We reiterate our NEUTRAL view on MREITs as the sector is lacking catalyst while downsides are largely priced-in. The asset acquisition pace may be maintained or improve slightly in CY16 as asset valuations are trending closer to more realistic cap rates. We are expecting an exciting 4Q15 results season while the operationally resilient MREITs that own stable assets include KLCC and PAVREIT. Moving forward, we expect bond yields to normalise to the 4.00% level in CY16, once the negative sentiment subsides. We will continue to monitor the situation closely in CY2016. Meanwhile, we advise investors to stay on the sidelines before selectively repositioning into MREITs, particularly those with better-thanaverage earnings growth and strong yield. Our Preferred Pick is SUNREIT (OP; TP: RM1.73) for its strong earnings growth in FY16, due to contribution from Sunway Putra Place (SPP). Meanwhile, we maintain our call and TP for PAVREIT (OP; TP: RM1.68), AXREIT (MP; TP: RM1.69), IGBREIT (MP; TP: RM1.38), KLCC (MP; TP: RM7.13), and CMMT (UP; TP: RM1.31).

3Q15 results review. 3Q15 results were mostly inline, with the exceptions of KLCC and CMMT coming in broadly within expectations. This is better than 2Q15 as both AXREIT and CMMT came in below expectations. QoQ, toplines were mostly flattish to positive (0%-5%), while bottom-line were positive, save for KLCC (-8%) and IGBREIT (-1%). YoY, GRI was mostly positive for all MREITs (3%-21%) save for KLCC (-1%), whereas RNI was positive (1%-14%) for all MREITs except SUNREIT. Earnings for FY15-16E were largely unchanged, except for a 2% cut in AXREIT FY16E earnings.

U.S. Fed raised interest rates by 0.25%. On 16th Dec 2015, U.S. Fed raised interest rates to the range of 0.25-0.50%, from 0.00-0.25% previously. It was the first hike in interest rates since 2006. Since 16th Dec 2015, MGS has been on a declining trend to the 4.22% level from 4.33%. Based on historical trends, we do not expect the 10-year MGS to be severely affected as increments to the U.S. interest rates will be very gradual, as suggested by the U.S. Fed, giving the market sufficient adjustment window. In CY2016, there is likely to be another four 25bps hikes to bring the rate up to a maximum limit of 1.4%, followed by four more hikes in 2017 to bring the rate to 2.4%. Due to available forward guidance on the Fed’s timing of the hikes, we believe this would help limit market shocks and volatility to the MGS. Additionally, even at peak U.S. interest rates back in CY2006 (at 5.25%), the MGS only reached a high of 5.00%, implying that minimal and gradual increments would not cause unexpected spikes to the MGS for prolonged periods.

Expecting no major surprises going forward. In 3Q15, most of the MREITs under coverage posted flattish to positive RNI growth (0.6%-8.9%), save for KLCC which RDI posted negative 8% growth due to higher financing cost, taxation and decline in fair value adjustment from closure of City Point podium. That said, we expect normalisation in 4Q15. However, we opine that KLCC will be operationally resilient due to its long-term, triple net lease (TNL) offices and high-end mall that can weather the effects of GST better. Meanwhile, we are comfortable with PAVREIT’s earnings due to its rock-solid occupancy and prime asset positioning. All in, we do not expect any major surprises going forward and anticipate better earnings quality in the upcoming 4Q15 results season, given that MREITs under our coverage will enjoy the full effects of lease renewals (MREITs under our coverage experienced between 0%-25% of NLA up for renewal in FY15) while the year-end festivities should bode well for retail MREITs.

GST poses no direct material impact to MREITs. We do not expect any direct material impact to earnings from GST, which would inevitably be a replacement of the current 6% sales tax. In light of GST implementation on 1st Apr 2015, we had expected that retail sales will slow down for 3-6 months as consumers will take time to acclimatize, while channel checks have suggested that tenant sales have slowed down c.1% to -5% YTD-YoY for malls under our coverage. Moving forward, we expect the retail spending trend likely to maintain in CY2016 and might pick up in CY2017 if the economy recovers.

Favours occupancy rates over strong rental reversions. In FY15, we did not see any major lease expiry and expected softer rental reversions due to GST and rising cost pressures. As for FY16, it will be a major lease expiry year for PAVREIT (67% of NLA), commanding 6.4% growth in FY16E, while other MREITs will see minimal lease expiry (22-37% of NLA). However, in view of current weak economic environment, we do not expect double-digit growth from rental reversion in PAVREIT. We reckon that retailers may continue to see slow recovery in demand post-GST, hence we factored into our model the expectation of largely flattish rental reversion in CY2016 for MREITs under our coverage.

KLCC crowned the top performer under our coverage on strong acquisition capability catalyst. KLCC stands out as the top gainer YTD, appreciating by 6.6% to RM7.15 which we believe was mostly due to: (i) it being a sizeable Shariah-compliant MREIT, and (ii) renewed shareholders’ approval on 16th Apr 2015, which is valid till next AGM in 2016, allowing them to issue up to 10% placement (estimated between RM1.1-1.2b) for sizeable acquisition plan. The only other gainer was PAVREIT (+2.1%), which announced the acquisition of Damen Mall and Intermark Mall. Other MREITs under our coverage saw negative YTD gains (-0.8% to -11.6%), in tandem with the overall stock market sell-down and expanding bond yields. 

Source: Kenanga Research - 7 Jan 2016