In light of the coronavirus outbreak, we spoke to several MREIT managers to determine the severity of the impact on their business activities. Broadly, the managers have not seen any material impact on the shopping malls’ traffic; instead, the managers attribute the current decline in footfall to the post-LNY lull and noted that February is a seasonally weaker month. The impact to hotels is more material, but difficult to ascertain at this juncture. Based on our assessment, AXRB’s earnings are least exposed to the outbreak while YTLREIT is relatively vulnerable. Maintain sector OVERWEIGHT. We recommend that investors look beyond the possible near-term earnings weakness and stay invested. The declining MGS yield should drive investor demand for alternative yield plays such as MREITs. Our top picks are AXRB and KLCCSS.

No Noticeable Impact on the Shopping Malls’ Footfall

Contrary to the chatter on social media / coffee shops, the retail-REIT managers have yet to notice any adverse impact from the coronavirus outbreak on their malls’ footfall. However, the managers attribute the current decline in shopping malls’ traffic to the post Lunar New Year lull and note that February is a seasonally weaker month. The managers expect footfall to pick up closer to the Hari Raya festival in May 2020.

Impact to the Hotels Is More Material, But Difficult to Ascertain

For the MREITs under our survey, foreigners typically account for close to three-quarters of hotel occupancy in Malaysia. The managers are seeing cancellations of rooms and events bookings, but are unable to fully determine the magnitude of the decline. Based on preliminary observations, some managers are seeing cancellations of over 50% while others expect the cancellation rates to come in below 20%.

AXRB Is Shielded; YTLREIT Is Relatively Exposed

Based on our assessments, we believe that AXRB’s earnings are shielded from the coronavirus outbreak while the impacts to KLCCSS and SREIT are low. For the retail-REITs, IGBREIT has a higher earnings sensitivity to the tenants’ sales (compared to PREIT) and hence, is slightly more susceptible to any slowdown in the retail spending. Lastly, YTLREIT’s earnings are vulnerable to the outbreak; lower tourist arrivals to Australia (if prolonged) may affect its Australian hotels’ profitability (accounted for 40% of FY19A net property income).

No Change to Our Earnings Forecasts

We maintain our earnings forecasts and stock recommendations for now. In general, we do not expect a significant worsening of the coronavirus outbreak in Malaysia and hence, the overall impact to MREITs’ earnings should be manageable. However, a prolonged or worsening of the outbreak, if materialised, may trigger a further cut in BNM’s Overnight Policy Rate (OPR), which will in turn support the economy and MREITs’ valuations, in our opinion.

Maintain Overweight, Top Picks Are AXRB and KLCCSS

All in, we recommend investors look beyond the possible near-term earnings blip and stay invested. The compression in MGS yields should drive investor demand for alternative yield-plays such as MREITs, thereby re-rating the MREITs’ valuations. For exposure, our top picks are: (i) Axis REIT (BUY, TP RM1.97) for its industrial / warehouse portfolio and attractive yields; and (ii) KLCCSS (BUY, TP RM8.90) for its highly defensive earnings / sustainable yields. Key sector downside risks: weak retail spending, lower economic growth, lower tourist arrivals and reversal in the global yield trend.

Source: Affin Hwang Research - 7 Feb 2020