SUNREIT plans to establish RM10b perpetual bond program for future financing given its high gearing level. We believe its ideal funding structure is a combination of existing borrowings and perpetual bonds to manage gearing and ensure DPU accretiveness. Maintain FY19-20E CNP, pending details of the perpetual bonds. Maintain MP but increase TP to RM1.85 (from RM1.65) on expectations of our ideal funding scenario and lower MGS.

Plans for a RM10b perp bond programme. Last week, SUNREIT announced plans to establish a RM10b Perpetual Note Programme (Perpetual Bonds) whereby net proceeds from the issuance will be utilised for financing investment activities, which include acquisitions, capex, refinancing borrowings and for working capital requirements. Financing rates and issuance amounts have yet to be determined, but the Group expects the first issuance by 4QFY19. SUNREIT is the first MREIT to embark on Perpetual Bonds for financing, joining the ranks of developers like SPSETIA, MAHSING as well as BOUSTEAD, whose perpetual bonds carries a c.6% p.a. coupon rate with a step-up rate after the fifth year.

SUNREITs ideal funding structure is a combination of existing borrowing facilities + perpetual bonds (refer to Scenario 3). Based on our analysis of the recent proposed acquisition of Sunway’s Education assets worth RM550m in Dec 2018, assuming perpetual bonds cost of debt is 6%, we believe SUNREIT’s best option for funding via a combination of existing borrowing facilities and perpetual bonds meet the criteria of: (i) ensuring the acquisition is DPU accretive, and (ii) able to keep SUNREITs high gearing of 0.39x at manageable levels of 0.40x. Cash calls via placements or rights issue are not suitable as they might be DPU decretive (Scenario 1.0 and 1.1) at current levels, while funding the acquisition fully via existing borrowing facilities would strain gearing levels to 0.43x (from 0.39x) despite being DPU accretive (Scenario 2).

Equity shareholders should be cautious in the event the RM10b perpetual bond program is maxed out as declining revenue will be detrimental. In the hypothetical maximum case scenario, if SUNREIT fully utilises the RM10b perpetual bond programme, the risk for equity holders lies in a situation of declining revenues. Assuming a 5% decline in revenue on the back of the high perpetual bond cost, equity holders would feel the pinch as DPU could decrease by 16%. Therefore, it is imperative that SUNREIT maintains its revenue on an upward trajectory whilst managing cost.

Maintain FY19-20E CNP of RM300-312m, for now pending the finalised details of the perpetual bond issuance (size and borrowing rate). We are long-term positive on the perpetual bond only if it is utilised in combination with existing borrowing facilities that is DPU accretive, as it helps manage SUNREIT’s gearing levels.

Maintain MARKET PERFORM but increase TP to RM1.85 (from RM1.65). Assuming our ideal funding scenario (Scenario 3) materialises, we believe future acquisitions will remain DPU accretive, allowing SUNREIT to grow its asset base and earnings beyond the conventional cash calls and borrowing facilities. As such, we lower our spread to the 10-year MGS to +1.8ppt (from +2.2ppt) to price-in the uniqueness of SUNREIT having the only perpetual bond facility program which will allow it to grow quicker than other MREITs; however, failure to ensure DPU accretive acquisitions going forward may prompt us to revisit our valuations and earnings. We also lower our 10-year MGS target to 3.90% (from 4.20%) in line with our adjustment across the sector.

Source: Kenanga Research - 29 Mar 2019