Maintain NEUTRAL rating for MREITs and Property Investment sector as current record high valuations will limit upside. MREITs have experienced record low yields and strong share price run-ups over the last few years due to global economic uncertainties and of late, GE risks. Hence, dividend yield spreads against the 10-year MGS for MREITs under our coverage have been compressed to record low levels of 1.3-1.7 ppt spread. We see limited upside for MREITs and KLCC as our TP reflect valuations at historical low yield spreads to our expected CY13E 10-year MGS yields of 3.0% (CY12: 3.5%). Post GE, there is risk that investors may switch to higher beta stocks, like developers, as per our House strategy. While there is a good chance of that, we are cognizant of the possibility of prolonged uncertainties post GE. Therefore, we recommend that investors maintain some exposure to resilient MREITs to safe-guard against any negative surprises, implying a tradingon-weakness strategy. We maintain MARKET PERFORM for all MREITs and property investment companies under our coverage, namely KLCC (TP: RM6.56), SUNREIT (TP: RM1.61), CMMT (TP: RM1.90), AXREIT (TP: RM3.18). Our preferred pick for trading on weakness is SUNREIT due to its strong organic growth from retail spaces and visible large pipeline from its parent.

4Q12 Results Review. Under our coverage, only KLCC came in above expectations, while the rest (SUNREIT, CMMT and AXREIT) came in within expectations. Growth in earnings was underpinned by positive rental reversions and healthy occupancy rates. MREITs with pure or sizeable retail space exposures were supported by strong organic growth of 11% YoY on average given the resilient retail spending growth in Malaysia and accretions from recent AEIs. KLCC exceeded expectations due to higher than expected lease renewal rates for Petronas Twin Tower (PTT). In spite of that, we are still maintaining a MARKET PERFORM rating on KLCC as its stock has already run up close to our TP due to its impending Stapled REIT restructuring and expectations that Suria KLCC will be REIT-ed; note that our valuations of KLCC include REIT-ing of Suria at 100% holdings.

Yield compressions at a record low. Since June 2012, MREITs under our coverage, namely CMMT, SUNREIT and AXREIT, have risen by 23%, 23% and 27% respectively. Over the same period, yields have compressed from 4.8%-5.8% to 4.3%-4.7%. Their spreads to the 10-year MGS yields are also at unprecedented lows. We analyzed the historical premiums of MREIT gross yields vs. the 10-year MGS since 2007. Our analysis illustrates that the spread between MREIT gross yields and the 10-year MGS yield is at unprecedented lows. The current spread for CMMT, SUNREIT and AXREIT stands at +1.3ppt, +1.7ppt and +1.6ppt respectively; we expect CY13 10-year MGS of 3.0% (CY12: 3.5%). We expect the 10-year MGS yield to trend lower to 3.0% as there is ample liquidity while global economic risks persist.

NPI yield accretive acquisitions may be challenging. The current average portfolio NPI yield is about 6.5-8.9% for MREITs under our coverage, while the prevalent cap rate for offices and retail spaces are 6.0%-7.0% and 5.0%-6.5%, respectively. As asset values have risen aggressively over the years, it becomes more challenging for MREITs to acquire portfolio NPI accretive assets as rental rates are lagging behind. Hence, asset financing structures must be optimal to extract the best return from such assets (refer overleaf for examples).

Recommendation. We maintain our MARKET PERFORM rating on the REITs sector given that investors are still seeking for safe haven running up to GE and global economic uncertainty despite the yield compression theme pushing yields to historical low levels. We maintain MARKET PERFORM ratings for all MREITs under our coverage, namely KLCC (TP: RM6.56), SUNREIT (TP: RM1.61), CMMT (TP: RM1.90), AXREIT (TP: RM3.18). Our preferred pick for trading on weakness is SUNREIT due to its strong organic growth from retail spaces and visible large pipeline from its parent, solid growth in retail spending in Malaysia and rental increase post-refurbishment for Sunway Putra Mall. Potential acquisitions for SUNREIT include Sunway University and Monash University (worth about RM200m each), and Sunway Giza (worth about RM50m). We value SUNREIT at a target price of RM1.61 based on a target net dividend yield of 4.4%.

Source: Kenanga