• Low occupancy and ADR, dismal corporate/event bookings and 3 prominent hotels no longer under guaranteed rent dampens earnings.

• Meanwhile, we remain cautious of the pace of recovery in the retail segment given the reimplementation of MCO which will drag sentiment.

• Due to the above concerns, we adjust our earnings forecasts by 1-7% for FY21-23E. Maintain HOLD on SREIT with a lower target price of RM1.50.

Hotel Segment to Remain Weak

The hotel segment should remain weak as 3 of its prominent hotels are now operating without guaranteed rent. Additionally, Sunway Resort is also closed for refurbishment for a period of 12-24 months, and to be reopened in phases. Occupancy rate is also expected to remain subdued, hovering below the 40% level given the cross-border travel ban and implementation of interstate/inter-district travels. Notably local occupants only made up 40% of 2019 occupancy. We also note that Sunway has conducted promotional efforts to boost staycations, which should lead to lower daily average room rate (ADR).

Reintroduction of Movement Control Order Fuels Concerns

A reimplementation of the movement control order (MCO) does not bode well for the retail sector. As seen in 2QCY20, Sunway Pyramid, which accounts for half of Sunway REIT’s total revenue and NPI, saw its contributions halved due to the MCO and rental assistance extended to tenants. However, unlike the previous MCO, more retailers are allowed to operate during the duration, hence we expect the impact to be less severe as compared to 2QCY20.

Office assets and maiden contribution from Pinnacle Sunway to the rescue

Elsewhere, we expect the office segment to support SREIT’s earnings in 2021 given its stable performance in 2020. Meanwhile, the maiden contribution from Pinnacle Sunway post its acquisition in November 2020 should further boost earnings. Elsewhere SREIT’s other asset segment’s earnings should remain stable in 2021.

Maintain HOLD With a Lower Target Price of RM1.50

Overall, we trim our 2021-2023E earnings forecasts by 1-7% to incorporate a weaker hotel and retail earnings recovery. We reiterate our HOLD call on SREIT with a lower DDM-derived price target of RM1.50 (from RM1.66) as we increased our cost of equity to 8.8% (from previous 8.2%) due to the risks surrounding the hotel segment.

A Mixed Bag Performance in 2021

Another Round of MCO/CMCO/RMCO Was Implemented

Given the surge in Covid-19 cases in Malaysia, (i) 5 states including Pulau Pinang, Selangor, Melaka, Johor and Sabah as well as federal territories were put under MCO; (ii) 6 states were put under Conditional Movement Control Order (CMCO) namely Pahang, Perak, Negeri Sembilan, Kedah, Terengganu and Kelantan; while (iii) Perlis and Sarawak were put under Rehabilitation Movement Control Order (RMCO) for a period of 2 weeks. Though we expect this to drag sentiment in 1HCY21, the availability and distribution of Covid-19 vaccines in 2QCY21 should lead to better sentiment in 2HCY21 and sequentially to a faster-paced earnings recovery.

Nevertheless, Hotel Earnings Should Remain Subdued

We expect the tourism outlook in 2021 to remain weak due to the expected prolonged restriction in cross-border, inter-state and inter-district travel, which leads us to believe occupancy will remain below 40% throughout 2021. Recall that SREIT has an international : local occupants split of 60 : 40. We also expect hotels to report lower average daily room rates (ADR) due to the promotional activities conducted to encourage staycations. Elsewhere, contributions from event / corporate bookings should also remain subdued in 2021, though we do expect some recovery in 2H21 from expected easement in SOPs on large group gatherings. Overall, we opine that the weak conditions should lead to 3 hotels, namely Sunway Putra Hotel, Sunway Hotel Georgetown and Sunway Clio Hotel, to only contribute the minimum guaranteed rent in 2021.

3 Hotels Without Minimum Lease Guarantees

Meanwhile, Sunway Resort, Sunway Pyramid and Sunway Hotel Seberang Jaya, which made up 28%, 19% and 4% of its FY2020 total hotel revenue respectively, are now no longer under the minimum lease guarantee. Though this arrangement is lucrative in a period of strong tourism activities, it backfires in times of economic downturn. This, coupled with Sunway Resort undergoing a refurbishment exercise for a period of 12-24 months, to be reopened in phases, should further dampen contributions from the hotel segment.

Retail Recovery Imperative to SREIT’s Earnings Recovery

Given that the retail segment makes up 74% and 72% of total revenue and NPI in 2019 respectively, another round of MCO/CMCO/RMCO and interstate/inter-district travel restrictions should slow down SREIT’s path to earnings recovery in 2021 despite more retailers being allowed to operate during the duration. Nonetheless, we are still of the opinion that 2021 will be a year of two halves. While 1HCY21 should still see weak contribution from the malls attributable to expected higher rental assistance given to tenants affected during the MCO period, as they are not allowed to operate (eg: fashion and optical outlets, hair dressers, beauty salons, karaoke and cinema), 2H21 should see a faster pick-up in earnings following the distribution of Covid-19 vaccines and expected easement of SOPs on large gatherings. The MCO affected areas includes Sunway Pyramid, Sunway Putra Mall and Sunway Carnival. However, should there be prolonged movement restrictions caused by a continuous high number of Covid-19 cases, we expect further earnings misses. Elsewhere, we expect rental rebates to continue, given at a case-by-case basis throughout 2021.

Mall Occupancy Remains High; Low Risk of Premature Lease Termination

Nevertheless, despite the lingering weakness in the retail segment, we observed strong occupancy in Sunway REIT’s retail assets. As of Sep-20, average occupancy remained high at 94% with a notable 45% increase in Sunway Clio Mall due to commencement of new tenants. At this juncture, we are not overly concerned of risk of premature lease termination in Sunway REIT’s assets given its stellar track record and prominent locations.

Maiden contribution from the Sunway Pinnacle to provide earnings support

The maiden contribution from the yield-accretive acquisition of Sunway Pinnacle should provide an earnings boost to SREIT in 2021. Meanwhile, other office rentals should remain relatively stable in the immediate term. While we are slightly concerned about the possibility of tenants downsizing their workspaces due to the work-from-home trend which has gained traction due to the ongoing pandemic, we do not foresee this to pose a material impact to SREIT’s earnings in the immediate term. As shown in fig 7, only Sunway Putra Tower reported slightly lower yoy occupancy as of Sep-20 while others reported an increase or full occupancy. While the risk of tenants downsizing their workspace area remains, we believe the possibility of tenants exiting the office asset completely remains low as we believe SMEs and large corporations would still opt to have a dedicated workspace for their employees once the pandemic is over to ensure operational efficiency. Nonetheless, we expect this work-from-home trend to put a lid on any increase in office rental, but it should not have a material implication to the sector within the current or next tenancy cycle. Elsewhere, Sunway University, Medical Centre and Sunway REIT Industrial’s earnings contribution should remain stable as it is not directly impacted by the pandemic.

Maintain HOLD With a Lower Target Price of RM1.50

We cut our FY21-23E EPU forecasts by 1-7% as we adjusted our forecasts to reflect the weakness in the hotel segment, heightened by the absence of minimum guaranteed rent in 3 of its hotels as well as a slower retail earnings recovery due to the re-implementation of MCO. Overall, we maintain our HOLD on Sunway REIT with a lower DDM-derived target price of RM1.50 as we also increase its cost of equity to 8.8% (from previous 8.2%) due to heightened risk to its hotel earnings. While we continue to like SREIT’s diversified asset portfolio, the weakness in the retail and hotel segments as well as earnings dilution from its share placement exercise may cap the share price upside. At 4.4% CY2021E yield, the stock is trading within its - 1SD 5-year historical average, which looks fair. For exposure to MREITs, our preferred picks are Axis REIT and KLCCPSG.

Key risks

Upside/downside risks: (i) faster-/slower-than-expected economic recovery; (ii) lower/higher interest rates; and (iii) stronger-/weaker-than-expected earnings due to lower visitorship to its hotels.

Source: Affin Hwang Research - 14 Jan 2021