Maintain NEUTRAL. 4Q16 results for MREITs were mostly in line with expectations while fundamentals for the sector are intact as we expect modest single-digit reversions on minimal leases up for expiry in FY17 (of 13%-34%). We believe PAVREIT (OP; TP: RM1.89) is likely to see an asset injection in FY17 (i.e. Pavilion Elite) with a visible acquisition path, while MQREIT and AXREIT may also see asset acquisitions in FY17-18. We are comfortable with our 10-year MGS target of 4.20% which is slightly conservative vs. current levels. Additionally, we do not discount possible knee-jerk reactions to the 10-year MGS due to US interest rate hikes in CY17 which my put slight downward pressure on MREITs’ share prices. Maintain NEUTRAL as the sector lacks strong rerating catalysts, while downsides are limited as MREITs are viewed as a preferred safe-haven. Our preferred picks are PAVREIT (OP; TP: RM1.89) on strong asset acquisition potential (13.5% total returns), and MQREIT (OP; TP: RM1.36) on stable assets backed by strong dividend yield of 6.6%. 4Q16 results were mostly within expectations, save for IGBREIT which was above expectations on better margins. All in, it was a better quarter than 3Q16. YoY, all MREITs saw flattish to positive top-line (0% to 14%), while most saw bottom-line growth (2% - 10%), save for AXREIT (-2% RNI) and PAVREIT (-2% RNI) due to higher operating and financing cost on recent acquisitions. QoQ, bottom-line growth was flattish to negative (2% to -13%) mostly from higher expenses and financing cost. All in, most MREITs earnings estimates were left unchanged, save for IGBREIT which we upgraded by 7.7% for FY17E on higher margin assumptions. This was better than 3Q16 when we downgraded AXREIT’s earnings. Our calls were unchanged during results season, but we upgraded our TPs for SUNREIT, CMMT and MQREIT upon fine-tuning our spread to the 10-year MGS as investors continued to search for yields, and upgraded IGBREIT on higher earnings.

IGBREIT top performer YTD, up 7%. IGBREIT remains the top gainer under our coverage in CY17, up 7% as of our report cutoff date (10th March 2017), likely due to its asset stability from strong occupancy (>99%) and double-digit reversions, on the back of a good set of full-year results. This was similar to CY16 when IGBREIT was the top performer as well, increasing by 19.4% vs. other MREITs of (between -1.8% to +17.1%), while IGBREITs gross yields prior to the share price run-up then was attractive at 6.2%, vs. other MREITs’ average of 5.8%. All in, MREITs’ share prices in CY17 appear to have stabilised compared to the strong run up in CY16 when investors were rushing to chase for dividends due to market volatility.

FY17 seeing minimal lease expiries and unexciting reversions. FY17 will see minimal leases up for expiry for MREITs under our coverage at 13-34% in FY17E which we have already accounted for. We are also forecasting mid-to-high single-digit reversions for retail MREITs assets under our coverage, and low-to-mid single-digit reversions for office and industrial assets to remain conservative. As such, we believe fundamentals are mostly intact while we expect DPU growth of 6.0-3.0% on average in FY17-18 from MREITs in our coverage universe.

PAVREIT likely to see an asset acquisition in FY17. We believe there may be strong asset acquisition potential from PAVREIT from the recently completed Pavilion extension or Pavilion Elite (which opened in late Nov 2016). Although details remain scarce, we reckon that the injection of Pavilion Elite could add 15.7% or RM66m to PAVREITs FY17E GRI (4% to bottom-line) based on 250,000sf NLA (11.8% of PAVREITs total NLA) on our assumed rental rate of RM22psf/month, while accretions to earnings and DPU will depend on the finalised asset cost and methods of funding (i.e. borrowings or cash call). Additionally, other potential assets for acquisition by PAVREIT include: (i) fahrenheit88, (pending the sponsors’ intention to sell), as well as assets from (ii) WCT (i.e. Paradigm Mall, AEON Bukit Tinggi and gateway@KLIA2) of which Tan Sri Desmond Lim and wife has a 20% stake. However, we believe PAVREIT may acquire assets should cap rates become more favorable i.e. from 6.0% and closer to 6.5%, while the group’s low gearing (0.25x) also allows for sizeable acquisitions. MQREIT may look to acquire Menara Celcom from its sponsor MRCB upon completion, likely by FY18 or later, while details of the acquisition may be too soon to finalize pending completion of construction. AXREIT is also eyeing c. RM400m worth of industrial asset acquisitions in Selangor, Pahang and Johor and is still pending the completion of the acquisition of Kerry Industrial Warehouse (worth RM33m), likely by 2Q17, which we have already imputed in our estimates.

Maintain our 10-year MGS target of 4.2%. Our current 10-year MGS target of 4.2% is post accounting for the Fed’s previous statement of potential four interest rate hikes in CY17, and as such we make no changes to our target. The 10-year MGS continues to stay range bound between 4.0-4.1% in CY17 thus far, while we remain slightly conservative and target 4.2%. Additionally, in light of US interest rate hikes in CY17, we do not discount the likelihood of possible knee-jerk reactions to the 10- year MGS which my put slight downward pressure on MREITs’ share prices. As such, we are comfortable with our 10-year MGS target. Lastly, we do not expect a severe spike in the 10-year MGS as Malaysian bonds are still fairly attractive vs. regional (Asia Pacific) 10-year bond yields (refer to table below).

Maintain NEUTRAL on MREITs. We maintain NEUTRAL as the sector lacks strong re-rating catalysts, while downsides are limited as MREITs are viewed as a preferred safe-haven. Most REITs under our coverage are commanding total returns between 2-7% (save for PAVREIT and MQREIT), warranting our NEUTRAL call on the sector. Additionally, gross yields of 5.1- 5.7% are decent vs. the 10-year MGS of 4.2%, save for MQREIT at 6.6% yields

Our preferred picks are PAVREIT (OP; TP: RM1.89) and MQREIT (OP; TP: RM1.36). We cherry picked PAVREIT due to its inorganic growth potential from likely asset acquisition in FY17 while low gearing allows for sizeable acquisitions or greenfield potential. All in, PAVREITs gross yield of 5.4% provides security to investors due to its stable assets, mainly Pavilion Shopping Mall, on the back of strong portfolio occupancy at 95%, while upsides for PAVREIT appear attractive due to its visible acquisition path. MQREIT is our other preferred pick due to its stable assets backed by strong dividend yields of 6.6%. At current levels, PAVREIT is commanding attractive total returns of 13.5%. MQREIT’s earnings prospect appears solid due to its stable asset profile as most asset on long-term leases (i.e. 5-15 years), while portfolio occupancy is expected to remain healthy at >97% with minimal lease expiries in FY17E of 13.0%, capping downside risk. At current levels, MQREIT is commanding 6.6% yield in FY17 which is far superior compared to MREITs under our coverage, at 5.1-5.7% yields.

Risks to our call. Factors that may affect our call include: (i) worse-than-expected consumer spending, (ii) cost-push factors that result in weaker-than-expected rental reversions, (iii) U.S. Fed increasing interest rates in a more aggressive manner, and (iv) weaker-than-expected occupancy rates, (v) further decline in oil prices and weaker MYR, which may increase pressure on the 10-year MGS.

Source: Kenanga Research - 30 Mar 2017