SREIT’s gross revenue grew 17% YoY while net property income (NPI) improved 13% YoY. This was mainly driven by the improved performance of its retail segments, particularly, Sunway Pyramid and Sunway Carnival. In addition, the phased reopening of Sunway Pyramid Hotel (which was closed for refurbishment commencing July 2020) since May 2022 has contributed to stronger YoY results.

• On QoQ comparison, SREIT’s 2QFY23 gross revenue fell 9% while NPI dropped 16%. This was mainly attributed to lower income from its retail segments in 2QFY23 following a strong 1QFY23 performance because of increased tenant sales during the new year festivity celebration.

• QoQ, average occupancy rate for overall segments rose steadily to 80% in 2QFY23 from 79% in 1QFY23 (Exhibits 4, 5 & 7).

• SREIT declared its gross distribution per unit (DPU) of 4.6 sen (+10% YoY) in 2QFY23, representing a 12-month trailing distribution yield of 6.4%.

• For its retail malls, we foresee a positive rental reversion of 5% in FY23F/FY24F. SREIT’s tenant sales in 2QFY23 were 15% higher than pre-pandemic level (2Q2019) on the back of sustained growth momentum of retail sales (Exhibit 10). Stronger tenant sales are anticipated to provide the group with the opportunity to negotiate for higher rentals in subsequent years.

• Meanwhile, we expect turnover rent derived from tenant sales to remain resilient in 2HFY23, buoyed by robust footfall traffic from domestic shoppers and an uptick in retail sales. Our projection of stronger retail sales is underpinned by our in-house economic team’s forecast of a stronger retail sales growth rate of 6.4% YoY in 2HFY23 vs. 5.2% YoY in 1HFY23. The positive outlook is backed by improving consumer sentiment on the back of expectations of no further interest rate hikes and improvement in the labour market.

• While a significant percentage of leases for retail malls (particularly Sunway Pyramid) 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.

• Meanwhile, the acquisition of 6 freehold hypermarkets from Kwasa Properties is on track to be completed by September or October 2023.

• 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. We expect the maiden contribution from the industrial property to kick in in 1QFY24.

• 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).

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

• 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 in-house economists maintain their forecast, anticipating that the Fed fund rate could 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.

• From FY23F onwards, we anticipate SREIT’s distribution yield spread against 10-year MGS to widen to 2.7% 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 11).

• We like SREIT for its well-diversified income base which could cushion potential downside risks. Its portfolio encompasses retail malls, offices, hotels, universities 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 15x vs. its 4-year average PE of 20x. Meanwhile, distribution yield for FY24F of 6.6% is attractive vs. current 10-year MGS yield of 3.9%.

Source: AmInvest Research - 18 Aug 2023