We attended Sunway REIT(SUNREIT) briefing last Friday and came away feeling positive on SUNREIT’s longer-term prospects as it is planning a 3-in-1 accelerated refurbishment plan for Sunway Putra Place, which involves refurbishment of Sunway Putra Mall (SPM), Sunway Putra Tower (SPT) and Sunway Putra Hotel (SPH) by 1QCY15. We are in favour of the synergistic benefits to be gained by all three assets post refurbishments with expected higher rental rates and better occupancy. However, these will only be felt from FY16 onwards. This is because we expect a dip in occupancy for SPH and SPT during the refurbishment and have trimmed our FY14E and FY15E earnings accordingly by 0.6% and 2.4% to RM210m and RM218m. Maintain MARKET PERFORM but lower TP to RM1.35 (from RM1.36) based on an unchanged target FY14E gross yield of 5.7% (net: 5.1%).

Accelerated refurbishment plan for synergistic benefits. Sunway REIT has chosen to accelerate its refurbishment plans at Sunway Putra Place by targeting to complete the major refurbishments for all three assets; Sunway Putra Mall (SPM), Sunway Putra Tower (SPT) and Sunway Putra Hotel (SPH) by 1QCY15. This is a positive surprise as management previously only guided that they will complete refurbishment at Sunway Putra Mall alone throughout FY14 and early FY15 while refurbishment works for SPH and SPT will only take place in 2H15. Management has now decided to do a 3-in-1 refurbishment exercise because; (i) ongoing work at the SPM currently is affecting occupancy rates at SPH and SPT, (ii) post refurbishment, management can demand better rental rates from SPT and SPH as their business operations are being affected by the closure of SPM, (iii) SPT (office asset) will enhance shopper traffic to SPM (shopping mall) as an est. 2,000 people working in SPT, (iv) SPH will also be able to leverage on SPT for corporate events and business functions/meetings, and (v) SPH will contribute to footfall traffic at SPM.

Expect a dip in occupancy for SPH and SPT during refurbishment. Business operations and occupancy for SPT and SPH are currently affected by the on-going works at SPM, with occupancy at SPH declining from 60% in 4Q13 to 43% in 1Q14 while occupancy at SPT is at 73% as of 1Q14 from 78% in 4Q13. As a result, we have lowered our FY14E and FY15E occupancy rates for SPH to 45% each from 50% and 60% and reduce our ADR assumptions by 5% each to RM180 for both years. As for SPT, we have already assumed low occupancy rates of 75% for FY14E but lowered FY15E occupancy rates from 85%. Hence, we have trimmed FY14E and FY15E earnings marginally by 0.6% and 2.4% to RM210m and RM218m.

FY16 outlook will be brighter. Despite the dip in occupancy and earnings, we are positive on the long-term benefits of this initiative, which will only accrete in FY16 onwards as the REIT will be able to; (i) command higher average rental rates for SPM (from RM4.00-RM4.50psf to RM6.00-RM7.00psf) and better occupancy rates (from 69% on average pre-refurbishment to 95% post refurbishment), (ii) higher average rental rates for SPT (from RM2.40psf pre-refurbishment to RM2.90-RM3.10psf, net of promotional and service charges) and better occupancy rates, estimated close to 90% from 78% at present, and (iii) higher average daily rates (ADR) at SPH from RM190 prerefurbishment to RM350-RM370 and better occupancy rates from 61.3% on average pre-refurbishment to 73%. Note the full post refurbishment impact will only be felt from 1QFY16 onwards.

Maintain MARKET PERFORM but lower TP to RM1.35 (from RM1.36) as our FY14E GDPU has been reduced by 0.6% to 7.64 sen. Our new TP is based on our FY14E target gross dividend yield of 5.7% (net: 5.1%) and an unchanged +1.8ppt spread to our target 10-year MGS.

Source: Kenanga