Investment Highlights

• We maintain our HOLD call on Sunway REIT with a lower FV of RM1.70 based on a forward target yield of 6% versus RM1.85 based on 5.4% previously.

• The higher forward target yield is to reflect the rising interest rate environment in 2018. Investors naturally demand higher yields from REITs as benchmark interest rates move higher. Also, the higher interest rates will increase borrowing costs for Sunway REIT, potentially affecting earnings and limiting future acquisitions (as at 31 Dec 2017, total borrowings stood at RM2.8 billion, in which 89% was due within one year and the weighted average interest rate was 3.93%, and 34% of the total borrowings were floating interest rate debt).

• Despite the subdued consumer sentiment coupled with increased competition from new malls, occupancy rates at Sunway Pyramid, Carnival and Putra Mall have remained stable at 98%, 96% and 94% respectively. Both Sunway Pyramid and Carnival have captive markets surrounded by mature townships, making them the leading malls in their locality, offering a wide array of retailers.

• The newly refurbished Putra Mall continues to maintain its high occupancy. At the same time, it provides rental rebates to encourage both tenant retention and new occupancy. We believe these occupancy rates should sustain while rental reversions grow in the mid-single digits (save for Sunway Putra) as we are not aware of any new malls coming up within 2km radius of these retail complexes.

• The hotel segment remains stable as all assets are currently on 10-year master leases. However, minimal growth is expected from this segment as the tourism industry remains subdued. We expect to see higher contributions from the latest acquisition, Sunway Clio Property, from 3QFY18 onwards.

• Sunway REIT is still predominantly a retail REIT with c.70% contribution coming from its retail assets, and the balance from hotels (c.20%), and offices, hospitals and industrial assets (10%).

• Overall, we are NEUTRAL on the REIT sector over the next 12 months. Prospects for the sector are expected to be subdued, especially with potential OPR hikes in 2018 as well as muted rental reversion opportunities affected partly by the oversupply of retail and office spaces. However, we believe that Sunway REIT will fare slightly better.

Source: AmInvest Research - 26 Feb 2018