We maintain MREITs at OVERWEIGHT. Bank Negara Malaysia (BNM) has raised the overnight policy rate (OPR) by 25 basis points to 3.25%, after the Monetary Policy Committee (MPC) meeting yesterday, the first hike since May 2011. We do not expect the hike to have any significant impact on MREITs’ earnings as MREITs have taken preemptive capital management measures over the last two years. We also believe the impact of this round of rate hikes on MGS yield has been priced-in by the market. However, should there be further hikes over the next 6-12 months, this may threaten our valuations and thus sector call. We maintain our 10-year MGS target at 3.80% (20bps lower than current levels) on the premise of a possible European QE. Maintain MREITs at OVERWEIGHT. Our TPs and CALLs are: KLCC (OP; TP: RM6.90), SUNREIT (OP; TP: RM1.56), CMMT (OP; TP: RM1.59), IGBREIT (OP; TP: RM1.35) and AXREIT (UP; TP: RM3.08). Our Top Pick is KLCC due to earnings excitement from a potential acquisition.

Bank Negara Malaysia (BNM) has raised the overnight policy rate (OPR) by 25 basis points to 3.25%, after the Monetary Policy Committee (MPC) meeting yesterday — the first rate hike since May 2011. The central bank’s move to increase OPR is expected, given the rising inflationary pressure. The monetary authority had placed the floor and ceiling rate for the OPR at 3% and 3.5% respectively

Immaterial impact on earnings. The increase in OPR rates is typically negative on REITS’ earnings in general as this would mean higher financing cost. However, most of the MREITs under our coverage have taken pre-emptive capital management actions over the last two years in view of rising interest rates. Most have changed their debt mix to lean towards fixed rather than floating rate debts and those under our coverage have between 60%-99% fixed rate debts, save for KLCC which has only 32% of its debts in fixed rates. A 25bps hike in OPR will have immaterial impact on the MREITs under our coverage; this also applies to KLCCSS. We did a stress test on KLCC and a 100bps increase in effective financing rates will reduce core earnings by only 1.6%, which we deem as not significant.

Weak correlation with 10-yr MGS. Additionally, in theory, an increase in OPR rate would also put upward pressure on the 10-yr MGS yield, which would mean less excitement for the REITs. This is because a hike in OPR could push bond yields higher and in turn makes REITs less attractive. However, historical data suggests that MGS yields and OPR rates have a rather weak correlation, which could be a result of other factors such as: (i) US QE tapering, (ii) a possible European QE, and (iii) the positive carry trade story, which the MGS is also susceptible to as a result of it being heavily held by foreigners (est. 40%)

We make no changes to our MGS target for now as we believe this round of OPR hike has been widely anticipated by the market and been factored in. Our MREITs’ base valuations is to our target 10-yr MGS of 3.80% (20 bps below current levels) to reflect the possible compression in bond yields as a result of a potential European QE. Our Economist is of the view that there may be subsequent interest rate hikes of another 25bps in Sept-14 while there is possibility of more hikes over the next 6-12 months, based on BNM’s trends. If so, this may threaten MREITs valuations and thus, our sector call.

We are assessing the situation and will be observing how the 10-yr MGS will behave if the European QE does take place this month. Maintain OW on MREITs. Our Calls and TP’s are; KLCC (OP; TP: RM6.90), SUNREIT (OP; TP: RM1.56), CMMT (OP; TP: RM1.59), IGBREIT (OP; TP: RM1.35), PAVREIT (OP; TP:RM1.41) and AXREIT (UP; TP: RM3.08). Our Top Pick is KLCC due to earnings excitement from a potential acquisition.

Source: Kenanga