The Covid-19 outbreak and the movement control order (MCO) have resulted in partial shutdowns of the shopping malls and hotels, leading to lower rental revenue for asset owners. In addition, the slump in global equities and commodities has further weakened consumer and business sentiment, which should in turn affect the rental growth rates for all property classes. Facing these unprecedented challenges, we expect the otherwise defensive MREITs to report a steep 14% decline in 2020E EPU, before recovering in 2021E. In view of the challenging business outlook and unexciting 2021E distribution yield of 5.6% (excluding YTLREIT), we downgrade the sector to Neutral (from Overweight). We are also downgrading AXRB and KLCCSS to HOLD ratings (from BUY).

Retails: We Expect Retail Landlords to Offer Rental Rebates

After enduring lower foot traffic in February / early March 2020, retailers have been hit with another major challenge - the government’s movement control order (MCO) has resulted in closure of non-essential services over 18-31 March 2020. While essential supplies and services (supermarkets, pharmacies, convenience stores, telecommunication services, F&B for deliveries and takeaway) are allowed to remain open, we expect these shops (F&B, convenience stores) to also see lower retail spending during these trying times. While the shopping mall owners and the Malaysia Shopping Malls Association have yet to announce their strategy for this difficult period, we believe the landlords will eventually offer some rental rebates, on a case-by-case basis. We have cut our earnings forecasts for all retail-REITs under our coverage, incorporating minimal turnover rent for 2020 and c.4% rental rebates for the year.

Hotels: Best Case Is Minimum Guaranteed Rent or Breaking Even

The hospitality industry has been the hardest hit, first by the reduction in international / domestic travellers and event cancellations in February / early March 2020 and now, the MCO. In general, the hotels are now open with reduced services and chartered for existing customers only; the hoteliers are not accepting new customers between 18-31 March 2020. To mitigate the sharp revenue decline, the hoteliers are undertaking various strategies including operational down-sizing (closing down several floors) and manpower right-sizing (non-renewal of contract workers, forced leave for permanent staff). Broadly, we expect the hospitality-REITs to only achieve the minimum rental guaranteed under their master leases (YTLREIT’s Malaysia operations, Sunway REIT); for those without master leases (KLCCSS’ Mandarin Oriental), we expect the hotels to achieve operating breakeven for 2020E.

Indirect Impact to Hit Offices, Warehouses / Logistics

While we do not expect the Covid-19 and MCO to have direct earnings impacts to the other asset owners (offices, warehouses, logistics), the ensuing weak economic growth, aggravated by the slump in global equity markets and commodities prices, should affect their 2020-22 rental growth. In light of the challenging economic outlook, we have cut our rental growth rates for the office, warehouse and logistics assets. For leases expiring in 2020-21, we now expect the rental to contract by -2% to -5% (from 0% to 2% growth). As a result, we are cutting Axis REIT’s 2020-22E EPU forecasts by 3-6%.

Strong Balance Sheet Is a Virtue

Under the current market conditions, we expect the MREITs with strong balance sheets (KLCCSS and IGBREIT) to weather the downturn comfortably. However, the REITs with higher gearing (ie, YTLREIT and SREIT) and / or substantial borrowings that are due for refinancing in 2020 (YTLREIT has an AUD343m term loan that is due for repayment on 29 June 2020) could see some uptick in financing costs, despite the lower OPR or other benchmark rates.

Cutting FY20-22E EPU by 3-14%

We are cutting the MREITs’ FY20-22E EPU by 3-14%, incorporating: (i) lower retail rental for 2020E (4% rental rebates, minimal turnover rental); (ii) slower retail rental growth for 2021-22E (we were earlier expecting a sharp rebound); (iii) the Malaysian hotels to achieve only minimum guaranteed rent or breakeven; (iv) rental contraction for the offices and warehouse / logistics assets; and (v) higher finance cost and weaker AUD-RM exchange rate for YTLREIT. Please refer to our company write-ups for further details.

Notably, this is our second major earnings cut for the MREITs under our coverage in March 2020. To recap, we had on 16 March lowered our earnings estimates, in tandem with our cuts in 2020E GDP growth and KLCI targets. Our second cut is to take into consideration: the MCO, deteriorating consumer / business sentiment, slump in global commodity prices and travel restrictions / border controls by major global economies.

Lowering Price Targets, Downgrading KLCCSS and AXRB to HOLDs

We have cut YTLREIT’s price target by 29% and the other five MREITs under our coverage by 10%-15% (please refer to the front page and company write-ups). The cuts in price targets are to take into consideration our earnings downgrades and the higher cost of equity due to the REITs’ increased earnings volatility and heightened investor risk-aversion. We observe that 10-year MGS yields have spiked by 76bps from its low 2.78% and last traded at 3.54% as of this writing.

We maintain our HOLD ratings for IGBREIT, PREIT, SREIT and YTLREIT while downgrading KLCCSS and AXRB to HOLDs (from BUYs).

- KLCCSS (downgrade to HOLD, PT RM7.60): while we still like KLCCSS for its iconic assets and defensive earnings portfolio, its share price has outperformed its peers and the broad market during the current sell-off. At 5.2% 2021E yield, its valuation looks fair.

- AXRB (downgrade to HOLD, PT RM1.77): Axis REIT’s asset portfolio is largely insulated from any direct impact of Covid-19 and the MCO; this has supported its share price. However, we believe that the ensuing weaker economic growth will pressure its office and warehouse / logistics assets’ rentals, thereby dampening its earnings prospects. At 5.2% 2021E yield, AXRB is trading at premium to peers, with little upside potential.

Downgrading MREITs to Neutral (from Overweight)

Facing these unprecedented challenges, we expect the otherwise defensive MREITs to report a steep 14% decline in 2020E EPU, before recovering in 2021E. In view of the challenging business outlook and unexciting 2021E distribution yield of 5.6% (excluding YTLREIT), we downgrade the sector to Neutral (from Overweight). Our relative preferences are KLCCSS and IGBREIT for their prime assets and strong balance sheets.

Source: Affin Hwang Research - 23 Mar 2020