‘Rent-free’ rebates for tenants during MCO period possible

This article first appeared in The Edge Financial Daily, on March 20, 2020.
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Real estate investment trust sector
Retain overweight:
To recap, it was a fairly decent quarter for real estate investment trusts (REITs) where six out of seven under our coverage recorded core earnings that were in line. We have cut our earnings by 8.6% to -21.7% to impute the negatives from Covid-19.

With the recent share price fall (KLREI dropped 19.8% in the past two days from its highest peak on August 2019), we feel that these negatives have been well reflected. As such, the positives from a dovish setting (expect another -50bps [basis points] OPR [overnight policy rate] cut), should outweigh from here on.

We are unable to fully pencil in the magnitude of the decline at this juncture due to uncertainties of this outbreak. In addition, the Malaysia Shopping Malls Association said they shall need more time for monitoring sales turnover over the next few months, depending on the further development of the current situation.

There are six stocks under our REIT coverage that have exposure to hotel and retail. Should Covid-19 prolong, it is not far-fetched to envisage this impacting their earnings from a i) lower footfall in malls which pressures the management to offer rent rebates; and ii) lower hotel occupancy from travel restrictions and contagion fears.

Moreover, landlords (i.e. REITs) will have to incur any cleaning and sanitisation costs should a case be detected within their premises. After running a sensitivity analysis of our stocks under our coverage, we find that after imputing 10% rental rebate for about six months, our annual earnings decline is not more than 10%.

The Movement Control Order (MCO), enforced from March 18 to 31, includes closure of retail outlets and some hotels. However, based on our channel checks, malls will not be closed but opening is only limited to essential services such as supermarkets, pharmacies, convenience stores, ATMs and clinics.

Also, we gathered that most REITs have not firmed out any strategy moving forward in relation to rental during the MCO period; we do not rule out the possibility of “rent-free” rebates for tenants during the MCO period.

The yield spread between M-REITs and the 10-year Malaysian Government Securities (MGS) is currently at 4.53%, which is +4SD (standard deviation) above its five-year mean of 2.08%. To keep abreast with the current 10-year MGS yield, we lower our assumption to 3.25% (from 3.5%); year-to-date average is at 3.07%.

Our top picks are Axis REIT and KLCCSS. We like Axis REIT (Buy; target price [TP] : RM2.46) in view of increased popularity in industrial properties, high occupant tenancy in its diversified portfolio, shielded from the Covid-19 impact and also one of the few syariah-compliant REITs.

We also like KLCCSS (Buy; TP: RM8.17) for its concentrated prime assets, syariah-compliant scarcity among REITs (only 4/18) and long-term tenancy agreement with Petroliam Nasional Bhd. Other “buys” are IGB REIT (Buy; TP: RM1.83), SunREIT (Buy; TP: RM1.74) and newly upgraded MQREIT (Buy; TP: RM0.71) — Hong Leong Investment Bank Research, March 19