SUNREIT has proposed a Perpetual Note Programme of RM10bn with an expected first issuance by 2Q19. Proceeds from the perpetual notes will be channelled to future expansion of its portfolio of properties. We are mildly positive on the news. We feel the increase in equity will simultaneously increase debt headroom, eliminating the need for a placement thus alleviating the risk of EPU (and DPU) dilution. The perpetual notes will only be issued for acquiring yield accretive assets. Thus, this move is inline with shareholders interest and it provides financing flexibility to SUNREIT. We maintain our forecast; reiterate our HOLD call with slightly higher TP of RM1.76 (from RM1.70).

Proposed RM10bn perpetual notes. SUNREIT has proposed to establish a Perpetual Note Programme of RM10.0bn. The first issuance of perpetual notes is expected to be out by the second quarter of 2019. The perpetual notes to be issued may be rated or unrated which shall be determined prior to each issuance and shall be transferable and tradable subject to the selling restrictions. We contacted management to gather some insights on this proposal.

Utilisation of proceeds. The net proceeds arising from the issuance of the perpetual notes (after deduction of expenses incidental to the perpetual notes) will be utilised to (i) finance investment activities which includes capital expenditure, asset enhancement as well as related acquisitions and financing expenses, (ii) refinancing of existing and/or future borrowings of SUNREIT’s investment activities and (iii) working capital requirements.

Positive. We feel marginally positive with this dynamic motion.

Increase in equity. From our understanding, perpetual notes are considered equity by the Securities Commissions (SC). Given such, by issuing perpetual notes, SUNREIT will not need to raise more equity or share placement to fund future acquisitions, as there will be more debt headroom made available with the increase in equity. SUNREIT gearing stood at 38.5% as at 2Q19, which is already closing in to MREITs gearing limit of 50%. This route also mitigates the risks of EPU and DPU dilution. Also, SUNREIT undertakes a dynamic review process of the overall capital structure by continuously reviewing to ensure appropriate funding ratio is optimised.

Yield accretive assets. The perpetual notes will only be issued to acquire new assets that yields higher than the perpetual notes interest cost. Thus, only yield accretive assets will be considered. As there is no “capital repayment” involved with the scheduled payment of perpetual debt, this helps to better match the rental inflows from the yield accretive assets with the outflows associated with the perpetual notes (i.e. interest payments).

Flexibility. By proposing a high quantum of Perpetual Note Program, we feel that this is more cost effective in the long run, as we comprehend that SC charges the same application fee, irrespective of the size. Furthermore, the full gain from rental reversion will be attributed to existing shareholders whereas perpetual notes holders’ benefit is limited to the interest coupon rate.

Forecast. Maintain.

Maintain HOLD, TP: RM1.76. We maintain HOLD with higher TP of RM1.76 (from RM1.70), based on targeted yield of 5.5% which is derived from 2 years historical average yield spread of Sunway REIT and 10 year MGS (assumption of 3.9%).

Source: Hong Leong Investment Bank Research - 8 Apr 2019