Maintain NEUTRAL. 2Q18 results continued to meet expectations, consistent since the 3Q17 results season. Meanwhile, share prices are recovering slowly since the unwarranted sell down in March-April 2018, at +7% to -22% YTD (from -7% to -31% lows in March-April 2018). Fundamentally, MREITs’ outlook is clouded by the oversupply of office and retail spaces in the Klang Valley, which is putting a dampener on the sector prospects, limiting our reversion outlook at mildly negative to single-digit reversions for MREITs assets under our coverage. All in, MREITs under coverage are seen maintaining mildly positive DPU growth YoY of 3-2% in FY18-19 as the saving grace is quality landmark assets and/or locations, which can weather oversupply conditions better being able to attract higher footfall traffic. Maintain 10- year MGS target of 4.20%, which is slightly more conservative than current levels of 4.00- 4.10%. MREITs’ earnings are unchanged, but we rolled forward our valuation base to FY19E, increasing our TPs by 0-8%. Reiterate NEUTRAL call with CMMT (OP; TP: RM1.25) as our preferred pick as its 7.3% gross yield (vs. MREITs’ average of 6.1%), post pricing in potential risk to earnings and valuations, appears to have absorbed the necessary risks.

Results have been consistently within expectations. All MREITs’ results were inline, a consistent trait over the past four quarters. YoY-Ytd, top-line growth was mostly positive (2-11%), save for CMMT and MQREIT, which were marginally lower by 4%. This resulted in positive bottom-line growth for most (4-13%), save for CMMT (-3%) and MQREIT (-7%), which were within our expectations. QoQ, bottom-line was mostly flattish to mildly negative (-1% to -15%) due to 2Q18 generally being a marginally weaker quarter for retail REITs due to softer sales while office REITs such as AXREIT and MQREIT saw marginal growth. All in, we made no changes to our earnings estimates, TPs and calls under this latest results review.

REITs’ share prices improving from March-April 2018 lows (of -7% to -31%) to +7% to -22% YTD, with the KLREIT Index recovery (-4% YTD vs. March-April lows of -13%). We postulate that the deep sell-down in March-April may have been due to perceptions of: (i) a growing oversupply of office and retail spaces in the Klang Valley, (ii) expectations of negative impact from an OPR hike, which we believe are unsubstantiated, and (iii) market uncertainties surrounding the local elections. However, we believe the sell-down in March-April were mostly unwarranted while subsequent 1Q18 and 2Q18 results came in within expectations for all MREITs, similar to prior results seasons (note that 3Q17 to 2Q18 results have all met expectations). We believe the slow recovery may have been due to investors gradually gaining some confidence upon the consistent results performance in recent quarters, while investors may also be looking for flights for safety in MREITs in light of market uncertainties.

Unexciting outlook for fundamentals. We are tepid on the outlook for MREITs going forward due to: (i) unexciting reversions, up to mid-single-digit for retail to mildly negative reversions for office assets due to competition from oversupply of office and retail spaces, and (ii) minimal lease expiries (14-30% of NLA for MREITs under our coverage) save for CMMT (45%) in FY18 which we have accounted for. Meanwhile, FY19 will see c. 21-53% leases up for expiry for MREITs under our coverage, but due to the oversupply of both office and retail spaces, we believe strong reversions will remain challenging as tenants will prefer to prioritise occupancy over reversions. As such, we believe we have accounted for most foreseeable near-term risks, on modest FY18-19E average DPU growth of 3-2% YoY.

MREITs with landmark assets will fare better than the market. To recap, considering oversupply fears, we believe MREITs with landmark assets will fare better than the market with above-average occupancy and positive reversions due to well managed assets. REITs such as PAVREIT, IGBREIT, KLCC, SUNREIT will continue to remain stable from higher footfall traffic (vs. neighbourhood malls). This enables such assets to retain close to maximum occupancy of 95-100% vs. domestic retail occupancy of c.80% and command positive reversions, albeit at a slower growth rate which we have accounted for. This is similar for landmark office assets (i.e. KLCC and MQREIT) which fare better than the industry average with close to full occupancy of 96-100% vs. the Klang Valley’s average of c.80%. Additionally, according to Bank Negara’s Financial Stability Review for 1H18, banks will be more cautious when lending to the office space and shopping complex segments going forward. Although this may not help near-term reversion rates, we believe it is a long-term positive as it helps address the oversupply situation which bodes well for MREITs.

Source: Kenanga Research - 5 Oct 2018