Investment Highlights

• We maintain BUY on Sunway REIT (SREIT) with a lower fair value (FV) of RM1.73/unit (from RM1.79/unit) based on our revised dividend discount model (DDM) (Exhibit 9).

• The decrease in our FV is mainly attributed to higher risk-free rate due to the surge in 10-year Malaysian Government Securities (MGS) to 4.3% from 3.9%. No change to our 4-star ESG rating (Exhibit 10).

• SREIT’s distributable income of RM240mil (+2.5x YoY) in 9MFY22 (Exhibit 1) came in slightly above our expectations, but within consensus. It accounted for 81% of our FY22F distributable income and 78% of street’s.

• The variance was mainly due to better-than-expected occupancy rate in its hospitality properties and lower-than-expected interest expense.

• We raise FY22F/FY23F/FY24F distributable income by 5%/3%/3%, after taking into account higher occupancy rate in its hospitality properties, particularly Sunway Lagoon Hotel to 55%/60% from 50%/55% in FY23F/FY24F.

• In 3QFY22, SREIT’s gross revenue accelerated 56% YoY, supported by a revenue surge of 56% YoY from Sunway Pyramid mall and 3x YoY from Sunway Carnival mall. The increase in revenue from the malls were driven by higher retail footfalls and tenant sales, as well as lower rental support provided in 3QFY22.

• 3QFY22 net property income (NPI) surged 82% YoY to RM128mil. This was mainly attributed to higher revenue, coupled with recovery of doubtful debts following continued improvement in rental collections from the retail segment. As a result, distributable income jumped 2.4x YoY to RM87mil.

• On a QoQ comparison, SREIT’s 3QFY22 gross revenue improved 15% while NPI rose 20%. This was mainly attributed to new contribution from the new wing of Sunway Carnival Mall, which opened in June 2022, as well as stronger contribution from the hotel segment following a phased opening of Sunway Resort Hotel from May 2022.

• The rental reversion for its retail malls is expected to remain at a mid-single-digit level in FY22F. We foresee a positive rental reversion in FY23F/FY24F of 5% with the expectation of stronger tenant sales as compared to pandemic levels, which will provide opportunity for the group to negotiate for higher rentals in subsequent years.

• SREIT’s debt-to-asset ratio stayed at 37%, well below REITs’ statutory limit of 50% (after 31 December 2022).

• There was no income distribution declared in 3QFY22. The REIT’s distribution in 3QFY22 will be paid together with that of 4QFY22 due to its semi-annual distribution policy.

• QoQ, the average occupancy rate rose slightly to 76% in 3QFY22 from 75% in 2QFY22. This was mainly contributed by the stronger occupancy rates of most hotels. In 3QFY22, the retail segment’s occupancy rate declined 1% while the office segment remained stable at 81%.

• China has recently begun to show some signs of early reopening of its borders, including shortening quarantines for inbound travellers and close contacts of infected individuals by 2 days, as well as removing the penalties for airlines that brought in many Covid cases. Notably, China has been Malaysia’s third biggest tourist country after Singapore and Indonesia since 2012.

• Hence, we expect a gradual recovery in average occupancy rates for the hotel properties to 53% in FY22F and 63% in FY23F from 44% in 9MFY22. The hotel’s average occupancy rate was 27.2% in FY2021 and 71.5% in FY2019 (prepandemic levels) (Exhibit 5). However, we do not expect a significant near-term recovery in the occupancy rate as rising interest rates and inflationary pressures could weaken consumer spending for leisure travels.

• The recent aggressive policy rate hikes in the United States (US) has caused US treasury yields to rise and this in turn has spilled over and resulted in an increase in 10-year MGS yield. However, we anticipate that the uptrend in 10-year UST yield to be tapering off with the expectation that the Federal Reserve may ease off aggressive rate hikes after the end of 2022 as a result of weaker economic data.

• Meanwhile, we anticipate the yield spread to be widening from FY22F onwards with the gradual recovery of retail footfalls and hotel occupancy rates, which will translate into higher distribution yields of 7% in FY22F-24F vs. 4% in FY21. We expect SREIT to be appealing to yield-seeking investors with its higher yield spread against 10-year MGS (Exhibit 8).

• 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. Also, the group is recognised for its environmental, social and governance (ESG) practices. Specifically, SREIT is the first amongst its local peers to incorporate sustainable financial considerations into its capital management strategies.

• SREIT currently trades at a compelling FY23F PE of 15x vs. its 4-year average PE of 19x. Meanwhile, distribution yield for FY23F of 7% is attractive vs. 10-year MGS yield of 4%.

• The downside risks are:
  (i) a lower-than-expected tenancy renewal and occupancy rate; and
  (ii) further contraction in yield spread against the 10-year MGS amid higher-than-expected increase in interest rates.

Source: AmInvest Research - 21 Nov 2022