SUNREIT proposed to acquire Sunway Pinnacle for RM450m, and proposed a private placement of up to 15.4% to raise RM710m to part fund the acquisition and the remainder for capex for Sunway Carnival extension. The acquisition price is fair with an NPI yield of 6.2%, but we expect dilution post placement in 1HFY21. Lower FY21E DPU by 7.9% to 8.8 sen. Maintain MARKET PERFORM but lower TP to RM1.50 (from RM1.65).

Acquiring Sunway Pinnacle. SUNREIT proposed to acquire Sunway Pinnacle for RM450m, via a proposed private placement that is expected to raise proceeds up to RM710m (est. 452.2m shares at RM1.57). The placement will be utilised for the acquisition (utilising RM405m) as well as to fund the capex for the Sunway Carnival Mall extension (RM295m) which would be completed by end CY21 (mid FY22), with the price and dilution yet to be determined pending the book building. Additionally, SUNREIT proposed to establish a distribution reinvestment scheme which we view positively as it would help retain cash within the company. The proposals are expected to be completed by 4QCY20 (by 1HFY21).

Sunway Pinnacle acquisition price is fair. Sunway Pinnacle acquisition is expected to start contributing by mid FY21 with a net yield of 6.20% which is higher than SUNREITs portfolio yield of 5.85%, while its other office assets yields are range bound between 5.2% to 6.6% (save for Sunway Tower). We like the fact that the asset is currently 100% occupied, and the acquisition will provide decent rental income c.3.2% to earnings, but we caution that the office segment is experiencing an oversupply in the Klang Valley and the impact of Covid-19 may affect certain sectors within the economy. Sunway Pinnacles’ tenants that are in fairly stable sectors such as technology and telecommunication, and pharmaceutical make up 65% of the assets NLA, while 10% is from oil and gas sector and 25% from other sectors.

Earnings increased by 6.3% to RM314m for FY21 but DPU is lowered by 7.9% to 8.8 sen. All in, FY20 remains unchanged but we increase FY21 earnings by 6.3% as the Sunway Pinnacle acquisition will contribute c.3.2% to earnings, while we believe the Group will utilise some of its excess cash due to the heavy dilution to pare down borrowings in the near term, resulting in lower borrowing cost by c.3.1%. However, FY21 DPU is expected to decline by 7.9% to 8.8 sen (from 9.5 sen) assuming the 15% placement. FY20-21E NDPU of 7.0-7.9 sen (from 7.0-8.6 sen) provides 4.4-5.0% net yield. Gearing is expected to decline to 0.36x in FY21 from 0.40x due to the placement.

Maintain MARKET PERFORM but lower TP to RM1.50 (from RM1.65). Our TP is based on a lower FY21E GDPS/NDPS of 8.8/7.9 sen (from 9.5/8.6 sen) and a +2.5ppt spread our 10-year MGS target of 3.30%. Our applied spread is at +2.0SD, on par with other MREITs under coverage (save for AXREIT) to account for earnings risk in light of the Covid-19 pandemic considering its exposure to retail and hospitality segments. We are comfortable with our MARKET PERFORM rating as we believe most near-term downsides have been accounted for, including the dilution while SUNREIT’s gross yield of 5.6% is marginally above large cap MREIT peers’ average of 5.3%.

Risks to our call include: (i) bond yield expansion or compression, and (ii) stronger or weaker-than-expected earnings in retail, hospitality and office divisions.

Source: Kenanga Research - 30 Jun 2020