AXREIT announced the development of Phase 1 of Axis PDI for a development cost of RM210.9m. We were not surprised and are positive on the deal as it secures long-term tenancy (10 years) with accretive impact to earnings post FY18. As such, we leave FY16-17E earnings unchanged. Maintain MARKET PERFORM call with higher TP of RM1.80 (from RM1.76) as we lower our spread to +1.85ppt (from +2.00ppt) to our 10-year MGS target of 3.60% as AXREIT capitalises on more exciting catalysts for its DPU.

Construction at Axis PDI. AXREIT announced that it is proposing to construct a warehouse on its existing land of 24.78ac at Axis PDI after entering into a tenancy agreement with Nestle Products Sdn Bhd for a development cost of RM210.9m. This is for Phase 1 Development of Axis PDI for a single-storey warehouse with a built up of 515,000sf NLA with 100% occupancy. The rental agreement is for a long-term period of 10 years with the option to renew for two additional terms of three years each, while rental stepup will be in later years and has not been pre-agreed at this juncture.

Decent gross yields of 7.6%. We are not surprised with this announcement as management has mentioned that they are keen on greenfield at Axis PDI upon securing a suitable tenant. We are also positive on this announcement as we favour long-term tenancies as it provides earnings stability. The industrial facility’s expected gross yield is decent at 7.60% vs. AXREIT’s recent targeted acquisition gross yields of 7.73%-7.89%, while its portfolio YTD gross yield is at 10.04%. Although gross yield appears decent at 7.6%, it is based on the development cost and purchase consideration for Axis PDI apportioned based on land area for the Phase 1 development. However, note that Phase 1 development GRI of RM19.2m suggest gross yields of 9.2% based on the total development cost alone which we deem as attractive given current market conditions.

Positive on the deal which will be DPU accretive from FY18. The development of Phase 1 of Axis PDI is only expected to be completed in Jan 2018, and will be funded via borrowings (refer overleaf). As for FY18, our back of the envelope calculation, it is expected that this asset could add an additional RM6.5m to FY18E earnings (0.59 sen to DPU), based on a financing rate of 4.2%. Assuming a 5% YoY growth to earnings in FY18, this would make up 5.7% of FY18E bottom line, which is better than AXREIT’s recent acquisitions that contribute <3% to bottom line.

All in, we make no changes to our forecast earnings in FY16-17E as any contribution from this asset will materialise in FY18 onwards, post the handover. We have imputed for the higher gearing mostly in FY17 but leave earnings unchanged as finance cost is capitalised.

Maintain MARKET PERFORM but increase TP to RM1.80 (from RM1.76). We lower our MGS spread to +1.85ppt (from +2.00ppt) to our unchanged 10- year MGS target of 3.60%, to encapsulate better earnings accretion in the longer run (post FY18) as AXREIT has been quick to capitalise on developing greenfield projects in line with SC consultation paper, and has identified exciting catalysts for its DPU which we believe is needed to re-rate the stock. We had previously applied a wider spread for industrial assets vs. pure retail assets (between +0.8ppts to +1.8ppt) since AXREIT has been lacking strong DPU accretive catalysts as recent acquisitions were mainly neutral to mildly positive to DPU. Going forward, investors can look forward to Phase 2 of Axis PDI, which should provide similar accretion to earnings. Downside risks to our call include: (i) bond yield expansion vs. our target 10-year MGS yield, and (ii) weakening rental income.

Source: Kenanga Research - 22 Aug 2016