Highlights

• Given the challenging economic outlook amid yield compression due to recent share price rally, we continue to remain NEUTRAL on M-REIT sector with preference on stocks with combination of high yield, good asset quality and strong management.
• Underlying fundamental of the sector remains unchanged since our previous update with slower organic growth guided, caused by slower rental reversion by major mall operators in tandem with subdued store sales growth in general; while rising e-commerce remains a long-term risk.

• The scenery of huge office space supply in the pipeline and slower business expansion are not likely to improve in the near term, causing downward pressure on rental yield for REIT.

• Besides, we expect yield of the MGS to largely remain stable for the rest of 2016 given expectations of unchanged OPR. We also expect normalization of the recent strong buying interest in REITs given the average yield for REITs is already compressed to 5.6% from 6.2% at the beginning of 2016.

• However, local consumption may improve gradually in 2H16 after a soft patch since 2Q15, given the normalization of GST effect, festive seasons and measures to support disposabl e income; all the above will spur retail sales in general.

• Nevertheless, we continue to believe that growth in the sector to be driven by inorganic growth as acquisition opportunity may emerge given the softer asking price for property in this sluggish market.

• For remaining FY16, we believe that there should not be unpleasant surprises given the quality of assets in the port folio for majority of REIT players under our coverage.

Catalysts

• Narrowing yield spread.

• Potential acquisition of quality assets to achieve growth as softer property outlook presents such opportunity.

• Higher disposable income may spur retail spending which will in turn boost retail REITs.

• Regulatory intervention in limiting the supply for office/mall.

Risks

• (1) Monetary policy tightening by BNM; (2) Prolonged erosion in consumer sentiment; (3) Failure to execute the planned asset injections; (4) Significant slowdown in broad economic activities; and (5) Narrower spread between yields.

Ratings

NEUTRAL

Maintain our NEUTRAL stance on the M-REIT sector given the overall cautious outlook and challenging operating environment.

• We roll forward our valuation parameters to FY17, maintain our conservative assumption of 10-year MGS yield at 4%.

Top Picks

• Maintain our BUY call on MQREIT (TP: RM1.25) given its high dividend yield of 7.5% based on FY17 DPU and imminent asset injection of Menara Shell.

• We upgrade PREIT (BUY; TP: RM1.80) to BUY as we turn positive on its income growth in FY17 post acquisitions and major reversion at a DPU yield of 5.8% at current price.

Source: Hong Leong Investment Bank Research - 27 Jun 2016