1Q18 realised net income (RNI) of RM21.0m is well within our and market expectations at 23% each. No dividend, as expected. FY18-19 will see minimal lease expiries of 28- 15%. Maintain FY18-19E CNP of RM90.4-90.7m. Downgrade to MARKET PERFORM on an unchanged TP of RM1.15 as our OP conviction call has been favourable with MQREIT rallying 12% since our 2Q18 Strategy and most positives priced in.

1Q18 realised net income (RNI) of RM21m came in within both our and consensus expectations at 23% each. No dividend, as expected.

Results Highlights. YoY-Ytd, top-line was down by 3% mainly from lower revenue generated from Platinum Sentral and Menara Shell, likely due to tenant incentives. Additionally, higher operating cost (+3%) from slightly higher routine operating expenses for some properties, and higher expenditure (+17%) due to; (i) increased administrative expense from the disposal of QB8-DHL, and (ii) higher valuation fees, caused RNI to decline by 9%. QoQ, top-line was rather flattish (-1%) likely due to similar reasons mentioned above, but operating cost also declined (-3%) allowing NPI margins to remain flat at 78%. All in, RNI declined by 2% on the back of higher expenditure (+12%) on increased administrative expense from the disposal of QB8-DHL despite lower finance cost (-12%) on lesser number of days in 1Q18 vs. 4Q17.

Outlook. FY18-19E leases up for expiry are minimal at 28-15% of net lettable assets (NLA) which is preferable under current market condition where the office market is facing an oversupply situation, and risk of tenant attrition. As such, we are expecting flattish to mildly negative reversion in FY18-19 (refer overleaf).

We maintain FY18-19E CNP of RM90.4-90.7m. Our FY18-19E GDPU of 8.30-8.20 sen (NDPU of 7.50-7.40 sen), suggest gross yields of 7.4- 7.3% (net yields of 6.7-6.6%).

Downgrade to MARKET PERFORM (from OP) on an unchanged TP of RM1.15. We maintain our +3.3ppt spread to the 10-year MGS target of 4.00%, based on FY18E GDPS of 8.30 sen. Our applied MREITs’ spread is +0.5SD above historical averages to encapsulate investors’ concerns of oversupply issues and OPR hikes, but we may look to remove this going forward once confidence returns to the sector (i.e. consistent earnings delivery suggesting that oversupply fears are exaggerated, and confirmation of a low probability of a second OPR hike).

We are comfortable with our MP call as our conviction OP call has been favourable with MQREIT rallying 12% since being named our Top Pick in our 2Q18 MREITs Strategy (dated 4th April 2018) vs. other MREITs peers of (7-17%). That said, we believe most positives are priced in at current levels, while we remain cautiously optimistic as we are still pricing in oversupply and OPR concerns that may affect valuations. At current levels, MQREIT’s FY18E gross yield of 7.4% (net: 6.7%) remains above large cap MREITs’ (>RM1b) average of 6.0% (net: 5.3%) but we believe this is likely due to the fact that; (i) MQREIT is slightly smaller than large cap REITs, and (ii) the office segment is still being weighed down by perceptions of an oversupply situation (vs. retail and industrial assets), which we have priced in our spreads.

Risks to our call include bond yield expansions or compressions and weaker-than-expected rental reversions.

Source: Kenanga Research - 18 May 2018