Sentral REIT recorded 2QFY22 core net profit of RM18.5m (-9.4% QoQ, -2.3% YoY) and 1HFY22 core net profit of RM38.8m (-2.0% YoY). We deem the results to be below expectations despite accounting for 45%-48% of our and consensus estimates, as we are projecting sequentially weaker quarters due to non-renewal of tenants for two of their properties. The marginal drop in 1HFY22 performance was due to lower rental income generated from (i) Quill Building 2 – HSBC, (ii) Wisma Technip, (iii) Quill Building 3 – BMW and (iv) Menara Shell, as occupancy rate decreases. We trim our earnings forecast by 8.9%/8.5%/5.2%, as we lower our occupancy rate assumptions, given the challenging outlook. We revised our TP to RM0.91 (from RM0.99) and downgrade to HOLD (from Buy).

Below estimates. Sentral REIT’s 2QFY22 core net profit of RM18.5m (-9.4% QoQ, - 2.3% YoY) brought 1HFY22 core net profit to RM38.8m (-2.0% YoY). We deem the results to be below our estimates despite accounting for 45%-48% of our and consensus estimates, as we are projecting sequentially weaker quarters, given non renewal of standalone tenants for two of their properties.

Dividend. Declared DPS of 3.40 sen (semiannual dividend) vs 3.43 sen SPLY.

QoQ. Top line fell to RM37.1m (-5.7%) mainly due to lower revenue generated from Quill Building 2 and Wisma Technip as leases of key tenants have expired at end April and June 2022, respectively without renewal. Meanwhile, property operating expenses rose to RM8.6 (+3.9%), leading to a reduction of net property income (NPI) to RM28.5m (-8.3%). This was, however, mitigated by slight decline in total expenditure to RM10.4m (-6.3%), mainly comprising manager’s fee (-2.3%), finance costs (-2.9%; savings on interests after refinancing exercise in Mar 2022). All in, core net profit decreased to RM18.5m (-9.4%).

YoY/YTD. Revenue shrunk (-3.0% YoY, -3.6% YTD) due to lower rental income generated from (i) Quill Building 2 – HSBC, (ii) Wisma Technip, (iii) Quill Building 3 – BMW and (iv) Menara Shell. Accordingly, property operating expenses decreased (- 0.1% YoY, -7.5% YTD), primarily attributable to lower expenses incurred by some properties. In tandem, these resulted in a marginal drop in net property income (-3.8% YoY, -2.5% YTD). Meanwhile, total expenditure fell (-6.9% YoY, -3.8% YTD), contributed by lower managers’ fee (-2.8% YoY, 2.5% YTD) and finance costs (-8.5% YoY, -6.8% YTD). Hence, core net profit declined slightly (-2.3% YoY, -2.0% YTD).

Occupancy and gearing. With nine properties, the overall occupancy rate decreased to 78% (1QFY22: 86%). As for gearing level, it decreased slightly to 37.0% (1QFY22: 37.4%).

Outlook. As Quill Building 2 and Wisma Technip have been vacant since end April and June 2022, respectively with no prospective tenants in sight, we foresee the downward impact to be more prominent in the upcoming quarters. Management is exploring the strategy of filling up the buildings as a multi tenanted property as opposed to leasing to a single occupier. Overall, management guided that rental reversions for its assets portfolio are expected to remain flattish. On a macro basis, the office market remains challenging due to substantial incoming supply which exacerbates the prevailing office glut. This adds to the challenge of securing new tenants with promising rates.

Forecast. We trim our earnings forecast by 8.9%/8.5%/5.2%, as we lower our occupancy rate assumptions, given the challenging outlook.

Downgrade to HOLD, TP of RM0.91. The recent gain in share price has diminished upside for Sentral REIT. This is coupled with our earnings adjustment in view of its declining occupancy rate and subdued tenancy replenishment. However, we believe the downside is supported for Sentral REIT due to its attractive dividend yield at around 7% and prime office properties at strategic locations. All in, we revised our TP to RM0.91 (from RM0.99). Our TP is based on FY23 forward DPU on targeted yield of 8.3%, which is derived from 5-year historical average yield spread between Sentral REIT and 10-year MGS. Downgrade to HOLD (from Buy).

Source: Hong Leong Investment Bank Research - 22 Aug 2022