We believe the worst is over for IGBREIT and the company is poised for strong recovery thanks to its prominent asset quality. Management has seen that their tenants’ sales have recovered strongly ever since the easing of MCO. Management will continue to offer rental support programme on a case-to-case basis to eligible tenants only and in a smaller quantum for 2H20. We are expecting a stronger 2H coming from lesser rental support programmes and recovering tenant sales. We increase our forecast by 6% in FY20 and 10% in FY21-22 to account for higher tenant sales. We upgrade IGBREIT to BUY from a Hold with a higher TP of RM2.01 (from RM1.71) pegged on FY21f DPU on targeted yield of 4.5%, which is derived from 2-year historical average yield spread between IGB REIT and 10-year MGS yield. Barring any unforeseen circumstances, we believe the worst is over for IGBREIT and the company should be able to recover quickly thanks to its robust asset quality.

We met with management yesterday with the following key takeaways:

Stronger-than-expected tenants’ sales recovery. The crowd in Mid Valley Megamall (MVM) and The Gardens Mall (TGM) have recovered significantly ever since the easing of MCO. The company saw that 90% of the crowd are actually going to the mall to make a purchase, which then translated into higher tenants’ sales for the malls (sales recovered to 85% of pre-Covid level). Furthermore, we have seen their exhibition centre has also started to have trade fairs as well as surrounding offices are slowly returning to work (c.70%), which has contributed to the increased mall footfall. Barring any unforeseen circumstances (i.e. second wave which could prompt a second lockdown), the company believes that tenants’ sales will be able to recover to almost 100% of pre-Covid level by year end. The company expects a resurgence of sales in 4Q (driven by Christmas and New Year sales) coming from people who used to shop luxury brand overseas (as borders are expected to remain close till year end).

Rental support programme to be extended on a case-to-case basis. Management shared that rental support programme is inevitable to retain their occupancy; however, it should be in a lesser quantum moving forward. Management believes that retaining their tenants is crucial and if possible, to avoid leasing new tenants as it could translate into lower revenue (as usually new tenants will receive a rent-free period). Management emphasizes that the rental support programme is dedicated only for struggling tenants on a case-to-case basis and retailers that have yet to operate in 3Q. The company hopeful that none of the support programme will be given in 4Q as they have seen footfalls and tenants’ sales have improved significantly coupled with the malls that has been operating 100%.

Other updates. Management shared that about 1/3rd of net lettable area (NLA) is expiring this year and all have been renewed successfully with flattish rental reversion. For FY21, the company will see another 30-40% NLA expiring in MVM while 10-20% of NLA expiring in TGM, and they expect to achieve a low single digit positive rental reversion for FY21 (historically +15% per rental cycle). Capex for FY20 and FY21 will remain low (c.RM15m annually) accounted for only essential maintenance and repair of the malls. On another note, the company’s pipeline asset, Mid Valley Southkey Megamall (MVSM), will have a delay in their injection into the REIT as the company will make sure that the asset becomes established first before injecting it into the REIT. Currently, the MVSM has above 90% occupancy and their tenants’ sales have recovered 70-80% pre-Covid level. As the mall has higher Singaporean exposure (c.30%), the company believes that it will not recover as fast as MVM and TGM if borders remained closed. Hence, the injection will be later than what they expected previously (they expected MVSM to be injected in 2022 previously).

Dividend to be distributed at least over 90%. We have seen that IGBREIT has changed its dividend payout to 92.5% from the 95% it had consistently declared during previous quarters as management are trying to remain prudent during this crisis. However, management assured on distributing at least 90% of the company’s income on a quarterly basis for FY20 as per Securities Commission’s guidelines to enjoy tax-free benefit.

Outlook. We believe the worst is over for MVM and TGM, and both malls will be able to have a strong recovery as they are more resilient to the challenging retail environment in Klang Valley thanks to its prominent location, which contributed to strong footfall traffic into the malls, hence preserving the malls’ premium rental and high occupancy rate of close to 100% as well as their low exposure to tourists (less than 10% exposure to international tourists). Although Retail Group Malaysia (RGM) stated that this year has been the worst for retailers since 1987, we have seen that consumer sentiment has been improving (see Figure 1) as well as some recovery in credit card operation in Malaysia (Figure #2), which could translate into higher spending among consumers. Furthermore, through our observation, mall operators and tenants are putting in a lot more efforts to attract footfall and consumer spending through more sales/promotions/campaigns. Hence, we believe MVM and TGM will be one of few malls that will be able to recover quicker thanks to their premium locations

Forecast. We increase our forecast by 6% in FY20 and 10% in FY21-22 to account for higher tenants’ sales.

Upgrade to BUY, TP: RM2.01. We upgrade IGBREIT to BUY from a Hold with a higher TP of RM2.01 (from RM1.71) pegged on FY21f DPU on targeted yield of 4.5%, which is derived from 2-year historical average yield spread between IGB REIT and 10-year MGS yield. Barring any unforeseen circumstances, we believe the worst is over for IGBREIT and the company should be able to recover well thanks to its robust asset quality.

Source: Hong Leong Investment Bank Research - 25 Sept 2020