Investment Highlights

• We maintain BUY on Sunway REIT (SREIT) with a higher fair value (FV) of RM1.79/unit from RM1.76/unit based on our revised dividend discount model (DDM) (Exhibit 9). The increase in our FV is based on a lower risk-free rate as the 10-year Malaysian Government Securities (MGS) yield has declined to 3.9% from 4.4%. We also take into account higher rental income and minimal rental rebates from FY22F onwards. No change to our 4-star ESG rating (Exhibit 10).

• SREIT’s distributable income of RM153mil in 1HFY22 (Exhibit 1) came in above our expectations, but within consensus' estimations. It accounted for 58% our FY22F distributable income and 50% of street’s.

• The variance to our forecast was mainly due to better-thanexpected rental revenue coupled with lower rental rebates offered to tenants. A strong pick-up in retail footfall and tenant sales for the Raya festive season also contributed to higher rental revenue.

• We raise FY22F/FY23F/FY24F distributable income by 13%/5%/5%, after taking into account higher rental income from its retail properties, particularly Sunway Pyramid Mall, with a mild positive (+2-3%) rental reversion in FY22F.

• In 1HFY22, SREIT’s gross revenue rose 44% YoY, supported by revenue growth of 2.4x YoY from Sunway Pyramid mall. The increase in revenue from the mall was driven by higher retail footfall and tenant sales, as well as lower rental support provided in 1HFY22.

• 1HFY22 net property income (NPI) surged 75% YoY to RM226mil. This was mainly attributed to higher revenue, coupled with the recovery of doubtful debts following the continued improvement in rental collections from the retail segment. As a result, distributable income jumped 1.5x YoY to RM153mil.

• On a QoQ comparison, SREIT’s 2QFY22 gross revenue decreased 6% while NPI declined 10%. This was mainly attributed to lower guaranteed income from Sunway Clio Property. We believe the drop in NPI is also due to higher utility cost as a result of the imposition of electricity tariff surcharge of 3.7 sen per kilowatt hour to the non-domestic sector starting from 1 February 2022, which increased property operating cost.

• SREIT’s debt-to-asset ratio stayed at 37%, well below the 60% statutory threshold required by the Securities Commission (SC).

• SREIT proposed a first interim gross DPU of 4.22 sen in 2QFY22, which represented a distribution payout ratio of 95%. This was 1.6x the 1.6 sen declared in 4QFY21.

• QoQ, the average occupancy rate rose to 75% in 2QFY22 from 72% in 1QFY22. This was mainly contributed by the increase in most of its hotels’ occupancy rates. In 2QFY22, retail and office properties have both seen 0.8% QoQ decline in occupancy rate in comparison to 1QFY22.

• With the reopening of international borders and further relaxation in SOPs, we expect a gradual recovery in average occupancy rate for hotel properties to 50% in FY22F and 55% in FY23F from 47% in 2QFY22. The hotel’s average occupancy rate was 27.2% in FY2021 and 71.5% in FY2019 (pre-pandemic levels) (Exhibit 5). This was largely due to business and leisure travel restrictions over the last 2 years amid multiple lockdowns for Covid-19. However, we do not expect a significant recovery in the occupancy rate as rising interest rates and inflationary pressures could weaken consumer spending for leisure travel.

• Moving forward, we foresee the discontinuation of Covid-19-related rental rebates offered to tenants as all businesses are allowed to fully operate after the reopening of the economy and borders. This will lead to a normalisation of rental income in the retail, hotel and office segments.

• Since the beginning of 2022, the yield spread between SREIT and 10-year MGS has been narrowing. This is contributed by the surge in the 10-year MGS yield which tracked the rising trend of the 10-year US Treasury yield (UST). However, we see a stabilisation in 10-year MGS yield with a decline to 3.9% from the peak of 4.4% following heavy foreign selling in June 2022 and also a tapering in inflationary pressures with the retreat in commodity prices from their high levels. FY23F distribution yield is estimated at 6%. We expect SREIT to be appealing to yield-seeking investors with its higher yield spread against the 10-year MGS (Exhibit 8).

• SREIT currently trades at a compelling FY23F PE of 17x vs. its 4-year average PE of 19x. Meanwhile, distribution yield for FY23F of 6% is attractive vs. 10-year MGS yield of 4%.

• We like SREIT, underpinned by its well-diversified income base which could cushion potential downside risks. Its portfolio encompasses retail malls, offices, hotels, universities, hospitals and an industrial property across Malaysia.

• We remain bullish about the outlook of Sunway eMall, which offers delivery and in-store collection for online shopping across its physical malls. Also, the group is recognised for its environmental, social and governance (ESG) practices. Specifically, SREIT is the first amongst its local peers to incorporate sustainability financial considerations into its capital management strategies.

• The downside risks are:
  (i) a lower-than-expected tenancy renewal and occupancy rate;
  (ii) further contraction in yield spread against the 10-year MGS amid a greater-than-expected increase in interest rates; and
  (iii) rental rebates reinstated if a lockdown is implemented again due to the emergence of more harmful Covid-19 variants.

Source: AmInvest Research - 19 Aug 2022