MQREIT witnessed steep YTD declines of 18%, with low PBV’s of 0.79x (vs. peers of 0.78-1.45x). We believe this is due to office oversupply and potential OPR hike concerns, which are not alarming. Pricing in these risks; (i) assuming lower reversions, and (ii) applying a temporary risk premium (+50 bps) on valuations, MQREIT still commands attractive yields of 8.1%. Maintain OUTPERFORM on lower TP of RM1.25 post lowering our earnings estimates by 4-6%.

Steep YTD decline of 18%, trading at a low PBV of 0.79x. MQREIT saw one of the steepest YTD declines, at 18% vs. large cap (>RM1b) peers under our coverage of 4-15%, save for CMMT. Its PBV is also trading at the lower end at 0.79x (vs. peers 0.78-1.45x). We believe investors are concerned about the oversupply of office spaces in the Klang Valley, which is a cause for concern, as well as a second potential OPR hike in 2H18, which is perceived to affect MREIT’s valuations (refer overleaf). We are of the view that these concerns do not pose significant risk to MQREIT, and it is still able to command attractive yields even after pricing in these risks.

Yes, there is oversupply, but will all assets go bust? Office occupancy in Greater KL is c.80% over the past 5 years while rental rates have remained subdued. However, MQREIT’s office assets are faring better than the industry average at 96% occupancy currently, and >90% historically. We believe MQREIT’s assets will be able to rise above tough market conditions due to its quality asset positioning being (i) strategically located in MSC zones while (ii) KL Sentral assets enjoy superior connectivity, as well as (iii) enriched by a host of reputable tenants. This is backed by long lease terms of c.5-15 years, which are favourable in an era of oversupply, as the REIT is able to retain occupancy and rental over longer periods (refer overleaf).

Taking it a notch lower to factor for investors’ concerns. FY17 has seen flattish to mid-single digit reversions, which will mostly accrete in FY18 as most leases will expire in 2H17. While we believe this is achievable, it has become apparent that investors are extremely doubtful. So to reflect the concerns of earnings quality, we opt to assume flat to mildly negative reversion (from low single digits) for FY18-19. As such, we expect the impact of lower reversions to be felt partially in FY18, but mostly in FY19. This is to ensure more conservative earnings estimates in light of unfavourable market conditions while we reckon that management will opt to maintain occupancy over bullish reversions. All in, we lower FY18-19E earnings by 4-6% to RM90.4-90.7m (refer overleaf).

Maintain OUTPERFORM but lower our TP to RM1.25 (from RM1.30) on a lower FY18E GDPS of 8.30 sen (from 8.40 sen). We maintain our +2.6ppt spread to the 10-year MGS target of 4.00%, which is the highest among large cap MREITs (>RM1b) under our coverage (between +1.30ppt to +2.30ppt), as MQREIT is slightly smaller than large cap REITs, while the office segment is weighed down by oversupply fears. Note that we have recently assumed a temporary risk premium (+50 bps) on all MREITs’ spreads to address investors’ concerns of an OPR hike. Despite our conservative valuations, we are comfortable with our OUTPERFORM call as MQREIT is commanding attractive gross yield of 8.1% (net yield of 7.3%) vs. MREIT peers (>RM1b) under our coverage with an average 6.6% yield (net: 6.0%).

Source: Kenanga Research - 30 Mar 2018