BNM cut its Overnight Policy Rate (OPR) for the fourth time this year, by another 25bps to 1.75%. Broadly, we expect the OPR cut to have minimal impact on MREITs’ near term earnings as most REITs have locked in majority of their loans at a fixed rate. Nonetheless, the OPR cut should support the sector’s valuation. While the sector-MGS yield differential has widened to 2.3% vs its 5-year average of 1.3%, this premium may not narrow over the near term given the MREITs less favourable earnings outlook. We remain Neutral on the sector. At 5.0% 2021E distribution yield, valuation looks fair. Our preferred pick is Sunway REIT for its diversified portfolio and relatively attractive yield.

BNM Cuts OPR by Another 25bps to 1.75%

Bank Negara Malaysia (BNM) cut its Overnight Policy Rate (OPR) by another 25bps to a record low of 1.75%. BNM has lowered its OPR by a total of 125bps since early 2020 in an effort to support domestic economic activity from the impact of Covid-19. It guided that the latest OPR cut is to provide “additional policy stimulus to accelerate the pace of economic recovery.” BNM is taking a precautionary measure in view of downside risks from possible renew Covid-19 outbreaks that may lead to re-impositions of containment measures, as well as concern on weakness in domestic labour market conditions. Broadly, the OPR cut was within market expectations.

Lower OPR Should Support MREITs Valuations

The 10-year MGS yields declined by 5 bps today to 2.74%, 56 bps below the end-December 2019 level of 3.30%. The compression in 10-year MGS was attributable to the decline in global government bond yields and the OPR cuts. BNM’s OPR cut should support sector valuations.

Minimal Impact on MREITs Under Our Universe

We believe the OPR rate cut has minimal impact on MREITs’ 2020E earnings (<1%), as most MREITs under our universe have pegged majority (>70%) of their borrowings to fixed rates (AXRB, IGBREIT, KLCCSS and YTLREIT). Elsewhere, PREIT and SREIT have fixed rates for 43% of their borrowings. These fixed-rate borrowings are largely MTN/Sukuk with long tenures. In addition, we believe the banks may not fully pass on the full reduction in the OPR rate due to the changing business (and risk) environment.

Maintain Neutral, Relative Pick Is Sunway REIT

We remain Neutral on the MREITs. For exposure, we like Sunway REIT (BUY, TP RM1.82) for its balanced asset portfolio, and relatively attractive yield in comparison to the other REITs under our universe. Sector upside risk is swift and strong recovery in consumer and business sentiment post Covid-19. Downside risks are prolonged weakness in consumer and business sentiment a sharper-than-expected economic contraction and second wave Covid-19.

Source: Affin Hwang Research - 8 Jul 2020