Recently, we observed that SUNREIT has declined more aggressively than its peers over the past one month with -5.3% returns on the period vs. peers’ average returns of -0.5%. As a result, SUNREIT is trading at 7.1% gross dividend yield vs other MREITs at 5.3%-6.1% at current levels. The question thus, is the market anticipating further earnings risks? Besides bond market volatility, we believe investors may be cautious on the stock due to market concerns in the office and hospitality segments. In view of this, we came up with a conservative forecast in our worst-case scenario analysis and concluded that the potential downside to our bottomline (RNI) estimate is capped to a maximum of 7.0% to RM258.7m. Despite a potential downwards earnings revision, impact to our GDPU is not overly significant at 6.6% to 9.6 sen (from 10.2 sen), which implies a yield of 6.6%, which is still a premium to peers’ average of 6.0%. We are also comfortable with our valuations as our applied target yield spread to the 10-year MGS of +1.9ppt is wider than average MREITs’ spread due to its mixed asset portfolio. Investors should also remember that SUNREIT has a strong visibility acquisition pipeline thanks to its parent, SUNWAY. We make no changes to our FY15E-FY16E RNI of RM242- 278m for now, pending clarity from upcoming 2Q16 results on 27-Jan-16. Maintain OUTPERFORM on SUNREIT based on an unchanged FY16E target gross yield of 5.9% (net 5.3%).

Addressing potential concerns: What could be the worst-case scenario? Recently, we observed its share price has declined more aggressively than its peers over past one month with -5.3% returns on the period vs. peers’ average returns of -0.5%. As a result, SUNREIT is trading at 7.1% gross dividend yield vs other MREITs at 5.3%-6.1% at current levels. While the volatile bond market has caused MREITs’ unit prices under our coverage to ease, SUNREIT experienced worse performance due to concerns on its office and hospitality segments. In our potential worst-case scenario analysis, we trimmed FY16E numbers for both the office and hospitality segment, as shown in Table 1 (refer overleaf). For the office segment, we assumed no new tenants will be secured in FY16 and tweaked our occupancy assumptions lower, based on historical low levels for: (i) Sunway Tower, to 20.0% (from 39.0%), after the anchor tenant, Ranhill Worley Parsons (Ranhill) vacated the premise and (ii) Menara Putra Tower, to 26.0% (from 55.0%). In the hospitality segment, we lowered occupancy rates closer to 1Q16 occupancy rates for: (i) Sunway Hotel Seberang Jaya to 60.0% (from 75.8%), assuming competition in Penang Mainland persists, and Sunway Putra Hotel to 40.0% (from 51.5%), assuming no growth in occupancy rates. We maintained our retail assumption as we have already imputed conservative assumptions previously. To recap, we have imputed lower FY16E occupancy rates for Sunway Putra Mall in 4Q15 results review and also forecasted low single digit step up rates in FY16E for other retail assets.

Impact of worst-case scenario is not so alarming after all. Based on our worst-case scenario analysis, we expect FY16E RNI to reduce by 7.0% after adjusting for higher direct property expenses (+3.3%), as we expect higher up-keeping cost. All in, GDPU will be lowered to 9.6 sen (from 10.2 sen), implying gross yields of 6.6% (net yield: 6.0%), which is still higher than our MREIT universe average of 6.0% (range: 5.3%-6.6%).

We still like SUNREIT for its new asset contribution and visible acquisition pipeline. Despite the potential weaknesses highlighted above, we expect FY16E to be better than FY15 as contributions from Sunway Putra Place (SPP) will be mostly accretive in FY16E. Additionally, SUNREIT has a strong visible pipeline of asset acquisitions in place (i.e. The Pinnacle Sunway, Sunway University, and Sunway Pyramid 3). Assuming that SUNREIT fully funds the acquisitions via debt, we believe the group can gear up to 0.40x from current levels of 0.33x, which is still within the group’s comfortable gearing level. This translates to additional RM460m borrowing capacity.

Valuation is still justifiable and warrants an OUTPERFORM. We opine that our applied gross yield spread of +1.9ppt to the 10-year MGS target of 4.0% is justifiable, i.e. target gross yield of 5.9% (net: 5.3%), given that it is higher than our MREIT universe’s average gross yield spreads of +1.8ppt (range: 1.0ppt-2.5ppt). The higher yield spreads take into account the potential weaknesses in the hospitality and office segments as well as it being a mixed segment MREIT. In our worst-case scenario analysis, assuming we lower GDPU to 9.6 sen (from 10.2 sen) whilst maintaining our target gross yield spread, this would only lower our TP to RM1.62 from RM1.73; this would imply a yield of 6.6% vs. the peers’ average of 6.0%. At this juncture, we opt to leave our earnings and TP unchanged, pending clarity from upcoming 2Q16 results on 27-Jan-16.

We maintain OUTPERFORM call with TP of RM1.73, based on a target gross yield of 5.9% (net yield of 5.3%). Risks that will alter our call are weaker-than-expected occupancy rates from office and hospitality segments, higher-than-expected direct property expenses, and lower-than-expected contribution from SPP. 

Source: Kenanga Research - 22 Jan 2016