We reiterate our BUY rating on Sunway REIT (SREIT) with a lower DDMderived price target of RM1.90, after lowering our retail growth forecasts and raising the cost of equity. Despite the cut, SREIT remains our preferred pick among MREITs for its diversified asset portfolio - diversified, defensive earnings are a virtue in the current asset cycle. Its retail-centric peers are facing a tough time, which could lead to a switch into SREIT and compress its yields (5.4-5.6% on our forecasts).

SREIT Has a Quality, Mixed Asset Portfolio

SREIT has a good mix of quality assets including: (i) retail assets (70% of NPI) that enjoy consistent, high occupancy rates; (ii) hotels (20%) that are seeing better demand; (iii) a medical centre (5%) where rental is covered by a triple net lease agreement; and (iv) offices (5%).

… and Its Diversified Rental Stream Is a Virtue

SREIT’s diversified, defensive rental stream is a virtue in prevailing property market conditions, where offices are facing a supply glut and retail malls are seeing lower occupancy / weaker rental revisions. The retail-centric MREITs have seen rising equity beta (fig 7) in recent years, partly due to the weak retail mall market. In contrast, diversified MREITs (eg. KLCCSS) and manufacturing / logistic peers (eg. Axis REIT) have seen lower equity beta.

Tweaking FY18-20E EPU by -3% to 0.5%

We tweaked our FY18/19/20 EPU forecasts by -3%/+0.3%/+0.5%, imputing: (i) 3% annual rental revisions for Sunway Pyramid (from 5%), in view of the weak prevailing retail market condition; and (ii) lower interest costs of 4.1%- 4.2% for FY18-20E (from 4.1%-4.3%), given SREIT’s proactive hedging strategy (82% of current borrowings are at a fixed rate).

Maintain BUY With a Lower Target Price of RM1.90

We reiterate our BUY rating on SREIT with a lower DDM-derived price target of RM1.90 (from RM2.05) after lowering our retail growth forecasts and raising our cost of equity to 7.9% (from 7.6%). SREIT is our preferred pick among MREITs for its diversified asset portfolio. At a 5.4% distribution yield for 2018E, its valuation looks attractive, considering its lower earnings risk (vis-à-vis other MREITs) and attractive asset injection pipeline from its sponsor (Sunway Bhd).

Key Downside Risks, Sensitivity Analysis

The downside risks to our positive view on SREIT include: (i) rapid, successive interest rate hikes (we pencil in an OPR hike for 2018); (ii) further deterioration in the retail mall market, leading to weaker-than-expected earnings; and (iii) lower-than-expected occupancy rates at its hotels.

Source: Affin Hwang Research - 2 Jan 2018