Investment Highlights

• We upgrade our recommendation on YTL Hospitality REIT (YTL REIT) to BUY from HOLD with an unchanged fair value of RM1.01/unit based on dividend discount model (DDM). No changes to our neutral 3- star ESG rating (Exhibits 8 & 9).

• The share price declined by 5% over the past 2 months as a result of aggressive policy rate hikes in US, which caused the 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 the uptrend in 10-year UST yield to taper 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. We also expect the yield spread to be widening from FY23F onwards with the recovery of its business.

• YTL REIT’s distributable income of RM31mil in 1QFY23 came in largely within expectation, making up 23% of our FY23F earnings and 25% of consensus estimate. Hence, we made no changes to our forecasts.

• In 1QFY23, YTL REIT’s gross revenue rose 25% YoY, mainly contributed by higher revenue (+49% YoY) from the Australian portfolio. However, its net property income (NPI) was flattish YoY at RM58mil due to higher operating expenses from hotel assets in Australia following the exit from the government isolation group business programme (Exhibit 2).

• On a QoQ comparison, YTL REIT’s gross revenue grew 6% while NPI rose 2% in 1QFY23. This was mainly contributed by higher revenue (+9% QoQ) from the Australian portfolio, which saw an increase in its revenue per available room by 7% to A$183 from A$171 in 4QFY22 (Exhibit 4).

• We have seen an improvement in average occupancy and average daily rates since 2QFY22. Notably, its 1QFY23 average daily rate has recovered to A$277 vs. pre-Covid (2019) level of A$271. Meanwhile, its 1QFY23 average occupancy rate of 66% was still lower than the pre-Covid level of 85% (Exhibit 4).

• The portion of the repayment of rental deferrals account for 11%/29%/13% of total distributable income in FY23F/24F/25F (Exhibit 3).

• No income distribution has been declared in 1QFY23. Its distribution in 1QFY23 will be paid together with 2QFY23 in line with its semi-annual payout policy.

• As at 30 September 2022, YTL REIT has 51% of borrowings denominated in AUD, 40% in MYR and the remainder in JPY. As 83% of its borrowing is in floating rates, the interest rate hikes in Malaysia and Australia are expected to result in higher borrowing costs in AUD and MYR (Exhibit 6). Nevertheless, we believe that the interest rate hike cycle in Malaysia has reached its tail-end with the expectation of another 0.25% increase to 3% in early FY23. Meanwhile, Bloomberg consensus estimates show that the Australian cash rate is expected to peak at 3.55% on 3QCY23 from its current level of 2.85%.

• We like YTL REIT for its stable recurring rental income and minimal occupancy risk for its hotel properties in Malaysia and Japan, secured by master lease agreements. Meanwhile, we anticipate the yield spread to be widening from FY23F onwards with the normalisation of lease rentals for its Malaysian and Japanese properties and repayment of rental deferral accounts, which will translate into higher distribution yields of 9%-10% in FY23F-25F vs. 5% in FY22. We expect YTL REIT to be appealing to yield-seeking investors with its higher yield spread against 10-year MGS (Exhibit 7).

• YTL REIT currently trades at a compelling FY24F PE of 10x vs. 2-year pre-pandemic (FY18-19) average of 13x. Meanwhile, FY24F distribution yield of 10% is attractive vs. its 2-year pre-pandemic (FY18-19) average of 8%.

• The downside risks are:
  (i) lower-than-expected occupancy and average daily rates for hotels in Australia; 
  (ii) reintroduction of lockdowns due to the outbreak of a more harmful Covid-19 variant; and 
  (iii) declining yield spread against 10Y MGS.

Source: AmInvest Research - 25 Nov 2022