Malaysian REIT sector’s underlying fundamentals remain unchanged

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This article first appeared in The Edge Financial Daily, on June 28, 2016.

 

Malaysian Real Estate Investment Trust sector 
Maintain neutral:
Given the challenging economic outlook amid yield compression due to the recent share price rally, we continue to remain “neutral” on the Malaysian Real Estate Investment Trust (REIT) sector with preference on stocks with combination of high yield, good asset quality and strong management.

Underlying fundamentals of the sector remain unchanged since our previous update with slower organic growth guided, caused by slower rental reversion by major mall operators in tandem with subdued store sales growth in general; while rising e-commerce remains a long-term risk. The scenery of huge office space supply in the pipeline and slower business expansion are not likely to improve in the near term, causing downward pressure on rental yield for REIT. Besides, we expect yield of Malaysian government securities (MGS) to largely remain stable for the rest of 2016 given expectations of unchanged overnight policy rate. We also expect normalisation of the recent strong buying interest in REITs given the average yield for REITs is already compressed to 5.6% from 6.2% at the beginning of 2016.

However, local consumption may improve gradually in the second half of 2016 after a soft patch since the second quarter of 2015, given the normalisation of the goods and services tax effect, festive seasons and measures to support disposable income; all the above will spur retail sales in general. Nevertheless, we continue to believe that growth in the sector will be driven by inorganic growth as acquisition opportunity may emerge given the softer asking price for property in this sluggish market. For the remaining of the year, we believe that there should not be unpleasant surprises given the quality of assets in the portfolio for majority of REIT players under our coverage.

Catalysts are a narrowing yield spread, potential acquisition of quality assets to achieve growth as softer property outlook presents such an opportunity, higher disposable income may spur retail spending, which will in turn boost retail REITs and regulatory intervention in limiting the supply of office/mall. Risks are monetary policy tightening by Bank Negara Malaysia, prolonged erosion in consumer sentiment, failure to execute the planned asset injections, significant slowdown in broad economic activities and narrower spread between yields.

Maintain “neutral” stance on the Malaysian REIT sector given the overall cautious outlook and challenging operating environment. We roll forward our valuation parameters to 2017, maintain our conservative assumption of 10-year MGS yield at 4%. Maintain our “buy” call on MRCB-Quill REIT (target price [TP]: RM1.25) given its high dividend yield of 7.5% based on its financial year 2017 (FY17) distribution per unit (DPU) and imminent asset injection of Menara Shell. We upgrade Pavillion REIT (TP: RM1.80) to “buy” as we turn positive on its income growth in FY17 post acquisitions and major reversion at a DPU yield of 5.8% at current price. — HLIB Research, June 27