We are initiating coverage on Sunway REIT (SREIT) with a BUY call and a DDM-based 12-month TP of RM2.05. Although SREIT is not the highest yielding REIT in the M-REIT universe, we believe that growth prospects of its existing assets and the potential asset injection from its sponsor (Sunway Bhd) provide decent earnings-growth catalysts.

Existing Assets Can Deliver 4-5% NPI Growth.

Despite several of SREIT’s assets (namely office assets) facing a challenging operating environment, we believe that most of the existing assets (excluding those acquired in FY17) are still able to deliver decent NPI growth over the next few years. The main drivers for the growth will be rental revision from the retail properties and the recovery in the occupancy rates for its hospitality properties. Although one of the key hotel properties may be due for major refurbishment in a few years, we believe the impact will be mitigated by the newly acquired assets.

Injection of New Assets Help Sustain Growth.

The 2 new assets that will start contributing in FY18E are the industrial assets in Shah Alam and also Clio (hotel + retail). We are expecting the injection of Clio to be completed by 4QFY18, and SREIT to reap the full benefits in FY19E. We believe that with the completion of Clio, management will have better flexibility in managing the refurbishment of Sunway Resort Hotel & SPA, as Clio can mitigate the reduction in NPI due to the refurbishment. Clio can be viewed as an extension to the current Sunway Pyramid Mall as they are linked via an air-conditioned walkway.

Asset Injection Can Come From Sponsor or 3rd Party

The REIT sponsor, Sunway Berhad (SWB MK, RM1.79, BUY), has a few assets that could be injected into the REIT and provide further upside to SREIT. As SREIT has recently received the approval to raise RM10bn with its new MTN program, based on its capex plans and regulatory cap on gearing, we estimate that SREIT has the flexibility to spend around RM350-400m in new assets before it needs to raise new equity. These assets can come from either its sponsor or a 3rd party. And, given its proposition as a diversified REIT, it has ventured into industrial property recently. Nevertheless, the bulk of its NPI would still be derived from retail assets. Overcapacity in the office segment is a key risk to our call.

Initiating With a BUY Rating and Target Price of RM2.05.

We are initiating coverage on Sunway REIT (SREIT) with a BUY rating and 10-year Dividend Discount Model (DDM)-derived 12-month target price of RM2.05 (Fig 1) based on the following underlying assumptions: i) 7.6% cost of equity; ii) 6.5% equity risk premium; iii) risk-free rate of 3.5%, and iv) 2.5% terminal growth rate. SREIT is the second largest (based on market cap) diversified REIT in Malaysia, and the sponsor, Sunway Berhad, still owns a 37% stake.

Source: Affin Hwang Research - 6 Oct 2017