Downgrading M-REITs to NEUTRAL from OVERWEIGHT as we believe there is limited room for further yield compressions. Even M-REITs 'risk-free-rate' reference point or the 10-year MGS yield has also been trending lower to current 3.5%. As investors seek safe havens in defensive stocks this year, we note that most M-REITs are trading at historically low gross yields, not to mention record low spreads to the 10-year MGS yields. Assuming the 10-year MGS yields trends lower to 3.3% (based on historical trends) in CY13E and M-REITs continues to demand current record low spreads, we have increased TPs of M-REITs under our coverage. However, our new TPs only provide less than 10% total returns, implying limited share price upsides. As a result, our CALLs/TPs are revised accordingly: 1) Downgrade CMMT to MARKET PERFORM even though we raised TP to RM1.80; 2) Maintain MARKET PERFORM on Sunway REIT even with higher TP of RM1.51; 3) Maintain MARKET PERFORM on Axis REIT even with higher TP of RM3.08. We prefer KLCC Property (OP; TP: RM6.87) as an alternative to M-REITs as our TP reflects a REIT payout structure and a target FY13E gross dividend yield of 4.6% (slightly lower than sizeable retail M-REITs). 

M-REITs have undergone severe dividend yield compressions throughout the year as investors seek safe havens in defensive stocks, with most of them trading at historically low gross yields since 2009 or post GFC (see note 1). Notably, M-REITs reference point, namely the 10-year MGS yield, has also been trending lower to current 3.5% for similar reasons. However, we strongly believe that M-REITs should command some premiums to the 10-year MGS or what we consider a 'risk-free-rate' asset as M-REITs, although defensive, are not completely risk-free. 

M-REIT spreads to 10-year MGS yields are at a record low. We analyzed the historical premiums of M-REIT gross yields vs. the 10-year MGS since 2009. Our analysis indicates that the thinnest M-REIT gross yield premium to the 10-year MGS yield is now +0.9ppt to +1.0ppt which is derived from Pavilion REIT and IGB REIT's FY12E gross dividend yield of 4.4% and 4.5%, respectively. This forms the basis of the valuations for M-REITs under our coverage (CMMT, Sunway REIT, Axis REIT) because both Pavilion REIT and IGB REIT M-REITs are commanding the lowest gross yield spreads because they are the top 2 largest M-REIT by market capitalization, owns 'landmark retail' assets in prime locations and have the highest retail asset exposure (retail spaces have higher average organic growth of 5%-7% p.a. vs. pure office/industrials 2%-3% p.a.). 

Limited upsides for M-REITs. The 10-year MGS has been falling by 0.2ppt-0.3ppt p.a. since 2009. Assuming the trend continues into 2013, we expect FY13E 10-year MGS yields of 3.3%. Although Pavilion REIT and IGB REIT are commanding extremely thin premiums to the 10-year MGS yield of +0.9ppt and +1.0ppt, we believe CMMT,  Sunway REIT and Axis REIT require slightly higher yields spreads of +1.4ppt, +1.9ppt  and +2.4ppt for the reasons mentioned above. This implies the following CALL/valuations for M-REITs under our coverage; 1) Downgrade CMMT to MARKET PERFORM even with higher TP of RM1.80; 2) Maintain MARKET PERFORM on Sunway REIT even with higher TP of RM1.51; 3) Maintain MARKET PERFORM on Axis REIT even with higher TP of RM3.08 (Refer overleaf for detailed explanations on calls/TP as well as risks). 

Prefer KLCC Property (OUTPERFORM) as an alternative to M-REITs with TP of RM6.87 based on a 5% discount to our FD SoP RNAV of RM7.20. The listing of IGB REIT has set new benchmarks of cap date at 5.5% and we think KLCC Property potential REIT-ing of its assets deserves better given their cr''me de la cr''me assets, which are located within KLCC precinct or the most prime address in town. We strongly believe KLCC Property REIT-ing exercise will take place within the next 12 months given the strong price run-ups, which was similarly observed with IGB's KrisAssets performance prior its IGB REIT announcement. Our TP assumes that all of KLCC Property's investment properties (except LotD1 landbank) will be REIT-ed while assuming 100% payout (similar to sizeable M-REITs) and a target FY13E gross dividend yield of 4.6%.  (Refer to KLCC Property report, 5/10/12 for details). 

Downgrade CMMT to MARKET PERFORM even though we raised TP to RM1.80 based on target FY13E gross yield of 4.7% or net yield of 4.2% (previously OUTPERFORM; TP RM1.69 based on target FY13E net yield of 4.5%). CMMT is a pure retail M-REIT but is only the 4^th  largest M-REIT in terms of market capitalization and retail asset exposure, hence the required higher spreads of +1.4ppt to the 10-year MGS yields compared to IGB REIT and Pavilion REIT. However, total return upside to our TP is limited at 7%. 

Maintain MARKET PERFORM on Sunway REIT even with higher TP of RM1.51 based on target FY13E gross yield of 5.2% or net yield of 4.7% (previously TP of RM1.42 based on target FY13E net yield of 5.0%). Although Sunway REIT is the 3^rd largest in terms of market capitalization and retail asset exposure, it is not a pure retail M-REIT and has significant exposure to hospitality and office space risks, hence the higher yield spread of +1.9ppt vs. CMMT's +1.4ppt to the 10-year MGS yields. Total return upside to our TP is 6%. 

Maintain MARKET PERFORM on Axis REIT even with slightly higher TP of RM3.08 based on target FY13E gross yield of 5.7% or net yield of 5.1% (previously TP of RM2.90  on a targeted FY13E net yield of 5.5%). Axis REIT is positioned as an office/industrial M-REIT in a backdrop of an oversupply of office spaces in the Klang Valley. Although it should carry higher yieldspreads to the 10-year MGS due to the absence of retail exposure, Axis REIT has proven to be a 'class  of its own' as it has maintained an aggressive acquisition pipeline which is yield-accretive. Additionally, it is commanding a sizeable market capitalization of RM1.4b unlike any other office/industrial M-REIT. Entry via placements (upcoming c.91m new units) would be ideal as placements are usually given a 5%-6% discount to the 5-day VWAP price fixing day. Total return upside to our TP is 6%.

Risk to our M-REIT CALLS/TP lies with further compressions in the 10-year MGS beyond our expected 3.3%. Additionally, our call does not take into account new asset acquisitions, which could re-rate CALLS/TP.  Risk to our KLCC Property CALL/TP depends on their parent's (KLCC Holdings) intentions of REIT-ing all or some of its investment properties, or even pursuing MREIT over the next 12 months, as well as M-REIT performance in terms of being able to maintain current yield compression environments.

Note 1: We excluded 2008 because of the GFC which resulted in unwarranted sell-downs on M-REITs as investors were influenced by the sell-downs of Singapore REITs, which had higher gearing profiles and higher exposure to MNC tenants who back then hit hard by Global Financial Crisis, vs. our M-REITs.

Source: Kenanga