Investment Highlights

• 1QCY23 results were within our expectation. All the 6 companies under our coverage were in line with our estimates. Most of the REITs posted a stronger CY23 results YoY except Hektar and UOA REIT (Exhibit 2). The following are the salient highlights of the companies’ performance:
  • Better rental reversion and occupancy rates for prime malls. IGB REIT, Pavilion REIT and Sunway REIT registered stronger earnings in 1QCY23 as a result of favourable rental reversion and improvement in occupancy rates in both the retail and hospitality segments. Meanwhile, the positive momentum in YTL REIT’s average occupancy rate and average daily rate have contributed to its stronger YoY earnings growth in 1QCY23.
     
  • However, the less established and suburban malls did not fare that well compared to the prime malls. YoY, the 33% drop in Hektar’s distributable income was mainly attributed to the increase in electricity tariff surcharge and the negative rental reversion.
     
  • Given UOAREIT’s flattish rental reversion in FY22, its YoY rental growth was inadequate to offset the electricity tariff hike in 1QFY23, which resulted in a 9% YoY decline in its 1QFY23 distributable income.
     
  • QoQ, most of the REITs posted stronger results (except YTLREIT) as a result of lower maintenance expenses as well as improving occupancy rates in both the retail and hospitality segments. YTLREIT recorded a 4% decline QoQ in distributable income as a result of the slight decrease of its average daily room rate (ADR) from its Australian portfolio to AUD307 from AUD311.
     
• Stronger rental revenue for retail malls in prime locations, partially offset by higher electricity tariff. In 1QCY23, the net profit margin of retail REITs was impacted by the increase in electricity tariff surcharge that took effect on the 1st of January 2023. Nevertheless, this was mitigated by the stronger rental revenue in 1QCY23 as a result of the substantial improvement in tenant sales and footfalls in retail malls. Moving forward, we foresee that the retail sector to maintain its growth momentum in CY23F on the back of our economist’s private consumption growth forecast of 6.1%.
  
  Hence, we maintain our forecast of a higher rental reversions of 3-6% in CY23F as compared to 0-3% in CY22, particularly for malls situated in prime locations such as Mid Valley Megamall, Pavilion Kuala Lumpur, and Sunway Pyramid. However, the rental reversions for less established malls are likely to remain flattish or slightly negative. For these smaller malls, increasing occupancy rates through attractive rents will be imperative (Exhibit 5).
   
• Occupancy and rental reversion rates in the office segment are expected to stabilise. Following a downtrend that began in CY20, the average occupancy rate for offices showing signs of stabilisation since 3QCY22 (Exhibit 4). However, we expect a flattish rental reversion in CY23F, particularly for older office buildings in Kuala Lumpur city centre, given the persistent oversupply of office spaces amid office decentralisation and flexible working arrangement trends.
   
• Hospitality segment set on a growth path. The hospitality sector has seen a strong recovery in occupancy rate and average daily rate since 2QCY22 and is continuing to be on a growth path. In 1QCY23, YTL REIT’s average daily rate room for its Australian portfolio was A$307, exceeded its pre-pandemic peak of A$298. Additionally, its occupancy rate has been steadily growing. Moreover, we foresee the occupancy rate of Sunway REIT’s hotel segments to grow further from 2QFY23 onwards given the full reopening of hotel rooms in Sunway Resort Hotel (100 out of 477 were closed for refurbishment previously). With the gradual recovery of Malaysia and Australia’s domestic travelling and influx of foreign tourists, we expect the average occupancy rate of hotel properties of YTL REIT and Sunway REIT to gradually improve in FY23F/24F and fully recover to pre-Covid levels in FY25F.
   
• The United States (US) monetary tightening cycle may stall. Given the weaker economic data and softening inflation in US, we anticipate the US Fed Funds rate to peak at current level of 5%-5.25% after the recent 0.25% hike in May 2023. The monetary policy tightening is likely to be paused if the inflation rate in the US continues to decline over the subsequent months.
  
  As such, we do not rule out the possibility that the 10-year MGS yield could ease further (from our 2023F forecast of 3.8%- 4%) if there are signals affirming a less hawkish tone by the US Federal Reserve.
   
• Maintain OVERWEIGHT. We believe CY23F will mark a turnaround year for REIT counters after 2 years of hardship, supported by the recovery in retail and hotel segments. Meanwhile, the arrival of international tourists may mitigate any deterioration of domestic consumer spending power under the current inflationary environment. With the gradual recovery in retail footfalls and hotel occupancy rates coupled with potential Fed rate stabilisation in 2HCY23, we are seeing a widening yield spread for REITs against 10-year MGS and expect the REIT sector’s high distribution yields of 6%-10% to appeal to yield-seeking investors (Exhibit 8).
   
• Selective criteria. We like REITs with high-quality assets situated at strategic locations and decent dividend yields. We also favour REITs with exposure in retail and hotel segments, both of which are anticipated to further recover in CY23F.

• Our top Buy are Pavilion REIT (FV: RM1.62/unit), Hektar REIT (FV: RM0.81/unit) and YTL REIT (FV: RM1.10/unit). For Pavilion REIT, we foresee its earnings to be resilient mainly underpinned by its prime asset portfolio as anchored by Pavilion Kuala Lumpur and Elite Pavilion Mall, which are the tourist hotspot that will benefit from the return of international tourist. Further increase in earnings is expected from Pavilion Bukit Jalil from 3QCY2023 onwards. We like Hektar due to its attractive FY24F distribution yield of 10% vs. average yield (excluding Hektar) of 8%. YTLREIT is another of our top picks due to its stable recurring rental income and minimal occupancy risks for its hotel properties in Malaysia and Japan, secured by master lease agreements. The stock also offers an impressive FY24F yield of 10%.
   
• Downside risks to our forecasts are: (i) higher-than-expected interest rate hikes in US that could weaken the Malaysian ringgit and cause an outflow in MGS, narrowing the dividend yield spreads against 10-year MGS; and (ii) stagflationary risks, which could substantively dampen revenue and earnings prospects due to lower occupancy rates, negative rental reversions and extension of rental rebates offered to tenants.

Source: AmInvest Research - 7 Jun 2023