Maintain OVERWEIGHT. 1QCY21 results were mostly broadly within as the 1Q was already expected to be weak in light of MCO 2.0. The worsening Covid-19 situation in May-June 2021 period has put a dampener on FY21E earnings prospects, signalling a weaker 2QCY21 and 3QCY21 ahead. For now, we expect short-term turbulence to MREITs’ FY21 payouts which will suffer the consequence of a Covid-19 pandemic resurgence, causing us to lower FY21E earnings by 8-52% for MREITs save for AXREIT and SENTRAL. That said, our unwavering optimism for the sector is premised on a rebound to the sector soon as the economy opens up which we believe is imminent, and investors should be looking ahead to a normalised FY22. The quick rebound is a result of fairly stable occupancy rates at most prime malls in light of rental rebates for struggling tenants in the short term as REITs always prioritise occupancy over rental. As such, tenants will be able to meet rent payments soon as the situation normalises by FY22. We increase our 10-year MGS target to 3.6% (from 3.3%) on a steepening yield curve, and as a result lower the MREITs’ FY22E TPs by 4-11%. Our preferred picks are AXREIT (OP; TP: RM2.15) and SENTRAL (OP; TP: RM0.935) on stable to positive earnings outlook despite the pandemic and decent yields of 5% and 8%, respectively.

Mostly within, 1QCY21 weakened by MCO 2.0. MREITs with prime malls (namely PAVREIT, IGBREIT, SUNREIT) posted 1QCY21 results that came in broadly within expectations. We are anticipating stronger quarters ahead as 1QCY21 was dampened by MCO 2.0 as expected. Meanwhile our 2QCY21 Strategy TOP PICKs - AXREIT and KLCC’s as well as our other OUTPERFORM call SENTRAL’s results were solid, coming in at c.23- 26% of our estimates despite MCO 2.0, while CMMT struggled, coming in below at only 8% of our, and 10% of consensus, estimate. As a result, we trimmed CMMT’s earnings by 9%. We also trimmed SUNREIT’s FP21E by 14% in anticipation of a weaker quarter ahead as the Covid-19 situation worsened in late May 2021 when SUNREITs results were announced.

SENTRAL REIT was the top performer YTD, up 8.2%, on decent results and attractive yields of 7.9%. CMMT rebounded making a 6.7% gain YTD, while KLCC and AXREIT declined by 0.6% and 5%, respectively, likely due to profit taking as their dividends went ex in May. PAVREIT and SUNREIT which both did not have any dividend distribution recently (as their dividends are paid semi-annually) were also down by 7.5% and 4.8%, respectively, likely as investors anticipated weaker quarters ahead given some struggling assets within their portfolio. All in, the KLREIT Index was down marginally by 1.1% due to the worsening Covid-19 situation.

MCO in the Klang Valley since early May. The Malaysian Government re-imposed a two-week Movement Control Order in Selangor from 6th May 2021 and Kuala Lumpur from 7th May 2021. During this period, dining in and social activities were banned while shoppers were only allowed to visit shopping malls and restaurants for two hours. However, on 28th May 2021, a total lockdown was imposed which only allowed essential sectors to operate, similar to the first full MCO on 18th March 2020 to 3rd May 2020 for a total of 46 days. As a result, we expect to see partial earnings weakness in 2QCY21 and likely 3QCY21 results. Most malls would be operating at 15-25% of NLA, and using MCO 1.0 as a benchmark, we trim FY21E earnings for retail MREITS by 8-52% with the highest cut being CMMT (-52%) and KLCC the lowest (-8%).

The industrial segment remains a safe haven and has been faring well during MCO and post MCO as most manufacturing tenants remained in operations. AXREIT, the only industrial MREIT which has no force majeure clause, implying that all of its c.150 tenancies have no legal ground to ask for discounts/rebates. However, the Group was willing to consider rental deferment on a case-to-case basis for struggling tenants, but the percentage of rental deferment even during the peak of the pandemic during the March-May 2020 MCO phase was minimal. Meanwhile the office segment will continue to remain stable, namely KLCC’s office segment and SENTRAL REIT as tenants have resumed working at offices or have the option to utilise work-fromhome arrangement, ensuring businesses continuity.

Optimistic of better days ahead. The Malaysian government appears resolute in getting the countries economy back and running again. The national vaccination programme will be picking up pace as mentioned in the Pemulih package announced on 28th June 2021. One of the main focus of the package is to increase the rate of vaccinations from current 200,000 per day over the last seven days. As of 26th June 2021, 6% of the population has received both doses of the vaccine. If the country maintains the current rate of vaccination, at least 80% of the population would be able to get their first dose by September 2021, and subsequently 2nd dose by Dec 2021 as we expect a step-up in vaccination daily rates. Barring any hiccups from the new Delta variant, we believe that adhering to similar SOPs post vaccination should suffice in combatting the pandemic. As such, we believe that the sector will bounce back in FY22.

Increasing the 10-year MGS to 3.60% (from 3.30%) as we expect the 10-year MGS to maintain its upward trajectory towards year-end given the opening up of economies and recovery post Covid-19. To date, the MGS has already risen by 27% from 2.58% to 3.3% currently. We prefer to remain conservative on MGS targets, increasing it to 3.6% in light of the Covid-19 situation improving towards year-end and a steepening yield curve. All in, we lower MREITs’ TPs by 4% to 11% on a higher MGS target.

Maintain OVERWEIGHT. We maintain our risk spread for MREITs to the 10-year MGS target at average to +1.0SD due to the volatility in earnings in the near term and to remain conservative. That said, our valuations are based on FY22 which we believe reflects a new normal for earnings as it is poised to be a recovery year for the ailing retail and hospitality segments. Our preferred picks are AXREIT (OP; TP; RM2.15) and SENTRAL (OP; TP: RM0.935) in light of their rock stable earnings as demonstrated during the harsh MCOs in FY20-21.

Preferred Pick is AXREIT (OP; TP: RM2.15). We favour AXREIT for its robust resilience during this pandemic. The Group is possibly the only MREIT under our coverage confident of positive reversions, and downsides are limited with minimal expiries at 18% (of which it has already locked in 32% with positive reversions). Fundamentally, the Group is actively acquiring numerous bite-size industrial assets, targeting RM135m for now, supported by its low gearing of 0.33x, which could potentially accrete up to 5% additional earnings in FY21. Essentially, we believe AXREIT’s valuations are severely undervalued given its solid growth trajectory vs. MREIT peers that have struggled especially in FY20. We also like AXREIT’s Shariah-compliant status, with attractive potential total returns of 15% on decent gross dividend yields of 5%.

Risks to our OW sector call include: (i) weaker-than-expected consumer spending, (ii) weaker-than-expected rental reversions, (iii) U.S. Fed increasing interest rates aggressively, and (iv) weaker-than-expected occupancy rates.

Source: Kenanga Research - 1 Jul 2021