Highlights

We  believe  that  t he  REIT  sector  offers  a  good  exposure  of a more  defensive  play  in  the  current  volatile  market.  Our  inhouse  economist  expects  there  will  be  no  more  interest  rate hike, which is no longer a drag  for REIT  sector.

T he  previous  fear  of  negative  impact  of  rising  cost  (i.e. electricity,  assessment,   quit  rent,  etc.)  is  now  proven  to  be unsubstantiated  as  REIT  operators  have  been  able  to  pass on  the  higher  cost  to  tenants  via  rental  reversion  and  /  or service  charge.

Despite  lowering  tax  rate  for  quit  rent  and  assessment  from 12%  to  10%,  DBKL  has  increased  the  property  valuation, which  has  leads  to  surge  in  quit  rent  and  assessment expenses.  We  understand  that  management companies have submitted  their  applications  to DBKL to revalue the properties downwards  and  we  expect  the  reimbursement  will  be  m ade in the next quarterly   results announcements.

We  still  prefer  retail  REITs  given  its  potential  of  higher  rental income  from  rental  reversion,  especially  for  prime  retail  mall (i.e. KLCC, Pavilion  and The  Gardens). Catalysts

Still  healthy  fundamentals  for  the  retail  sector, underpinned  by:  (1)  Sustained  consumption  theme  in Malaysia  (albeit  at  slower  growth  rate);  (2)  High  consumer confidence  and  strong  employment  market;  and  (3) Expectation of no more interest rate hike.

Risks

• Over  supply issues for office space in Klang Valley.
• Increasing  competition faced  by retailers  
• Failure to execute proposed  acquisition plan.

Rating NEUTRAL

• Positives:  (1)  CMMT,  Sunway  REIT,  Pavilion  REIT  and  IGB REIT  provide  investors  with  exposure  to  the  retail  sector;  (2) QCT  focus  on  special  built  building,  tenants  require  large office  space and based on long term lease.
• Negatives:  (1)  Intensifying  competition  for  retail  assets;   (2) Bleak outlook for office

Valuation

We  take  this  opportunity  to  revise  our  DPU  assumptions  in order  to  reflect  latest  updat e from companies and parameters.

As  such,  we  revised  our  TPs  for  QCT  (BUY;  RM1.30),  IGB REIT  (HOLD;  RM1.23),  Pavilion  REIT (HOLD;   RM1.44),  Sunway  (HOLD;   RM1.48), CMMT  (HOLD;   RM1.46)  and  KLCCSS  (HOLD;  RM6.49)  based  on  historical  average  yield  spread and 7-year MGS.

Source: Hong Leong Investment Bank Research - 24 Oct 2014