MREITs 2QCY14 Inline, Door Still Open For European QE By Sarah Lim l sarahlim@kenanga.com.my NEUTRAL We downgrade MREITs to NEUTRAL. MREITs 2QCY14 results were mostly inline, with the exception of AXREIT. There was finally an asset acquisition as AXREIT proposed to acquire 5 office/industrial assets. However, we do not expect this trend to follow through with other MREITs as the asset acquisition environment remains challenging. Organic growth rate is at 3.0%-6.8% for MREITs (save for SUNREIT at 10.6% due to SPP) under our coverage after accounting for the indirect impact of GST and other cost pressures. Despite the delayed timeline of the European QE, we are still bullish on the possible implementation and maintain our 10-year MGS target at 3.80%; but we may review our sector call if it fails to materialise by CY14. We are also comfortable with our yield-spread valuations basis because we have previously assumed more conservative spreads, while sector risks have been priced in. Thus, we keep our valuations and earnings estimates largely unchanged, except for CMMT. We downgrade MREITs to NEUTRAL (from OVERWEIGHT) as most MREITs share prices have appreciated over 3QCY14 (save for CMMT). We have downgraded our calls for KLCC, SUNREIT, IGBREIT and PAVREIT to MP (from OP), and reduced our TP for CMMT due to weaknesses at SWP; despite that the stock remains an unwarranted laggard. Our TPs and CALLs are: KLCC (MP; TP: RM6.90), SUNREIT (MP; TP: RM1.56), CMMT (OP; TP: RM1.57), IGBREIT (MP; TP: RM1.35), AXREIT (MP; TP: RM3.53) and PAVREIT (MP; TP:RM1.41) 2Q14 results review. All MREITs results were within expectations save for AXREIT s 1H14 results which came in slightly below our expectations at 41%, but within consensus due to higher-than-expected financing and operating cost. QoQ, topline growth was flattish to negative. Retail MREITs such as IGBREIT and SUNREIT (1% topline growth) saw flattish growth from minimal rental revisions, while other retail MREITs recorded negative growth due to lower occupancy rates and the seasonality factor (KLCC and PAVREIT) as 2Q is usually the weaker quarter for the hotel segment, and lower percentage rent for retail. AXREIT also saw negative topline growth from both lower occupancy and weak rental reversions at 0.65%, which is a historical low. This dragged down RNI as most MREITs, save for IGBREIT, recorded negative RNI QoQ (-2% to -10%), mainly due to higher utilities expenses. KLCC and AXREIT s lower RNI was due to a one-off occurrence from higher refinancing cost for KLCC, and the absence of gains on disposal for AXREIT. YoY, all retail MREIT s recorded positive topline growth (3% to 10%) on the back of positive rental reversions, but industrial-based AXREIT saw no growth due to slower reversions, and one asset lesser than 1H13 after disposing Axis Plaza. Retail MREITs positive topline pushed earnings, as RNI increased (by 4% to 36%) with IGBREIT and KLCC on the upper end of the spectrum at 16% and 36%, respectively. IGBREIT s stronger growth was due to strong reversions and its ability to better manage cost, while KLCC s REIT structure became effective in 2Q13 allowing for tax incentives. AXREIT increase in RNI (3%) was mainly due to the gains on disposal of Axis Plaza; excluding the gains, RNI actually decreased by 1%. PP7004/02/2013(031762) Page 1 of 9
MREITs Quarterly Growth M-REIT Period under review Quarterl y core PATAMI YTD core PATAMI Rev QoQ Core NP QoQ Rev Ytd YoY Core NP Ytd YoY Quarterly GDPS YTD GDPS Div Expectat ions KLCC 2Q14 148.0 313.0-2% -10% 8% 36% 7.57 15.70 Within SUNREIT 4Q14 56.1 231.9 1% -4% 3% 6% 2.00 8.36 Within CMMT 2Q14 36.7 74.9-1% -4% 6% 4% 2.20 4.50 Within Axis REIT 2Q14 20.8 43.1-2% -7% 0% 3% 5.30 10.60 Within IGB REIT 2Q14 58.5 116.2 1% 1% 10% 16% 1.96 3.89 Within PAVREIT 2Q14 55.6 112.3-2% -2% 8% 6% 1.90 3.84 Within Asset acquisitions at last. AXREIT signed the SPA s for 3 Warehouse/Office assets in Shah Alam and submitted a Letter of Offer (LO) for an additional 2 assets (industrial facility in Prai and Johor) on 4 th August 2014. The news did take us by surprise as MREITs under our coverage have not done any asset acquisition since Dec-12 (Sunway Medical by SUNREIT) due to the low cap rate environment. However, AXREIT managed to secure the assets at 7%-8% NPI yield, which is a positive surprise due to the low cap rate environment. The total acquisition cost for all 5 assets is RM472m which will be satisfied via borrowings, and we expect a share placement to follow through to pare down borrowings and reducing net gearing back to 0.35x. We are expecting AXREIT to complete the acquisition of all 5 assets by year end, with earnings expected to come in by FY15. As such, we raised our FY15E earnings by 23% to RM122m, and deem the acquisitions to be mildly yield accretive as it contributes an additional 0.8 sen to FY15E GDPU (post the additional 83.6m new units from a share placement). Apart from AXREIT, we are banking on a possible asset acquisition by KLCC as it has already obtained a share placement of 10% of its fund size (on 17 th April 2014), while KLCC also has an added advantage to acquire from: (i) low effective cap rates of 5.5%, close to market expected cap rates of 5%-6%, and (ii) the lowest gearing among MREITs under our coverage (save for PAVREIT) at 0.16x, allowing for lower financing cost and greater acquisition power if it chooses to gear up. That being said, we do not expect asset acquisitions to be a trend with other MREITs this year as the asset acquisition environment remains challenging due to the low cap rate. AXREIT outperformed YTD, while retail MREITs scored above average gains (save for CMMT). AXREIT recorded the strongest YTD gain at 23.0%, likely due to the 5 asset acquisitions in August. SUNREIT and KLCC followed closely behind, increasing by 21.3% and 15.2%, respectively, possibly due to Sunway Putra Place (SPP) as a catalyst for SUNREIT, and asset acquisition potential for KLCC. IGBREIT and PAVREIT have also seen above average gains which may have been a result of strong earnings growth (6%-16%). Big cap retail MREITs performed better than office and industrial MREITs (save for AXREIT due to the 5 acquisitions), as retail REITs are also more susceptible to bond yield fluctuations as the dropped by 17.3ppt to 3.94% year to date. Are investors being too harsh on CMMT? On the flip side, CMMT has not performed as well as its big cap retail peers, possibly due to on-going weakness at Sungei Wang Plaza (SWP). However, investors may be overly harsh considering the following facts: (i) SWP only makes up 27% of portfolio NPI, and (ii) all other assets are showing stronger-than-average rental reversions of 7%- 13% which is more than sufficient to negate SWP weaknesses. To prove to investors that weakness from SWP maybe overexaggerated, we have taken a more conservative stance and assumed -10% rental reversions at SWP for the leases up for expiry (rental reversions are currently at -7.4%) for the next 3 years or until the MRT construction works are completed in 2017. Other assets rental reversion assumptions remain unchanged at 7%-14%. Hence, we reduce CMMT s FY14E-FY15E core earnings by 1.4%-1.5%. We are also comfortable with our current valuation basis for FY15E and a target gross yield of 5.9% based on 2.1ppt spread to the of 3.8%; in our previous sector report, we had priced in the weakness arising from SWP by increasing CMMT s spread to the to 2.1ppt, above pure retail MREITs of 1.8ppt. Thus, CMMT s TP has been reduced slightly to RM1.57 (from RM1.59). Even so, CMMT still warrants an OUT call providing total returns of 16.4%. We believe CMMT is an unwarranted laggard as the stock is able to command 6.5% gross dividend yields vs. other MREITs yields under our coverage of 5.2% to 6.2%. PP7004/02/2013(031762) Page 2 of 9
MREITs Share Price YTD Gains (%) MREITs YTD Gains (%) -14.0% -9.0% -4.0% 1.0% 6.0% 11.0% 16.0% 21.0% 26.0% AXIS REAL ESTATE INVESTMENT SUNWAY REAL ESTATE INVESTMEN KLCC PROPERTY HOLDINGS BHD AL-'AQAR HEALTHCARE REAL EST IGB REAL ESTATE INVESTMENT T PAVILION REAL ESTATE INVEST Average AMANAH HARTA TANAH PNB CAPITAMALLS MALAYSIA TRUST HEKTAR REAL ESTATE INVESTMEN UOA REAL ESTATE INVESTMENT FBM KLCI YTL HOSPITALITY REIT QUILL CAPITA TRUST ATRIUM REAL ESTATE INVESTMEN AMFIRST REAL ESTATE INVESTM AMANAHRAYA REIT TOWER REAL ESTATE INVESTMENT GST to hit tenants the hardest. The implementation of GST is fast approaching (April 2015) and we expect the biggest impact of GST to be on the tenants, particularly tenants of retail assets. We expect GST to be less detrimental on office and industrial assets as they have longer lease periods and lower step up rates compared to heavy retail MREITs. Retail MREITs tenants will face increasing operating cost and will be affected on three fronts: (i) higher material cost on goods sold as GST will be implemented on all levels of the supply chain, causing tenants to increase prices to avoid denting profit margins, (ii) slower consumer demand which will be more apparent in the short run as consumers may avoid shopping due to the higher prices, and they may also hold back from shopping due to the rising cost of living from GST, and (iii) higher rent cost or occupancy cost as tenants will have to pay GST on rental. On top of that, the rising cost environment from subsidy rationalisation (eg: electricity tariff hikes and petrol hikes) may add to tenants rental cost as MREITs will not bear the higher cost but may choose to pass it on to tenants in the form of higher service charge or rental reversion. As a result of additional cost increases incurred by tenants, we believe this may dampen strong rental reversions for retail MREITs in the short to medium term as they would prefer to prioritize occupancy. We have already accounted for less bullish rental reversions by assuming humbler step-up rates in our FY15E earnings during the GST announcement during the Budget 2014 announcement (October 2013). Organic growth rate is at 3.0%-6.8% (save for SUNREIT at 10.6% due to SPP) for MREITs under our coverage after accounting for the indirect impact of GST and other cost pressures. MREITs with a higher proportion of Turnover Rent may feel the pinch of GST. The implementation of GST and other costpush factors such as subsidy rationalisation may limit strong rental reversions in the short to medium term, but more so for MREITs which have a higher proportion of Turnover Rent vs. Base rent. Retail MREITs have a two-pronged approach to rental rates: (i) charging tenants a base rent (which is a fixed amount to be paid each month), and; (ii) percentage/turnover rent, (which is charged as a % of tenant s monthly turnover). We believe that MREITs, such as IGBREIT, that have a larger portion of turnover rent ( mid-teens ) vs. other MREITs (3%-7% of GRI) may see a slight decline in GRI if tenant sales take a beating. On the flipside, IGBREIT s rental formula is the more conducive in protecting occupancy rates. We have already accounted for more conservative earnings estimates for IGBREIT from GST, as such make no changes to our earnings at this juncture. We also do not expect other MREITs under our coverage to see any material decline in earnings as; (i) they have a low percentage of turnover rent (3%- 7%), (ii) we do not expect occupancy rates in the more affluent malls (Suria KLCC, Pavilion Shopping Mall, Sunway Pyramid) to suffer as the more well renowned brands would not be severely affected by margin compression, and (iii) CY15 is not a major lease expiry year for most of the MREITs under our coverage (10%-33% of leases up for expiry), so weaker rental reversions will affect a smaller portion of the REITs portfolio. Door still open for a European QE. YTD, the 10-year MGS has declined from a high of 4.3% to 3.94% currently, and we expect it to come down further once the European QE is implemented. We had previously expected a European QE to take place in June/July but the ECB has taken other stimulating measures which have failed to bear fruit so far. On 5 th September 2014, the European Central Bank (ECB) announced two measures to combat the worsening inflation outlook in the region: (i) cut lending rates to 0.05% (from 0.15%) and deposit rates to -0.2% (from -0.1%), and (ii) announced that it will purchase covered bank bonds and bundled loans known as asset-backed securities, with further details and the size of the programme to be released in October. Should these measures prove ineffective, the ECB is still open to QE. PP7004/02/2013(031762) Page 3 of 9
For now we maintain our view and target at 3.80% in anticipation of a European QE. However, should the European QE fail to materialise by CY14, we would increase our back to pre-anticipated European QE levels of 4.15%, which will result in a downside bias to our TPs which may affect our sector ratings. At this juncture, we are comfortable with our 10-year MGS yield-spread valuations basis because we have previously assumed more conservative spreads with most of the sector risk priced in. Current Scenario: Based on of 3.80% Last Price as at 19/9/14 Last Price GDPS (RM) FY Yield based on last price Target Yield yield spread to target TP (RM) Total Returns KLCC 6.68 0.35 FYDec15E 5.17% 5.00% 1.20% 3.80% 6.90 8.2% SREIT 1.54 0.10 FYJun15/16 E 6.19% 6.10% 2.30% 3.80% 1.56 7.0% CMMT 1.42 0.09 FYDec15E 6.52% 5.90% 2.10% 3.80% 1.57 16.4% AXRB 3.58 0.22 FYDec15E 6.22% 6.30% 2.50% 3.80% 3.53 4.3% IGBREIT 1.28 0.08 FYDec15E 5.92% 5.60% 1.80% 3.80% 1.35 11.1% PARVEIT 1.38 0.08 FYDec15E 5.70% 5.60% 1.80% 3.80% 1.41 7.0% No European QE Scenario: Based on of 4.15% Last Price as at 19/9/14 Last Price GDPS (RM) FY Yield based on last price Target Yield yield spread to target TP (RM) Total Returns Change in TP KLCC 6.68 0.35 FYDec15E 5.17% 5.35% 1.20% 4.15% 6.45 1.4% Downgrade SREIT 1.54 0.10 FYJun15/1 6E 6.19% 6.45% 2.30% 4.15% 1.48 1.5% Downgrade CMMT 1.42 0.09 FYDec15E 6.52% 6.25% 2.10% 4.15% 1.48 10.2% Downgrade AXRB 3.58 0.22 FYDec15E 6.22% 6.65% 2.50% 4.15% 3.35 2.6% Downgrade IGBREIT 1.28 0.08 FYDec15E 5.92% 5.95% 1.80% 4.15% 1.27 4.9% Downgrade PARVEIT 1.38 0.08 FYDec15E 5.70% 5.95% 1.80% 4.15% 1.32 1.0% Downgrade Downgrade MREITs to NEUTRAL (from OVERWEIGHT). Since our report dated (6 th June 14) highlighting the catalyst from a European QE, MREITs share prices have rallied by 1.2%-7.5% (save for CMMT). We are downgrading KLCC, SUNREIT, PAVREIT and IGBREIT to from OUT, as a result of the recent share price increases, and we do not expect any share price or earnings catalyst going forward, as we are comfortable with current valuations. For AXREIT, we maintain and TP of RM3.53 because we deem the acquisitions to be mildly yield accretive as it contributes an additional 0.8 sen to FY15E GDPU (post the additional 83.6m new units from a share placement. As for CMMT, we are keeping OUT on the stock but reduced TP marginally to RM1.57 (from RM1.59) after assuming -10% rental reversions for SWP over the next 3 years. Even after factoring additional earnings weakness, CMMT still warrants an OUT call providing total returns of 16.4%. We believe CMMT is an unwarranted laggard as the stock is able to command 6.5% gross dividend yields vs. other MREITs yields under our coverage of 5.2% to 6.2%. Our CALLs and TPs are; KLCC (MP; TP: RM6.90), SUNREIT (MP; TP: RM1.56), CMMT (OP; TP: RM1.57), IGBREIT (MP; TP: RM1.35), PAVREIT (MP; TP: RM1.41), and AXREIT (MP; TP: RM3.53) Risks to our call. Thus far, we have accounted for the effects of a rising cost environment. However, worse-than-expected rising cost and weak rental reversions would bite into earnings and dividends. A possible interest rate hike in the US may cause Malaysian bond yields to increase slightly, or if the European QE fails to materialise, this may put some downward pressure on MREITs share prices. PP7004/02/2013(031762) Page 4 of 9
Peer Comparison Last Price as at 19/9/14 Last Price GDP S (RM) FY Yield based on last price Target Yield yield spread to 10-yr MGS target Current Call TP (RM) Share price upsid e Total Returns Comments KLCCSS 6.68 0.35 FYDec15E 5.17% 5.00% 1.20% 3.80% MP 6.90 3.4% 8.2% No changes in yield spread and TP. Downgrade call to MP (from OP) as share price has rallied by 15.2% YTD. SREIT 1.54 0.10 FYJun15/1 6E 6.19% 6.10% 2.30% 3.80% MP 1.56 1.5% 7.0% No changes in yield spread and TP. Downgrade call to MP (from OP) as share price has rallied by 21.3% YTD. CMMT 1.42 0.09 FYDec15E 6.52% 5.90% 2.10% 3.80% OP 1.57 10.6% 16.4% No changes in yield spread but reduced earnings and GDPS by 1.4% after factoring in continuous negative reversions from SWP until 2017. Maintain CALL but downgrade TP (from RM1.59) AXRB 3.58 0.22 FYDec15E 6.22% 6.30% 2.50% 3.80% MP 3.53-1.3% 4.3% No changes in yield spread and TP. Maintain call as the stock still warrants a call at current levels. IGBREIT 1.28 0.08 FYDec15E 5.92% 5.60% 1.80% 3.80% MP 1.35 5.7% 11.1% No changes in yield spread and TP. Downgrade call as share price has rallied by 6.7% YTD. PARVEIT 1.38 0.08 FYDec15E 5.70% 5.60% 1.80% 3.80% MP 1.41 1.9% 7.0% No changes in yield spread and TP. Downgrade call to MP (from OP) as share price has rallied by 6.2% YTD. PP7004/02/2013(031762) Page 5 of 9
NAME Price (19/09/14) Mkt Cap PER (x) Est. NDiv. Yld. ** Historical ROE P/BV Net Profit (RMm) FY14/15 NP Growth FY15/16 NP Growth Target Price Rating (RM) (RMm) FY13/14 FY14/15 FY15/16 (%) (%) (x) FY13/14 FY14/15 FY15/16 (%) (%) (RM) M-REIT & PROPERTY INVESTMENT UNDER COVERAGE KLCCSS * 6.68 12,060 21.8 18.9 18.4 4.7% 8.2% 1.0 552.1 637.7 655.7 15.5% 2.8% 6.90 Pavilion REIT 1.38 4,159 19.4 18.5 18.0 5.0% 9.3% 1.2 214.1 224.7 231.3 4.9% 2.9% 1.41 IGB REIT* # 1.28 4,405 21.2 20.0 19.3 5.2% 6.1% 1.2 206.9 221.0 230.1 6.8% 4.1% 1.35 Sunway REIT* 1.54 4,514 17.9 16.9 14.6 5.2% 11.1% 1.1 231.9 246.3 283.7 6.2% 15.2% 1.56 CapitaMalls (M) Trust* 1.42 2,526 17.0 16.4 15.7 5.6% 8.0% 1.2 148.5 153.9 160.4 3.7% 4.2% 1.57 OUT Axis REIT* 3.58 1,660 19.5 17.4 16.1 5.4% 11.0% 1.6 84.5 95.3 122.0 12.7% 28.0% 3.53 * Core NP and Core PER ** KLCCSS, CMMT, AXREIT, PAVREIT and IGBREIT based on FYDec15E and SUNREIT on FYJun15E/FY16E # FY13/14 core earnings growth based on non-annualized FY12/13 core earnings CONSENSUS NUMBERS STARHILL REAL ESTATE INVESTM 1.00 1,324 26.1 12.5 12.5 8.0% 3.6% 1.0 50.7 106.0 106.0 109% 0% 1.23 BUY AL-'AQAR KPJ REIT 1.46 1,016 13.5 17.2 16.8 5.8% 9.4% 1.3 75.1 59.2 60.6-21% 2% 1.67 NEUTRAL AMANAHRAYA REIT 0.90 516 29.9 11.3 11.3 8.9% 3.5% 0.9 17.3 45.9 45.9 166% 0% 1.36 BUY AMFIRST REAL ESTATE INVESTM 0.96 659 10.8 12.0 10.7 7.3% 7.5% 0.7 61.0 54.9 61.8-10% 13% 1.18 BUY HEKTAR REAL ESTATE BUY INVESTMEN 1.51 605 10.3 12.1 12.1 7.5% 9.7% 1.0 58.8 50.1 50.1-15% 0% 1.67 QUILL CAPITA TRUST 1.16 453 12.4 12.2 11.7 7.4% 7.7% 0.9 36.4 37.1 38.6 2% 4% 1.31 BUY TOWER REAL ESTATE BUY INVESTMENT 1.33 373 13.2 10.2 10.2 9.0% 14.3% 0.7 28.3 36.5 36.5 29% 0% 1.87 UOA REIT 1.46 617 14.0 13.3 12.2 6.8% 7.1% 1.0 44.2 46.5 50.7 5% 9% 1.64 BUY ATRIUM REAL ESTATE INVESTMEN 1.27 155 6.3 12.7 12.7 7.1% 16.8% 1.0 24.4 12.2 12.2-50% 0% 1.79 BUY Source: Kenanga Research PP7004/02/2013(031762) Page 6 of 9
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 7 of 9
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 8 of 9
Stock Ratings are defined as follows: Stock Recommendations OUT : 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%). : A particular stock s Expected Total Return is WITHIN the range of 3% to 10%. UNDER : 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 9 of 9