Cherry Picking MREITs with Acquisition Potential

MREITs Cherry Picking MREITs with Acquisition Potential By The Kenanga Research Team l research@kenanga.com.my NEUTRAL Maintain NEUTRAL. MREITs 2Q16 results were in line, while upsides are seen from major leases expiries in PAVREIT and SUNREIT and earnings risks, if any, have been accounted for. Fundamentals are mostly intact as we expect modest earnings growth from MREITs in our universe with an average of 5.9-6.5% in FY16-17E. At current levels, MREITs under our coverage are commanding modest gross dividend yields of 5.1-6.1% in FY17E, while our On Our Radar Top Pick, MQREIT (TB; TP: RM1.35), is commanding superior gross yields of 6.5% in FY17E on stable earnings. Maintain our 10- year MGS target of 3.60%. We reiterate our NEUTRAL view on MREITs as the sector lacks a strong near-term catalyst as most upsides have been priced in, evident from decent YTD gains of 3.7-22.4% for MREITs under our coverage. However, we recommend investors to look out for selected MREITs with visible acquisition pipeline in FY17, with selected picks on more resilient MREITs with acquisition potential (i.e. PAVREIT, SUNREIT, KLCC, AXREIT), which may lend some excitement to earnings growth should the acquisitions are sizeable and earnings accretive. Preferred MREITs include KLCC (OP; TP: RM8.25), PAVREIT (OP: TP: RM2.15) and SUNREIT (OP; TP: RM1.85) for earnings resiliency from strong asset stability and earnings excitement from acquisition potential. Meanwhile, we have MARKET PERFORM call on AXREIT (TP: RM1.80), CMMT (TP: RM1.65), and IGBREIT (TP: RM1.66). 2Q16 results within expectations, similar to 1Q16. QoQ, bottom-line growth was slightly negative (-2% to -10% RNI QoQ) due to lower topline mostly due to seasonality factors from lower turnover rent, and weaker margins, which was slightly worse off than 1Q16, as expected. YoY, all MREITs saw positive topline and bottom line growth (2%-8% RNI YoY), save for AXREIT, which was down slightly (-3%) on higher operating and financing cost for new acquisitions. MREITs were mostly positive YoY on the back of positive reversions of mid-to-high single digits for leases up for expiry, which was largely within our expectations. As such, we believe fundamentals are intact as we have accounted for mid-to-high single digit reversions for most MREITs under our coverage. All in, we made no changes to earnings as results were in line, which was similar to 1Q16. Our calls and TPs were also unchanged, but we upgraded AXREIT s TP to RM1.80 (from RM1.76) post results on adjustments of valuations for the development of Axis PDI. IGBREIT was the top performer under our coverage. IGBREIT emerged as the top gainer YTD, appreciating by 22.4% to RM1.64 as of report cut-off date (15 th Sep 2016), which we reckon may be due to its asset stability from high occupancy (>99%) and stable double-digit reversions, while gross yield before the share price run-up was fairly attractive at 6.2%, above our MREITs average of 5.8% back then. All in, MREITs under our coverage saw positive YTD gains as investors continue to seek safe havens and stable returns in light of volatile markets, outperforming the FBMKLCI (-2%) and FBM Small Cap (-4%) to date. Note that share prices for both SUNREIT and PAVREIT have also increased by 17.8% and 13.5% YTD, respectively, in line with our OUTPERFORM recommendation throughout 2016. MREITs Annual Gains Year KLCC SUNREIT CMMT IGBREIT PAVREIT AXREIT 2012 100.0% 24.0% 25.0% -2.9% 27.5% 19.5% 2013-7.1% -20.0% -22.2% -10.5% -7.9% -6.4% 2014 14.7% 22.6% 2.1% 10.1% 14.1% 23.5% 2015 5.2% -3.9% -3.5% 2.3% 6.2% -9.4% 2016 YTD 8.4% 17.8% 10.1% 22.4% 13.5% 3.7% Major renewals for PAVREIT and SUNREIT, which we have accounted for in our estimates. To recap, FY16 is a major lease expiry year for PAVREIT (69.0% of NLA), from Pavilion Shopping Mall (PSM) of which we expect single-digit rental reversions. As such, we anticipate 1.5-13.0% growth in FY16-17E RNI as the positive reversions will accrete mostly in FY17. Additionally, SUNREIT will experience major lease expiries for two of its largest assets, namely; (i) Sunway Pyramid (56.7% of asset NLA), and (ii) Sunway Carnival (58.0%of asset NLA). Although SUNREITs leases up for expiry in FY17E constitute only22% of portfolio NLA, both these assets make up 67% of SUNREITs gross rental income (GRI) as Sunway Pyramid alone makes up 58.2% of the Groups GRI. Based on our channel checks, the retail segment remains soft in CY16 and likely CY17. Hence, in order to be prudent, we maintain our mid-to-high single-digit reversion in FY17 for the abovementioned assets translating to 3-8% growth in FY17-18E RNI for SUNREIT. Save for PAVREIT and SUNREIT, other MREITs under our coverage have 22-30% of leases up for expiry in FY16, and 18-34% in FY17 of NLA which we have already accounted for in our estimates. As such, we believe fundamentals are mostly intact while we expect modest earnings growth from MREITs in our universe at an average of 5.9-6.5% in FY16-17E. PP7004/02/2013(031762) Page 1 of 7

Asset acquisitions moving at a slower pace than FY15, greenfield development to the rescue. YTD, for MREITs under our coverage, there was only two asset acquisition by AXREIT that totalled RM75.0m vs. five assets in CY15 totalling RM1.2b. The acquisitions by AXREIT in FY16 were small industrial facilities, and we did not see any acquisitions for retail or office assets for MREITs under our coverage. We believe this is likely due to the challenging cap rate environment as REITs are finding it tough to acquire yield accretive assets in the current low cap rate conditions (4-6% cap rates for retail assets and 6-8% for industrial assets). The silver lining is the Securities Commissions (SC) s Proposed MREITs Guidelines, which recently obtained public feedback for a list of 16 new proposals, among which was for the development of greenfield assets. To date, two MREITs (SUNREIT and AXREIT) have already come forward to seek SC s exemption to develop greenfield, with AXREIT targeting to spend RM210.9m on development cost for Axis PDI, while SUNREIT acquired a vacant land adjacent to Sunway Carnival mall in Penang for RM17.2m. Going forward, we believe MREITs would prefer to take on greenfield development (i.e. development cost) instead of asset acquisitions from 3 rd parties due to lower cash capital outlays required. However, greenfield development may only accrete in the long run (over 2-4 years), while near-term earnings excitement will still come from asset acquisitions should the yields are favourable. All in positive on SC s list of Proposals, as we expect news flow primarily related to Proposal 1 to 4 to bode well for share price sentiment and valuations, with minimal impact to earnings in the near term. Overall, besides Proposal 1, Proposals 2 to 4 are expected to be beneficial to unitholders as it is catered towards facilitating earnings growth by increasing the scope of permitted activities by MREITs, making it easier for MREITs to secure tenants or minimise vacant space. We maintain our 10-year MGS target of 3.60%. We expect the 10-year MGS to remain close to current level of 3.60%. We believe the 10-year MGS will remain range bound and close to current levels of 3.59% as; (i) We do not anticipate further downside bias to the 10-year MGS as it is already hovering at 60bps above the current OPR rate of 3.00%, while historical data suggests that the 10-year MGS trades at 70bps on average to the OPR since CY12 (range bound between 50 to 88bps). Going forward, our in-house economist expects OPR rate to be maintained at 3.00% in FY17, as such, we expect minimal downsides to the MGS from here on. (ii) (iii) Additionally, we believe downsides to the 10-year MGS are limited as foreign shareholdings of the MGS have reached an all-time high of 51.9% (vs. 41-49% over the past four years) which we believe may be due to the fact that investors may have limited options for stable returns. We do not expect significant upsides to the 10-year MGS as markets have already priced in one US Fed rate hike by year end. This concurs with our view that the US Fed will implement at least one interest rate hike by 1Q17, while anything more than one rate hike may prompt us to re-look at our MGS estimates with a slight upside bias. That being said, going forward, we believe US rate hikes will not significantly affect the MGS as the frequency of rate hikes will be minimal and while any increase will be on a gradual basis. 10-yr MGS vs. OPR YTD 2016 CY2015 CY2014 CY2013 CY2012 Average 10-yr MGS 3.76 4.05 4.01 3.71 3.50 Average OPR 3.17 3.25 3.13 3.00 3.00 Foreign Shareholding of the MGS 49.3% 46.4% 45.4% 45.3% 40.9% -Max 51.9% 48.5% 48.4% 48.3% 44.4% -Min 47.1% 43.5% 41.9% 41.4% 38.5% Sensitivity Analysis of MREITs TP's based on 10-yr MGS level 10-yr MGS level (%) KLCC TP SUNREIT CMMT TP AXREIT TP IGBREIT PAVREIT 4.00 7.61 1.73 1.54 1.68 1.54 1.97 3.80 7.92 1.79 1.59 1.74 1.60 2.05 3.60 8.25 1.85 1.65 1.80 1.66 2.15 3.40 8.61 1.92 1.72 1.87 1.73 2.25 3.20 9.00 1.99 1.79 1.95 1.80 2.36 3.00 9.42 2.07 1.86 2.03 1.88 2.49 Source: Kenanga Research Maintain NEUTRAL on MREITs, with selected picks on more resilient MREITs with an acquisition potential. The sector lacks a strong near-term catalyst going forward as most upsides have been priced in, evident from decent YTD gains for MREITs under our coverage of 3.7-22.4% (as of our cut of date on 15 th Sep 2016). As such, we maintain NEUTRAL on MREITs for now, but investors can look out for selected REITs with a visible acquisition pipeline in FY17, (i.e. PAVREIT, SUNREIT, KLCC, AXREIT), which may lend some excitement to earnings growth, should: (i) the acquisitions are sizeable (>5% accretion to bottom-line), (ii) with attractive asset yields (>7.5% NPI yield for industrial assets, >6.5% NPI yield for retail assets). At current levels, MREITs are commanding gross yields of 5.1-6.1%. (refer to table in page 3) PP7004/02/2013(031762) Page 2 of 7

MQREIT (TRADING BUY; TP: RM1.35) our Top Pick. We recently released an On Our Radar report (dated 30 th Sep 2016) on MQREIT with a Trading Buy call as we like the stock for its earnings stability and undemanding valuations. Post placement by 4Q16, MQREIT will move into the large cap MREIT space (>RM1.0b), increasing its market cap to c.rm1.3b (from RM820m) implying better trading liquidity and added institutional shareholding from placements to EPF. However, we believe the stock is still trading at a discount to large cap MREITs, at 6.5% on FY17E gross yields vs. 5.1-6.1% for large cap MREITs under our coverage, albeit its stable earnings profile. Additionally, MQREIT s earnings prospect appears solid due to its stable asset profile as the Group had recently acquired Menara Shell, a fully-tenanted asset with a long-term lease, while existing assets are also on long-term leases (avg. 5 years). Going forward, portfolio occupancy is expected to remain healthy at >97% with minimal lease expiries (6.7-13.0% in FY16-17) capping downside risk, while MQREITs is backed by two sponsors for future acquisitions. We like MQREIT as it warrants 14% total returns) on a conservative +2.40 ppt spread to our 10-year MGS target of 3.60%. Preferred MREITs under our coverage include KLCC (OP; TP: RM8.25), PAVREIT (OP: TP: RM2.15) and SUNREIT (OP; TP: RM1.85). We continue to like KLCC and PAVREIT for their earnings resiliency as both REITs have maintained strong asset stability, with KLCC s assets on long-term leases (i.e. 15 years) and a triple-net-lease (TNL) basis, while PAVREIT s occupancy is strong at >97%. Additionally, both these REITs have low gearing s (0.15-0.25x), allowing for sizeable acquisitions or greenfield potential based on SC s new proposed guidelines, while further clarity on its asset acquisition pipeline will be a positive re-rating catalyst for the stock. As for SUNREIT, we maintain our OUTPERFORM call for its income contribution from Sunway Putra Place and visible acquisition pipeline, thanks to its parent, SUNWAY. Risks to our call. Factors that may affect our call include: (i) worse-than-expected consumer spending, (ii) cost-push factors that result in weaker-than-expected rental reversions, (iii) U.S. Fed increasing interest rates in a more aggressive manner, and (iv) further decline in oil prices and weaker MYR, which may increase pressure on the 10-year MGS. MREITs Peer Comparison MREITs Last Price as at 15/9/16 GDPS FY Gross Yield based on last price Target Gross Yield Gross yield spread to 10-yr MGS 10-yr MGS targ et Current Call Share price upside Total Returns KLCC 7.65 0.40 FYDec17E 5.2% 4.80% 1.20% 3.60% OP 8.25 7.8% 12.4% S UNR EIT 1.72 0.11 FYJun17/18E 6.1% 5.70% 2.10% 3.60% OP 1.85 7.8% 13.3% CM M T 1.52 0.09 FYDec17E 5.9% 5.40% 1.80% 3.60% MP 1.65 8.8% 14.1% AXR EIT 1.70 0.10 FYDec17E 5.8% 5.45% 1.85% 3.60% MP 1.80 5.7% 10.9% IGB R EIT 1.64 0.09 FYDec17E 5.3% 5.20% 1.60% 3.60% MP 1.66 1.2% 5.9% PAVR EIT 1.76 0.09 FYDec17E 5.4% 4.40% 0.80% 3.60% OP 2.15 22.0% 26.8% Source: Kenanga Research This section is intentionally left blank. PP7004/02/2013(031762) Page 3 of 7

Peer Comparison NAME Price (15/9/16) Mkt Cap PER (x) Est. NDiv. Yld. ** Historical ROE P/BV Net Profit (RMm) FY16/17 NP Growth FY17/18 NP Growth (RMm) FY15/16 FY16/17 FY17/18 (%) (%) (x) FY15/16 FY16/17 FY17/18 (%) (%) Target Price Rating M-REIT & PROPERTY INVESTMENT UNDER COVERAGE KLCCSS * 7.65 13,811 21.5 19.6 18.4 4.6% 9.2% 1.1 641.3 705.2 752.2 10.0% 6.7% 8.25 OUTPERFORM Pavilion REIT 1.76 5,320 22.0 21.7 19.3 4.3% 7.4% 1.4 241.3 244.8 276.6 1.5% 13.0% 2.15 OUTPERFORM IGB REIT* MARKET 1.64 5,721 22.4 21.9 21.6 4.7% 6.9% 1.5 254.0 261.3 266.3 2.9% 1.9% 1.66 PERFORM Sunway REIT* 1.72 5,066 19.2 18.6 17.4 5.4% 8.0% 1.1 262.5 270.3 289.1 3.0% 6.9% 1.85 OUTPERFORM CapitaMalls (M) Trust* 1.52 3,088 18.6 17.8 17.0 5.0% 10.5% 1.2 163.0 173.1 181.3 6.2% 4.8% 1.65 MARKET Axis REIT* 1.70 1,879 20.4 18.4 17.3 4.9% 7.2% 1.4 91.5 102.3 108.3 11.7% 5.9% 1.80 * Core NP and Core PER ** KLCCSS, CMMT, AXREIT, PAVREIT and IGBREIT based on FYDec16E and SUNREIT on FYJun17E/FY18E PERFORM MARKET PERFORM CONSENSUS NUMBERS YTL Hospitality REIT 1.11 1,470 1.0 13.9 15.9 5.4% 3.4% 0.8 55.9 106.0 92.7 90% -13% n.a. BUY Al-'Aqar Healthcare BUY -11% 1% REIT 1.62 1,180 16.6 18.6 18.4 5.2% 8.0% 1.3 70.9 63.4 64.1 1.80 AmanahRaya REIT 0.92 527 8.7 14.2 13.7 7.2% 9.0% 0.8 60.5 37.3 38.4-38% 3% n.a. BUY AmFIRST REIT 0.78 532 7.9 19.4 19.4 5.2% 8.0% 0.6 67.5 27.5 27.5-59% 0% n.a. SELL Hektar REIT 1.55 621 212.3 13.5 12.9 7.1% 0.5% 1.1 2.9 46.1 48.1 1475% 4% 1.57 BUY MRCB-Quill REIT 1.24 820 13.1 14.3 14.9 6.7% 7.8% 0.9 62.8 57.5 54.9-8% -5% 1.34 BUY Tower REIT 1.20 337 12.2 n.a. n.a. n.a. 5.1% 0.6 27.7 n.a. n.a. n.a. n.a. n.a. BUY UOA REIT 1.69 715 6.5 15.4 15.4 6.5% 16.4% 1.0 110.0 46.5 46.5-58% 0% n.a. BUY Atrium REIT 1.07 130 11.5 n.a. n.a. n.a. 6.6% 0.8 11.3 n.a. n.a. n.a. n.a. n.a. BUY Al-Salam REIT 1.04 603 n.a. 18.9 16.0 4.7% n.a. n.a. n.a. 11.9 12.2 n.a. 18% n.a. BUY Source: Kenanga Research PP7004/02/2013(031762) Page 4 of 7

MREITS FWD PBV KLCC: Fwd PBV Band SUNREIT: Fwd PBV Band CMMT: Fwd PBV Band AXREIT: Fwd PBV Band IGBREIT: Fwd PBV Band PAVREIT: Fwd PBV Band PP7004/02/2013(031762) Page 5 of 7

MREITS FWD PER KLCC: Fwd PER Band SUNREIT: Fwd PER Band CMMT: Fwd PER Band AXREIT: Fwd PER Band IGBREIT: Fwd PER Band PAVREIT: Fwd PER Band PP7004/02/2013(031762) Page 6 of 7

Stock Ratings are defined as follows: Stock Recommendations OUTPERFORM : A particular stock s Expected Total Return is MORE than 10% (an approximation to the 5-year annualised Total Return of FBMKLCI of 10.2%). MARKET PERFORM : A particular stock s Expected Total Return is WITHIN the range of 3% to 10%. UNDERPERFORM : A particular stock s Expected Total Return is LESS than 3% (an approximation to the 12-month Fixed Deposit Rate of 3.15% as a proxy to Risk-Free Rate). Sector Recommendations*** OVERWEIGHT : A particular sector s Expected Total Return is MORE than 10% (an approximation to the 5-year annualised Total Return of FBMKLCI of 10.2%). NEUTRAL : A particular sector s Expected Total Return is WITHIN the range of 3% to 10%. UNDERWEIGHT : A particular sector s Expected Total Return is LESS than 3% (an approximation to the 12-month Fixed Deposit Rate of 3.15% as a proxy to Risk-Free Rate). ***Sector recommendations are defined based on market capitalisation weighted average expected total return for stocks under our coverage. This document has been prepared for general circulation based on information obtained from sources believed to be reliable but we do not make any representations as to its accuracy or completeness. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may read this document. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees. Kenanga Investment Bank Berhad accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or any solicitations of an offer to buy or sell any securities. Kenanga Investment Bank Berhad and its associates, their directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein from time to time in the open market or otherwise, and may receive brokerage fees or act as principal or agent in dealings with respect to these companies. Published and printed by: KENANGA INVESTMENT BANK BERHAD (15678-H) 8th Floor, Kenanga International, Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia Telephone: (603) 2166 6822 Facsimile: (603) 2166 6823 Website: www.kenanga.com.my Chan Ken Yew Head of Research PP7004/02/2013(031762) Page 7 of 7