- Distribution yields at current level have normalised: In this report, we will look at the next potential re-rating among the retail REITs. Distribution yields have converged close to cost of debt as witnessed by the significant yield compression. Underpinned by the unit price outperformance, the market has priced in the REITs’ positive attributes for any exponential earnings trajectory, in our view. As such, distribution yields have normalised at current levels.

- Narrowing of spread over the risk-free rate: Distribution yields for CMMT, PREIT and IGBR have compressed to a tad below 5%, vis-a-vis the average MREITs’ historical yield of 7%-8%. The spread between the 10-year MGS and PREIT and IGBR has narrowed to 77bps and 74bps, respectively, even lower than CMMT of 140bp. This is in fact tighter than the current spread for SREIT of c.300bps. Furthermore, the risk free rate in Singapore of 1.5% is lower than Malaysia’s at 3.5%.

- Next wave of growth – acquisition driven: Hence, the first-mover acquisition advantage is the next re-rating catalyst for the REITs. In addition, the lower cost of funding in the current environment makes acquisitions more attractive, given the potential lower hurdle rates.

- CMMT likely to embark on acquisition first: In essence, PREIT and IGBR have a visible and sizeable pipeline of assets for acquisition. However, we believe CMMT is in an advantageous position for acquisitions in the immediate term, given stabilisation of rental yields at Queensbay Mall and on the back of:-

(1) Positive rental reversion: Queensbay Mall has achieved over 20% rental reversion, since Capitamalls Asia’s acquisition, thanks to the active tenant remixing and asset enhancement initiatives. Average rentals currently stand at c.RM6psf with an occupancy rate of c.95%.

(2) Hints of acquisition in the making: CMMT appears to be paving the way for acquisitions to expand its portfolio. Furthermore, with the pre-emptive mandate to issue more shares of up to 353.6mil (representing 20% of the existing paid-up capital), this signals the potential acquisition of Queensbay Mall. We reckon CMMT will acquire Queensbay Mall, via a mix of debt and equity funding. CMMT’s gearing is manageable at 28% as at end-FY12. (3) Complements Gurney Plaza: No cannibalisation between Queensbay Mall and Gurney Plaza, despite both being in Penang. Both are located in different affluent geographies at Bayan Lepas and Georgetown, respectively.

- To put things into perspective, PREIT’s and IGBR’s potential assets not ripe for injection in the immediate term. Fahrenheit 88’s earliest injection is seen only for FY14F, despite PREIT’s sizeable acquisition pipeline. Rental yields at Fahrenheit 88 have yet to stabilise and will be undergoing rental reversion in this coming 3Q. The tentative timeline for the injection of da:men mall in USJ and Pavilion Extension are in FY15F and FY16F, respectively. Meanwhile, IGBR appears to lack a visible acquisition pipeline in the near term. The potential injection of Southkey Mall is still far-off – to take place earliest after completion in FY18F (and +3 years for stabilisation of rental yields). IGBR earnings are poised for organic growth.

- Given CMMT’s front runner position for acquisition, we have upgraded CMMT (FV: RM2.15/unit) to a BUY. We believe this is a start of an upward re-rating cycle for CMMT, following the potential injection of Queensbay Mall. This will enhance CMMT’s earnings starting from FY14F onwards.

- Greater scope for accretion: More importantly, the acquisition, which will likely be partly funded by debt, is also accretive to overall DPU, given CMMT’s average cost of debt at 4.7% is lower than our implied cap rate of 5.5%. Post injection, accretion to DPU is visible, rising to 10.4sen and 11.0sen in FY14F and FY15F, respectively, from its pre-injection DPU of 9.4sen and 10.0sen. CMMT trades at higher yields for FY14F and FY15F, respectively, at 5.4% and 5.7% vs. 4.9% and 5.3% for PREIT.

- Our top sector BUY is CMMT: PREIT and IGBR remain as HOLDs, with respective fair values of RM1.65/unit and RM1.45/unit. YTD, these three stocks have outperformed the FBM KLCI, on average by 9%. Hence, we re-iterate our NEUTRAL stance on the REIT sector until the key valuation driver is seen to turn more constructive. Long-term, M-REITs’ growth remains positive and intact.

- Upcoming KLCCP stapled security REIT in May: It will be the largest REIT by asset value (RM15bil) and market capitalisation. Hence, REITs are progressively becoming a distinct asset class, given the increasing REITs’ sector representation in the market.

Source: AmeSecurities