We recently visited Al’Aqar Healthcare REIT and have come off convinced that there is more value to be unlocked. Al-Aqar operates in a niche market as it is the only Healthcare REIT, and represents one of only three Islamic REITS in Malaysia. Positive contributions from its yield accretive asset acquisition in Australia of c. 8.5% will drive growth going forward, while rental reversions are stable and is limited to a maximum reduction of 2% p.a. We derive a TP of RM1.41 (11.7% total return) and recommend an OUTPERFORM based on a target gross dividend yield of 6.4% (net: 5.8%), or a +3.4ppt spread to our CY13E 10year MGS of 3.0%

Potential asset acquisition from parent. The group is keen on acquiring assets by FY14 from its parent, KPJ (has rights for the first option to acquire KPJ properties), and third parties (e.g. retirement homes in Australia) while acquisition news could be as soon as 3Q13. Management appears extremely interested in third party acquisitions to accelerate growth as acquiring from the parent is a lengthy 3-4 year process as the parent prefers to spin-off matured assets. However, the REIT has limited gearing room as its current gearing level is now 0.48x (close to SC’s limit of 0.50x). If the group places-out 20% (696.2m new units) of its fund size, based on placement price of RM1.25 (5% discount to the 5-day VWAP price of RM1.32), it will raise proceeds of RM174.6m. If the entire placement proceeds are used for acquisitions, we expect gearing to be lowered to 0.43x. 

Australian assets to drive growth. Australian assets currently make up 10% of total group asset composition (Malaysia-85.0%, Indonesia-5.0%). Management has highlighted that it derives high asset net yields of c. 8.5% from Jeta Aged Care Facility and Retirement Village in Australia, and the group is eyeing other potential Australian assets that could derive similar yields. These are more attractive than their current NPI yield of 6.7% while most of the tenancies are on a triple net lease arrangement. With our estimated RM174.6m from placement proceeds while assuming 8.5% NPI yield for the Australian asset acquisition, we expect FY14E RNI to increase by 22.3% to RM74.3m, assuming the annualized impact of the acquisition while FY14E DPU will increase by 3.9% to 9.4sen. It is also noteworthy that many other MREITs are finding it challenging to acquire local assets given the low cap rate environment. 

The only Islamic Healthcare M-REIT, stable tenant base but flattish reversions. Healthcare REIT is relatively stable in terms of tenant contribution compared to Retail, Office and Industrial REITs which command a shorter renewal period (2-3 years for Retail, 2-3 years for Office, 5-15years for Industrial) and higher reversion rates. Al-Aqar REIT rents the entire asset achieving 100% rental collection under a single lease arrangement with a long lease period of 15 years (with the option to renew for another 15 years) and review rental every 3 years. The review rental, however, is capped with a plus-minus 2% per annum to protect the tenant from increasing rental rates and protect Al-Aqar during an economic down-cycle, thus limiting rental reversions. Assuming no acquisitions in FY13, GRI can only reduce by 2% to RM101.3m (assuming a worst-case scenario).  We like this security as it earnings downside risks are capped. However, the trade-off is the less than the exciting organic growth rate of c.0.8%-2.0% which is lower than the average for Retail (6%-9%), and Office and Industrial REITs (2%-4%).

TP of RM1.41. We derive a TP of RM1.41 (11.7% total return) and recommend an OUTPERFORM based on FY14E target net dividend yield of 6.4% (net: 5.8%) vs. peer average of 7.0% - Al-Aqar REIT tends to trade at 50-70bps below its peer average. Al-Aqar REIT is currently trading at FY13-14E gross yields of 6.4%-6.7%, PER of 15.8x-15.1x, and FY14E PBV of 1.1x. We believe the stock deserves a slight premium to its peers as it is the only Healthcare M-REIT and operates within a niche market with minimal direct competition, while downside to the stock is limited as reversions reductions are capped to maximum 2% per annum.

Source: Kenanga