Maintain OVERWEIGHT. Sector coverage’s 4QCY21 results were good with 4 within, and 3 above, our expectations. MREITs made a strong comeback in 4QCY21 with revenge buying during the holiday season and purchases of luxury goods taking centre stage. Going forward, FY22 is expected to see business operations and earnings normalize closer to pre Covid levels with the country entering endemic phase and 80% of the population already received two doses of vaccination. Additionally, the opening of Malaysian borders to international travellers will be the last leg for economic activity to resume to pre-Covid levels and support MREITs’ earnings eventually. MREIT industrial segment remains a stable favourite for earnings consistency, with AXREIT as our preferred pick (OP; RM2.05). Additionally, we remain cautious on the office segment over the long run given the ongoing oversupply situation and anticipate declining demand, save for KLCC (OP; TP: RM6.90) due to its long-term leases (>10 years) and easy to manage triple-net-lease (TNL) structure.

4QCY21 saw MREITs reporting commendable performance - 4 within, and 3 coming in above (KLCC, PAVREIT and SUNREIT), expectations. YoY, top-line was down by an average of 4.1% across the sector mainly dragged by a tougher year as MCOs caused c.9 months (1QCY21 - 3QCY21) of disrupted business operations vs. c.5 months disruption in CY20. However, most MREITs made a strong comeback in 4QCY21 with revenge buying during the holiday season and purchases of luxury goods taking centre stage. CNP on the other hand increased by 7.7% boosted by better operating margins for prime asset MREITs (KLCC, PAVREIT) and industrial and industrial and office REITs (AXREIT and SENTRAL). All in, we made no changes to earnings estimates but lowered our TPs slightly upon increasing our 10-year MGS target to 3.90% (from 3.60%).

KLCC the top performer YTD, up 1.4% as share price was relatively stable during the period. Other MREITs saw decline in share price with IGBREIT being the worst at 13%, likely on some profit taking post dividend entitlement (went ex in mid Feb).

FY22 is expected to see business operations and earnings normalize closer to pre-Covid levels. With the country entering endemic phase and 80% of the population already received two doses of vaccinations, we believe down time for malls would remain limited from here on. Additionally, the Malaysian borders have reopened to international travellers starting 1st April 2022 with no quarantine requirements imposed. This would be a boost for the local economy, particularly retail shopping especially at prime malls such as Suria KLCC, Pavilion Shopping Mall, Mid Valley and Sunway Pyramid which are attractions for foreign tourists. As such, earnings are expected to normalise closer to pre-Covid levels as the economic situation continues to return to the old normal. That said, we do not completely discount the possibility of further economic disruptions from potentially new Covid variants, but believe the probability of this happening is low for now.

The industrial segment is preferred for its stability. 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 seek 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 Preferred Pick - AXREIT (OP; TP:RM2.05) - 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 expires 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 17% on decent gross dividend yields of 5.4% vs. MREIT peers’ average of 5.5%.

Office segment may see decline in demand vs. pre-Covid era, save for KLCC. We believe that the office segment may see decline in demand, either from shorter lease terms or tenants requiring less office space (NLA) as a most of the corporates were able to function seamlessly through work-from-home arrangement during the pandemic. This may also further exacerbate the pre-existing oversupply of offices in the Klang Valley. However, this is not applicable to KLCC even though it is primarily office space driven as it is well protected by its secured long-term leases (>10 years vs. retail of 2-3 years) and with an easy to manage triple-net-lease (TNL) structure. We like KLCC as its earnings are well supported by the stable office segment (which makes up c.50% of earnings), its premium asset quality and the fact that it is one of the best disclosure companies for ESG under our coverage (Kenanga score of 91%) with priority for Environmental disclosures and advanced Integrated Reporting. We also like KLCC’s Shariah-compliant status, with attractive potential total returns of 9% on decent gross dividend yields of 5.2%.

Maintain OVERWEIGHT on expectations of earnings improvements in FY22 on which our valuations are pegged. We are comfortable with our 10-year MGS target of 3.90% in line with our in-house estimates, and have pegged MREIT’s TP at +0.5SD to +1SD due to err on the conservative side on potential volatility of the Covid-19 situation going forward. 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 preferred picks are AXREIT (OP; TP: RM2.05) and KLCC (OP; TP: RM6.90) 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 - 4 Apr 2022