MQREIT’s 2Q19 core net profit of RM16.5m (-15.2% QoQ, -22.7% YoY) translated to 1H19 core net profit of RM35.9m (-15.2% YoY). The result was below both ours and consensus estimates due to lower than expected revenue contribution. Declared dividend of 3.43 sen per unit. Overall, we cut FY19/20/21 earnings forecasts by -7.3%/-5.9%/-5.8% respectively after factoring in lower revenue. We downgrade to HOLD with lower TP of RM1.09 (from RM1.15) based on targeted yield of 6.7%. That said, we note that MQREIT still has an attractive dividend yield offering of >6% (highest among REITs in our universe).

Falling below expectations. 2Q19 core net profit of RM16.5m (-15.2% QoQ, -22.7% YoY) translated into 1H19 core earnings of RM35.9m (-15.2% YoY). The results were below both ours and consensus expectations; at 44% and 43% of full year forecast respectively. The deviation was due to lower than expected revenue.

Dividend. Declared semi-annual dividend of 3.43 sen per unit (1H18: 4.23 sen) going ex on 22nd August 2019.

QoQ. Total gross revenue decreased by 6.3% to RM38.8m, which then led to a fall in core net profit to RM16.5m. The cutback was caused by poorer revenue contribution by Platinum Sentral (SPAD downsized & MyHSR moved out in May), Wisma Technip (tenant downsized) and QB5 (IBM moved out in April). However, this was slightly cushioned by the decline in administrative expenses.

YoY. Core net profit fell by 22.7% to RM16.5m. The drop was driven by lower revenue contribution; mainly from Platinum Sentral, Wisma Technip and QB5. However, the fall was marginally mitigated by the reduction in property operating expense (-3.4%) owing to cost efficiency, lower finance costs as well as lower manager’s fees.

YTD. Revenue for 1H19 decreased by 8.3% to RM80.2m. Likewise, core net profit of RM35.9m showed a decrement of 15.2%.The lower revenue was due to (i) loss of revenue from QB8 (disposed in April 2018); (ii) lower occupancy rate from Platinum Sentral (SPAD downsized & MyHSR moved out), Wisma Technip (tenant downsized) and QB5 (IBM moved out). Nevertheless, it was cushioned by (i) lower property expenses (-3.8%) and (ii) lower finance costs (-0.2%).

Occupancy and gearing. Occupancy rate stayed at 89% (1Q19: 89%). The average debt to maturity decreased to 2.07 years from 2.32 years (1Q19), while average cost of financing was kept at 4.5%. As for gearing level, it tapered to 37.1% (1Q19: 37.5%), with a majority of its total borrowings being charged a fixed interest rate (76%).

Outlook. The lacklustre overall office market has dragged MQREIT’s showing. Going forward, management will focus on cost discipline and tenant retention. We believe MQREIT will continue to sustain, despite the moving out of tenants in a few assets. While there are tenants moving out, new tenancies for approximately 89k sf of NLA have been executed which includes a co-working space. We expect income contribution from these new leases by 3Q/4Q19. However we do acknowledge that finding a tenant replacement in QB5 will take some time, as demand for office spaces in Cyberjaya is not as vibrant compared to areas in the KL fringes.

Forecast. We reduce our FY19/20/21 earnings forecasts by -7.3%/-5.9%/-5.8% respectively after factoring in lower rental income.

Downgrade to HOLD, TP: RM1.09. We cut our rating to HOLD with lower TP of RM1.09 (from RM1.15) based on targeted yield of 6.7%. Our valuation is based on the 2-year historical average yield spread between dividend yield and 10 year MGS.

Source: Hong Leong Investment Bank Research - 8 Aug 2019