Kenanga downgrades MREITs to ‘underweight’, expects volatile bond market

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KUALA LUMPUR (December 31): Kenanga Investment Bank Bhd has downgraded its rating for Malaysian real estate investment trusts (MREITs) to “underweight” from “neutral”, in anticipation of a more volatile bond market in 2015.

In a note today, the research house said Malaysian government securities (MGS) saw sharp yield expansions in Dec 2014 to 4.2%, compared to 3.9% in Nov, as foreigners started selling Malaysian bonds following the drop in oil prices and the weakening ringgit against the greenback.

It also sees the potential interest rate hike by the US Federal Reserve in 2H15 as casting a shadow on the bond market.

“So, it may be a very volatile bond market in 2015 considering that foreign shareholding is at a high of 47%, implying that MREIT valuations are at risk, not to mention potential yield spread expansions if bond yields continue to expand,” said Kenanga.

Other analysts concurred, saying MREITs usually offer a premium to government bond yields, and higher yields from government bonds would mean higher yields for MREITs, translating to lower share prices of MREITs.

On the goods and services tax (GST), the research house said the implementation of the new tax structure was not expected to have any direct material impact on REITs as the GST would be replacing the current 6% sales tax.

However, Kenanga expects the GST to have an indirect impact on MREITs, which will be felt from 2Q15 to 3Q15, due to higher GST-related costs for tenants, slower consumer demand, and higher rent costs due to the GST.

“On the bright side, we believe premium mall owners like Suria KLCC (KLCC REIT Bhd), Pavilion Shopping Mall (Pavilion REIT) and The Gardens (IGB REIT) will be able to weather out the effects of the rising inflation compared to neighbouring areas, mass or niche malls because their shoppers tend to enjoy higher purchasing power.

“We believe non-premium malls like Sungei Wang, Mid Valley and Sunway Pyramid may see slight declines in sales per shopper or potentially even a dip in shopper traffic volume during the ‘adjustment period’,” it said.

Going forward, Kenanga said there could be some rebound rallies in 1Q15 but had advised investors to sell on strength, and do some “bottom fishing” in 2Q15 and 3Q15, to reposition for a better 4Q15 as the oil crisis and MGS environment is expected to stabilise.

The research house added that retail spending would pick up in the latter part of 2015, after the negative sentiment surrounding GST fades, which should be positive for rental reversions.

“As a result of a higher 10-year MGS target, we have lowered our call for KLCC to underperform (from market perform) and downgraded the target prices by 6.0%-7.4% for all MREITs based on a higher 10-year MGS target of 4.2% (from 3.8%) due to the reasons above,” said Kenanga.

The research house’s top pick for the sector is Sunway REIT, for which it keeps an “outperform” rating and a target price of RM1.57.