Maintain OVERWEIGHT. 3QCY21 results were mostly within expectations, with four stocks meeting, and three coming in slightly above, forecasts. The local economy begun gradual reopening in August and September 2021 while most malls were already recording up to 80% return of shopper traffic in 4QCY21 compared to pre-Covid levels. The hospitality segment has also resumed operation for local travellers while we expect more lenient entry requirements for international travellers in 2022. The quick roll-out of vaccinations from 3QCY21 onwards has also helped to normalise economic activity with 79% of the Malaysian population fully vaccinated (vs. 61% in September and 46% in August), while booster shots have been given to 14.9% of the population. This should bode well for the national defence against any new Covid variants threat to economic activity, and ensure smooth economic operations in FY22. As such, we believe an economic comeback is afoot. Segment-wise, (i) for the industrial segment, AXREIT remains our shining star having fared well, charting positive rental reversions throughout the pandemic on minimal downsides with low lease expiries and an active acquisition trail; (ii) the office segment remains stable for now, while (iii) the retail and hospitality segments are poised to see better days. Our TOP PICKs are AXREIT (OP; TP: RM2.15) and KLCC (OP; TP: RM7.35) on stable to positive earnings outlook despite the pandemic and decent dividend yields of 5.1% and 5.4%, respectively.

Stocks coverage’s 3QCY21 performance was mostly within, with four stocks meeting our expectations (AXREIT, CMMT, IGBREIT, and SENTRAL), and three above (KLCC, PAVREIT and SUNREIT) on lower-than-expected rental rebates. All in, sector top-line and earnings were still down by 8.6% and 8.3%, respectively as CY21 has been a more challenging year for the sector compared to CY20 with more MCOs disrupting business operations. Due to the variability of the rental rebates across malls each quarter, we revised the current FY earnings forecasts upwards for KLCC, PAVREIT and SUNREIT, while FY22E earnings remains unchanged for all as it is expected to be a year of return to normalcy with the reopening of the economy.

SENTRAL REIT the top performer YTD, up 8%, as earnings continued to meet expectations on decent earnings and attractive yields of c.8% as the office sector saw minimal disruptions from the pandemic. However, its retail segment took a hit due to MCOs which disrupted earnings momentum, declining between 3% to 14%.

Economic reopening, 4QCY21 should see the best earnings YTD. Retail MREITs are seeing mall shopper traffic gradually picking up to 80% of pre-Covid levels and the expectation of revenge buying and holiday season shopping all packed in the last quarter imply that 4QCY21 should be the best quarter YTD. Due to concerns of the new Covid variant, we remain mildly cautious for upcoming quarters on the retail sector should there be further MCO restrictions, but the likelihood of this is low at this juncture. The quick roll-out of vaccinations in 3QCY21 onwards has also helped to normalise economic activity with 79% of the Malaysian population fully vaccinated (vs. 61% in September and 46% in August), while booster shots have been given to 14.9% of the population. This should bode well for the national defence against any new Covid variant threats to economic activity, and ensure smooth economic activities in FY22. As such we believe an economic comeback is afoot.

The industrial segment remains our solid favourite. This has been the only MREIT segment that had fared well during MCO and post MCO as most manufacturing tenants remained in operations. As the only industrial REIT, AXREIT also 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.

We continue to like our TOP PICK AXREIT (OP; TP:RM2.15) as the group is steadily on a growth trajectory with positive rental reversions (low single-digit) and an active acquisition pipeline targeting RM187m worth of assets for now, supported by its low gearing of 0.27x, which could potentially accrete up to 5% additional earnings in FY22. The Group also has limited downside on minimal lease expiries at 18% (of which it has already locked in 87% with positive reversions). 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 16% on decent gross dividend yields of 5.1% vs. MREIT peers’ average of 5.7%.

Office assets remain stable. Office REIT’s under our coverage continued to chart stable occupancy as there were minimal tenant movements during the pandemic. This was due to effective work from home (WFH) arrangements that allowed businesses to continue operations. SENTRAL REITs occupancy was stable at 91% (from 91.7% in 2QCY21) while KLCC’s occupancy remained at 100%. We like KLCC for its secured long-term leases (>10 years vs. retail of 2-3 years) and with easy to manage triple-net-lease (TNL) structure. Hence, KLCC (OP; TP: RM7.35) is our second TOP PICK as its earnings are well supported by the stable office segment (which makes up c.50% of earnings). Additionally, we continue to like KLCC’s premium asset quality and the fact that it is one of the best disclosed companies for ESG under our coverage (Kenanga score of 91%) with priority for Environmental disclosures and advanced Integrated Reporting. KLCC’s recent exclusion from the FTSE4Good (June 2021) review was due to low trading liquidity and not on ESG factors. We also like KLCC’s Shariah-compliant status, with attractive potential total returns of 20% on decent gross dividend yields of 5.4%. That said we are long-term cautious on the office segment as we believe demand may decline either from shorter lease terms of tenants requiring smaller office space (NLA) since WFH policies have proven to be workable and cost effective, and this may also further exacerbate the pre-existing oversupply of offices in the Klang Valley.

Maintain OVERWEIGHT as the sector should continue to see better days. We have assigned the lowest risk spread for industrial-based AXREIT at average SD to our 10-year MGS of target of 3.60%, while we’re assuming slightly higher risk for other MREITs under coverage at +0.5SD to +1.0SD on low potential volatility in earnings as a result of the pandemic, but we are more confident going forward as the economy reopening trajectory has persisted given high vaccination rates. Our valuations are based on FY22E numbers to encapsulate a new normal for earnings as 2022 is poised to be a recovery year for the ailing retail and hospitality segments. Our Top Picks are AXREIT (OP; TP; RM2.15) and KLCC (OP; TP: RM7.35) in light of their rock stable earnings as demonstrated during the harsh MCOs in FY20-21.

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 - 28 Dec 2021