We maintain our NEUTRAL view on MREITs as near term catalyst for MREITs are generally lacking. On the bright side, we do not expect further earnings risk in MREITs as we believe that most downside risks have been factored in. The challenging conditions post-GST implementation may dampen CY15 rental reversions but the saving grace is that MREITs under our coverage have minimal leases up for expiry this year. Asset acquisitions may pick up towards end-2015 and 2016 as asset valuations are trending closer to more realistic cap rates. The main concern now is the quasiproxy bond market which has been volatile in recent weeks due to ongoing macroeconomic issues (i.e. weakening Ringgit, 1MDB saga, possible interest rate increase by US Fed). There may be medium-term knee-jerk reactions from negative sentiment pending more concrete news on the key economic events mentioned. Even with the recent volatile bond market, which sent the 10-year MGS to a recent high of 4.12%, which has settled down to 4.04% vs. our target of 3.90%; this is reminiscent of what happened earlier this year. Hence, we maintain our bond yield outlook for now. We advise that investors should wait for the bond market to stabilize before selectively repositioning in 4Q15. Note that 4Q15 is likely to see an upcycle in retail spending recovery post the adjustment to GST, which usually takes 6-9 months after implementation, and of course, seasonal festivities. We advise investors to opt for MREITs with better-than-average earnings growths and strong yields. Our Preferred Pick is SUNREIT (OP; TP: RM1.76) due to strong earnings growth in FY16 mainly boosted by value accretion of Sunway Putra Place (SPP). Meanwhile our recommendations on KLCC, IGBREIT, PAVREIT and AXREIT are all MARKET PERFORMs, while CMMT is UNDERPERFORM.

1Q15 results review. 1QCY15 results were within expectations except for AXREIT which came below our expectations due to weaker performance from 2 assets (Axis Business Campus, and Prai Industrial Facility). Occupancy was flattish for all MREITs, while reported rental reversions were positive single digit for all on a portfolio basis. QoQ, RNI was positive for all MREITS (6% to 24%), except KLCC and SUNREIT due to a weak hotel segment, while CMMT’s decline (-2%) was due to low topline growth (+1%) coupled with higher cost pressures. YoY, RNI was positive for most MREITs (1%-16%), except KLCC (-4%), while bottomline was generally positive (1%-21%) with the exception of KLCC (-3%) and CMMT (-2%) due to similar reasons mentioned above. Earnings estimates were maintained save for AXREIT, which we trimmed FY15-16E earnings by 8%-3% due to the two non-performing assets.

Gains maximized if one sold out in the last rebound rally! In our last strategy (dated 31st Dec 2014 and 6th April 2015), we had recommended investors to sell on rebound rallies in 1Q15, (and this materialised in end Jan-15) or pre-dividend entitlements. We also highlighted in our previous Strategy that 2Q15-3Q15 would be seeing more newflows on weaker consumer spending and potential downgrades in MREITs’ 2Q15 earnings as we may be charting into unprecedented times, while foreigners could continue to exit the bond market on the back of a weaker Malaysian economic outlook (continued depreciation of the MYR to USD and slumping oil prices). Evidently, this did materialise as MREITs’ 1QCY15 average share prices increased by 3.6% (1.9%-5.4% for MREITs under our coverage, save for AXREIT). However, year-to-date (2QCY15), MREITs’ average share price only increased by 0.9% (-3.6%-5.5% for MREITs under our coverage). 

Source: Kenanga Research - 3 Jul 2015