Sunway REIT’s 1QFY19 normalised net profit of RM70.8m (-8.8% YoY) was marginally below ours but within consensus’ expectations. Declared dividend of 2.48 sen per unit. The decline YoY was primarily due to higher finance costs. However, it was slightly mitigated by the improved performance in retail, office and others segment. We reduced our FY19-20 earnings forecast by 9.5% and 13.0% respectively after factoring in higher operating costs and finance costs. Downgrade to HOLD call with a lower TP of RM1.66 (from RM1.82).

Marginally below expectations. 1QFY19 revenue of RM143.7m (+1.8% YoY) translated into normalised net profit of RM70.8m (-8.8% YoY). The results were slightly below ours but within consensus expectations at 23% and 24% respectively. This was due to higher than expected operating costs and finance costs while revenue growth was slower-than-expected despite having 2 months of tax holiday.

Dividend. 1QFY19 DPU of 2.48 sen (1QFY18: 2.67 sen), going ex on 15th Nov 2018.

QoQ. Revenue increased by 5.5% followed by an improvement of 15.1% in net profit. The increase was due to improved performance from retail and hotel segments. However, it was slightly offset by the higher finance costs.

YoY. Revenue increased by 1.8% thanks to revenue contribution from newly acquired Sunway Clio Property (since Feb 2018) and full quarter contribution from Sunway REIT Industrial – Shah Alam 1. However normalised net profit decreased by 8.8%, mainly due to increased property expenses and finance costs. Higher financed costs were caused by (1) higher principal amount to fund acquisitions and (2) higher average cost of debt (4.03%; 1QFY18: 3.94%) (post OPR hike in Jan 2018).

Segments contribution. Retail segment revenue recorded a 1.3% improvement YoY mainly contributed by Sunway Pyramid Shopping Mall thanks to better turnover rent. Nevertheless it was partially offset by lower performance from other malls. Office segment, increased by 13.0% YoY, largely contributed by higher occupancy in Sunway Putra Tower thanks to new tenants on board. This was partly offset by lower occupancy in Wisma Sunway which is not alarming as it is due to transition of tenants. Also, other segment improved by 10.3% YoY mainly due to rental reversion in Sunway Medical Centre and full quarter contribution from Sunway REIT Industrial – Shah Alam 1. However, lower revenue of 2.2% YoY was attained in the hotel segment that was driven by the lower income from Sunway Resort Hotel & Spa, caused by the partial closure for refurbishment and high base effect from Sunway Putra Hotel due to the higher occupancy in 1QFY18, during the SEA Games and ASEAN Para Games.

Outlook. Hotel segment contribution is expected to be affected primarily due to soft hospitality industry with the expectation of lower tourists arrivals, paired with the disruption from the refurbishment activities at Sunway Resort Hotel & Spa. Management shared their interest in repositioning itself from retail-focused REIT to a diversified REIT. We do not expect inorganic growth in short term due to the limitation of gearing ratio at 38.6% currently.

Forecast. We reduce our FY19-FY20 earnings forecasts by 9.5% and 13.0% respectively after factoring higher operating and finance costs, and updating for annual report figures, as well as management guidance on a dip in FY19’s DPU due to general market uncertainties.

Downgrade to HOLD, TP: RM1.66. We downgrade our call to a HOLD after lowering our TP to RM1.66 (from RM1.82), based on targeted yield of 5.8% which is derived from 2 years historical average yield spread of Sunway REIT and 10 year MGS.

Source: Hong Leong Investment Bank Research - 2 Nov 2018