Investment Highlights

• We maintain BUY on UOA REIT with an unchanged fair value (FV) of RM1.32/unit based on our 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.

• We make no changes to our earnings forecast as UOA REIT’s 9MFY23 distributable income of RM43mil came in within expectations, making up 70% of both ours and consensus’ FY23F forecast.

• In 9MFY23, UOA REIT’s gross revenue slid 1% YoY while net property income (NPI) fell 5% 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, both UOA REIT’s revenue and NPI rose marginally by 1%. The slight improvement in the NPI margin was mainly attributed to lower direct operating expenses incurred for Wisma UOA Damansara, Wisma UOA Damansara II and UOA Corporate Tower.

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

• The weaker occupancy rates in Wisma UOA Damansara II and UOA Corporate Tower were mitigated by improvements in UOA Centre Parcels and Wisma UOA II.

• We recognise that a significant portion of UOAREIT’s tenants with expiring leases in FY23 are from UOA Corporate Tower. Given the departure of existing tenants upon lease expiry, we have seen a 2% QoQ decline in occupancy rate for UOA Corporate Tower in 3QFY23.

• Nevertheless, we remain confident that UOA REIT will be able to secure replacement tenants primarily attributed to UOA Corporate Tower’s MSC status and its strategic location within the MSC Malaysia Cybercentre@Bangsar South City.

• As at 30 September 2023, 30% out of the 57% floor space or NLA occupied by tenancies which will be expiring on FY23 were renewed. Management is confident that 80% of the remaining 27% of NLA, which is occupied by tenancies expiring in FY23 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 that the oversupply of office spaces persists, coupled with inflationary pressures impacting tenant sales.

• No income distribution was declared in 3QFY23 due to its semi-annual distribution policy.

• Our in-house economist anticipates the Fed fund rate to peak between 5.5%-5.75% by 4QCY23 from current levels of 5.25%-5.5%. We expect the uptrend in 10-year US Treasury yield to taper off after a pause in the Federal Reserve’s rate hikes in 4QCY23. Our in-house economist also expects the Federal Reserve to start cutting rate in mid-2024 by 75 to 100bps. This would eventually bring the Fed fund rate to 4.5%-4.75% by the end of 2024.

• The 10-year MGS yield has been projected by our economic team to be at 3.95% in 4QCY23 with a gradual decline to 3.8% by 4Q2024. However, we do not rule out the possibility that the 10-year MGS yield could be lower than our projection of 3.95% in 2023 should there be an earlier than expected Fed pivot on US interest rates.

• 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 continue to 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. the 10-year MGS yield of 3.85%.

Source: AmInvest Research - 17 Nov 2023