Investment Highlights

• We maintain BUY on UOA REIT with a lower fair value (FV) of RM1.23/unit (from RM1.32/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 FY25F distribution yield of 7%, at parity with its 5- year median.

• The lower FV stems from the cut to FY24F/FY25F distributable income by 5%/6% to reflect higher property operating expenses.

• UOA REIT’s FY23 distributable income of RM54mil was below expectation. It was 11% below our forecast and street’s.

• The variance was mainly due to higher-than-expected electricity fee and maintenance cost.

• In FY23, UOA REIT’s gross revenue slid 1% YoY while net property income (NPI) fell 7% 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, along with higher lift maintenance costs.

• QoQ, UOA REIT’s gross revenue declined 5% while NPI dropped 12%. The decline was mainly attributed to higher direct operating expenses incurred for Wisma UOA II and Menara UOA Bangsar (Parcel B).

• QoQ, UOA REIT’s average overall occupancy rate was flat at 81% in 4QFY23 (Exhibit 3).

• The weaker occupancy rates in older buildings (aged >20 years), namely UOA Centre Parcels and Wisma UOA Damansara were mitigated by improvement in newer buildings, including UOA Corporate Tower and Wisma UOA Damansara II.

• Notably, UOA Corporate Tower, a key contributor to UOAREIT (accounting for 46% of NPI in FY23) achieved a remarkable occupancy of 98% in 4QFY23. We recognise that a significant portion of UOAREIT’s tenants with expiring leases in FY24F are from UOA Corporate Tower. Despite this, we are optimistic on the outlook of UOA Corporate Tower, driven by its MSC status and its strategic location within the MSC Malaysia Cybercentre@Bangsar South City.

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

• UOA REIT declared its gross distribution per unit (DPU) of 3.9 sen in 4QFY23. The FY23 DPU of 7.8 sen represents a distribution yield of 7%.

• Our in-house economist anticipates US Federal Reserve funds rate to peak at current levels of 5.25%-5.5%. Our economics team also expects the Federal Reserve to start cutting interest rates in mid-2024 by 75 bps to 100bps. This will eventually bring the Fed funds rate to 4.5%-4.75% by end-2024.

• As such, the 10-year MGS yield has been projected by our economic team to be lower at 3.63% in 4QCY24 from the current level of 3.82%. From FY24F onwards, we anticipate UOA REIT’s distribution yield spread against 10- year MGS to widen to 3.6% vs. a pre-pandemic (2017-2019) 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 95% of net income to unitholders with a strong FY23F-FY25F distribution yield of 7%; and (iv) large pipeline of potential asset injections from its sponsor – UOA Development (Exhibit 6).

• UOA REIT currently trades at a compelling FY25F PE of 13x vs. 4-year average of 15x. Meanwhile, FY25F distribution yield of 7.5% is attractive vs. the 10-year MGS yield of 3.82%.

Source: AmInvest Research - 23 Jan 2024