Investment Highlights

• 9MCY23 results were largely within our expectation. Out of the 6 companies under our coverage, 5 were in line while 1 was below expectations. Most of the REITs posted a stronger YoY 9MCY23 results except Hektar and UOA REIT (Exhibit 2). The following are the salient highlights of the companies’ performance:
  ➢ Better rental reversion and occupancy rates for prime malls. IGB REIT, Pavilion REIT and Sunway REIT registered stronger earnings in 9MCY23 as a result of favourable rental reversions and improvement in occupancy rates in both retail and hospitality segments.
  ➢ However, less established and suburban malls did not fare as well compared to prime counterparts. YoY, the 32% drop in Hektar’s distributable income was mainly attributed to the increase in finance cost and negative rental reversion in FY22.
  ➢ Given UOAREIT’s flattish rental reversion in FY22, its YoY rental growth was inadequate to offset an electricity tariff hike and increased finance cost in 9MFY23, which resulted in a 10% YoY decline in its 9MFY23 distributable income.
  ➢ QoQ, the earnings of REITs were mixed. IGB REIT, Pavilion REIT and Sunway REIT posted stronger results, mainly attributed to better rental reversions as well as improving occupancy rates in both retail and hospitality segments. Moreover, Pavilion REIT’s earnings was boosted by 4-month contribution from newly acquired Pavilion Bukit Jalil, after its injection on 1 June 2023. Notably, Sunway REIT experienced higher revenue due to the completion of Sunway Resort Hotel's refurbishment and full opening of its 460 rooms in July 2023.
  YTLREIT recorded a 1% QoQ decline in distributable income mainly due to the realisation and receipt of its first deferred rental in the previous quarter. Hektar and UOAREIT registered weaker QoQ distributable income caused by increased finance cost.

• Stronger rental revenue for retail malls in prime locations, partially offset by higher electricity tariff and increased finance cost. In 9MCY23, the net profit margin of retail REITs was impacted by the increase in electricity tariff surcharge that took effect on 1 January 2023. Nevertheless, this was mitigated by the stronger rental revenue in 9MCY23 as a result of substantial improvement in tenant sales and footfalls in retail malls. Looking ahead, we expect the retail sector to maintain its growth momentum in 4QCY23, as 4Q typically stands out as the strongest for retail REITs due to year-end sales. 
  Hence, we maintain our assumptions of higher rental reversions of 5%-6% in CY23F as compared to nil-3% in CY22, particularly for malls situated in prime locations such as Mid Valley Megamall, Pavilion Kuala Lumpur and Sunway Pyramid. However, rental reversions for less established malls are likely to remain flattish or slightly negative. For these smaller malls, increasing occupancy rates through more affordable rents will be imperative (Exhibits 4-5).
• Occupancy and rental reversion rates in office segment expected to be flattish. Challenges persist for offices in Kuala Lumpur city center due to oversupply, impacting a recovery in occupancy and rental reversion rates. Competition from The Stride Strata Office in Bukit Bintang City Centre and The Exchange TRX further adds to increased supply of office spaces in the Klang Valley. Meanwhile, we anticipate a flattish rental reversion for offices and limited improvement in occupancy rates in CY24, given persistent oversupply of office spaces amid corporate decentralisation and flexible working arrangement trends.
• Hospitality segment is on a growth trajectory, witnessing a robust recovery in occupancy rates and average daily rates since 2QCY22. Despite being the traditionally weakest quarter of the year, YTL REIT’s Australian portfolio achieved an average daily rate (ADR) of A$292/room in 3QCY23, comparable with its pre-pandemic peak levels. Moving forward, we anticipate YTL REIT’s ADR to rebound in 4QCY23, supported by festive and summer holiday seasons following the similar trend of previous financial years. Additionally, its occupancy rate has been steadily growing. With the gradual recovery of domestic travelling in Malaysia and Australia coupled with an influx of foreign tourists, we expect the average occupancy rate of hotel properties of YTL REIT and Sunway REIT to gradually improve in FY23F/24F and fully recover to pre-Covid levels by FY25F.

• Buying opportunities from widening yield spread against 10-year MGS yield amidst the tail end of monetary policy tightening and potential 2H2024 interest rate cuts in developed economies. 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 economics team also expects the Federal Reserve to start cutting interest rate in mid-2024 by 75bps to 100bps. This will eventually bring the Fed fund rate to 4.5%-4.75% by end of 2024. Meanwhile, 10-year MGS yield is projected to be 3.95% in 4QCY23, subsequently declining gradually to 3.8% by end of 4Q2024. However, we do not rule out the possibility that 10-year MGS yield could be lower than our projection of 3.8% by 4QCY24 should there be an earlier than expected Fed pivot on US interest rates. We see buying opportunities in Malaysian REIT stocks given widening yield spreads against 10-year MGS (Exhibit 8), supported by appealing distribution yields of 6%-10%.

• Maintain OVERWEIGHT with stable occupancy rates seen across key assets (retail, office and hospitality). We anticipate retail REITs to continue experiencing healthy growth in CY24F, driven by stable occupancy rates and positive rental reversions. This is underpinned by a stable labour market, modest inflation rate of 2.5%-3.5% (due to the impact of subsidy rationalisation and service tax increase) and continued gradual recovery in the tourism industry. Additionally, the hospitality segment of REITs is poised to benefit from government policies aimed at boosting tourism. The gradually increasing influx of international tourists back to pre-pandemic levels is expected to contribute to improvement in retail sales.

• Selective criteria. We like REITs with high-quality assets situated at strategic locations and decent dividend yields. We also favour REITs with exposure in retail and hotel segments, both of which are anticipated to further recover in CY24F.

• Our top BUYs are Pavilion REIT (FV: RM1.62/unit), IGB REIT (FV: RM1.92/unit) and YTL REIT (FV: RM1.11/unit). For Pavilion REIT, its earnings tend to be resilient, mainly underpinned by a prime asset portfolio anchored by Pavilion Kuala Lumpur and Elite Pavilion Mall, which are tourist hotspots that benefit from the return of international tourist. Further increase in earnings is expected from Pavilion Bukit Jalil (PBJ) in CY2024. We believe PBJ is positioned for a positive rental reversion in CY2024, supported by improving footfall traffic and occupancy rates.
  We like IGBREIT due to its long-term resilient outlook underpinned by the group’s strategically located assets in the heart of Klang Valley. Robust demand for its retail lots is evidenced by the near-full occupancy rates of its retail assets. 
  YTLREIT is another of our top picks due to its stable recurring rental income and minimal occupancy risks for its hotel properties in Malaysia and Japan, which are secured by master lease agreements. Besides, we anticipate higher distributions from FY24F to FY29 due to the receipt of rental repayments that have been deferred earlier in FY21-FY22. The stock also offers an impressive FY24F yield of 10%.
• Downside risks to our forecasts are: 
  (i) Escalation of geopolitical tensions that could disrupt global trade and supply chains, leading to a prolonged period of elevated inflation. Consequently, 10-Y MGS yield may persist at a higher rate if expected benchmark interest rate cuts in developed economies do not materialise; and
  (ii) continued high interest rates and inflation which will weigh further on personal consumption expenditures due to higher borrowing costs and prices for consumer goods. This could lead to the softening of tenant sales and hotel occupancy rates as consumers turn cautious in spending on discretionary goods and leisure activities.

Source: AmInvest Research - 1 Dec 2023