Maintain NEUTRAL. Results in 3Q18 again met expectations, a consistent trait since 3Q17. However, the average share price of our coverage MREIT universe declined 6.2% YTD, which is in line with KLREI Index (-7.5% YTD). This is likely due to the oversupply of retail and office spaces in the Klang Valley, dampening prospects by limiting strong reversions. Going forward, we maintain our reversion outlook of mildly negative to single-digit reversions for MREITs’ assets under our coverage, which is not overly exciting as we expect MREITs to prioritise occupancy over reversions. As a result, MREITs under our 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 by being able to attract higher footfall traffic. Maintain 10-year MGS target of 4.20%, which is slightly more conservative than the current level of 4.00-4.10%. Reiterate NEUTRAL call on sector with CMMT (OP; TP: RM1.15) as our preferred pick as its 7.7% gross yield (vs. MREITs’ average of 6.3%), post pricing in potential risk to earnings and valuations, appears to have absorbed the risk in general.

Results consistently within. All MREITs’ results were within expectations, a consistent trend seen over the past five quarters. QoQ, top-line growth was mostly positive (1-11%), save for CMMT which was marginally lower by 1%. This translated to bottom-line growth for most (1-15%), save for CMMT (-5%) and MQREIT (-3%), which were within our expectations. YoY-Ytd, bottom-line was positive for most (-1 to 13%) on positive reversions, except for CMMT (-5%), SUNREIT (-7%) and MQREIT (-6%) on higher operating and financing cost. All in, we made no changes to our earnings estimates and TPs, save for IGBREIT which we upgraded from UP to MP.

Our MREIT universe’s under coverage price was down 6.2% YTD on average (as at our report cut-off date on 14th December 2018), dragged down mostly by CMMT (-28% YTD) and MQREIT (-14% YTD), while the KLREI Index declined by 7.5%. We believe that MREITs’ lacklustre performance in 2018 was due to continued perceptions of the oversupply of office and retail spaces in the Klang Valley, but MREITs with weak assets (i.e. negative reversions and declining occupancy) recorded steeper YTD declines. Meanwhile, MREITs under our coverage with YTD share price improvements were IGBREIT (+5.6% YTD) and AXREIT (+1.4% YTD) which recorded marginal gains. We believe IGBREIT had fared better than most MREITs due to its stable asset profile with almost full occupancy (>99%) and positive reversions, while AXREIT’s share price remained firm as it is one of the few Shariah-compliant MREITs coupled with its stable long-term prospects being focussed on more industrial plays.

Tough reversions = unexciting fundamental outlook. We do not expect strong earnings improvements YoY due to the oversupply of both office and retail spaces. As such, strong reversions will remain challenging as tenants will prefer to prioritise occupancy over reversions. FY18 had seen minimal lease expiries 14-30% of NLA for MREITs under our coverage save for CMMT (45%) which have been mostly accounted for. Looking ahead at FY19, MREITs will see c. 21-53% of NLA for MREITs under our coverage up for expiry, with the largest being PAVREIT at 53% of NLA. However, we are not overly concerned for PAVREIT as the bulk of its lease expiries is from Pavilion Shopping Mall (65% of its NLA up for expiry) which we believe would have no issues of securing/maintaining tenants as occupancy is consistently strong >95% due to strong shopper traffic. 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. In light of 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 that own landmark malls such as Pavilion Shopping Mall, Mid Valley, Suria KLCC and Sunway Pyramid, will continue to remain stable from higher footfall traffic (vs. neighbourhood malls). These assets are able 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 - 3 Jan 2019