We attended AXREIT’s 1H17 briefing yesterday and came away feeling cautious of its future prospects. As a result, we have trimmed earnings by 13-3% in FY17-18E accounting for lower occupancy for some assets, conservative reversions and higher financing cost in FY17, while FY18 will see improvements from the new Kuantan acquisition, Axis PDI and lower financing cost post placement. Maintain MP but lower TP to RM1.50 (from RM1.55) on a lower FY18E GDPS.

1H17 earnings slightly below our expectations due to delayed Johor asset (Kerry) acquisition and pending a placement. To recap, 1H17 earnings fell below our expectation (44%) due to: (i) delayed acquisition of Kerry industrial asset in Johor (RM33m) which was recently completed (24th Jul 2017), but was accounted in our full-year FY17E numbers, and (ii) pending completion of the 1st tranche of the placement in FY17 which would help lower financing cost. However, post briefing, we reckon that the 1st tranche of the placement will take place in 4Q17, closer towards the completion of the Kuantan asset acquisition for RM155m (announced 24th Jul 2017).

QoQ top-line weakness due to lower occupancy and Axis Eureka disposal in 1Q17. Although 1H17 top-line was up (by +1.8%) on positive reversions and contributions from Scomi Facility Rawang (Aug 2016), we noticed QoQ top-line weakness (-2.4%) due to: (i) absence of Axis Eureka (disposed in end 1Q17), and (ii) lower QoQ portfolio occupancy to 89.1% (from 91.9% in 1Q17) due to the absence of occupancy from BMW PTP asset (previously 100%), and lower occupancy at Quattro West, Menara Axis, Infinite Centre and Axis Business Park (refer table in overleaf). That said, overall Group reversions were positive at 5.94% for tenants secured thus far (35% of FY17 lease expiries).

Outlook. FY17-18 will see minimal lease expiries with 17.5-15.0% of portfolio NLA. AXREIT accepted a LO to acquire an industrial facility in Iskandar Puteri, Johor (on 7 Apr 2017) for RM50m. As asset details are scarce pending the SPA announcement, which we have yet to take into account. We believe the Group will likely utilise part of the proceeds from the proposed 20% private placement by 4Q17 (announced 24th May 2017, not completed) to pare down its gearing which is expected to increase to 0.39x in the near term (from 0.34x) post the Kuantan asset acquisition, as it will breach the Group’s internal gearing limit of 0.35x.

All in, we lowered FY17-18E earnings by 13-3% to RM92.4-119.9m post accounting for the net negative impact from: (i) lower occupancy at BMW PTP, Quattro West, Menara Axis, Infinite Centre and Axis Business Park, closer to current levels, (ii) more conservative reversions (flattish to 3% p.a.), and (iii) slightly higher financing cost as the private placement is likely to occur in 4Q17 instead of our expectation of 2Q- 3Q, as well as positive impact from: (i) incremental revenue from the Kuantan Industrial asset in FY18 (RM155m), and (ii) lower financing cost in FY18 from the placement in 4Q17.

Maintain MARKET PERFORM but lower TP to RM1.50 (from RM1.55). We lower our TP post accounting for the net negative impact to our earnings which is based on FY18E GDPS of 8.6 sen (from 8.8 sen) post dilution from the placement and on an unchanged +1.70ppt yield spread to our 10-year MGS target of 4.00%. Our MARKET PERFORM call is premised on our neutral outlook for AXREIT due to the lack of convincing near-term catalysts while most downsides have been imputed. However, being highly institutionalized and one of the few Shariah-compliant MREITs offers some downside risk protection.

Risks to our call include: (i) bond yield expansion vs. our target 10-year MGS yield, and (ii) weakening rental income. 

Note that we have already accounted for the 20% placement to accrete in 2 equal tranches; (i) 1st tranche by end FY17, and (ii) 2nd tranche in 1H18. As such, we expect Group FY17-18E gearings of 0.29-0.25x (from 0.29-0.20x) upon completion of the Kuantan asset acquisition.

Source: Kenanga Research - 26 Jul 2017