M-REITs - Under pressure by bond-yield reversals

Maintain NEUTRAL on MREITs. The sector’s risk-reward ratio has become less favorable given threats of bond yield reversals. There has been an absence of acquisitions in 1H13, given GE13 risks and mismatch of asset values vs. rental rates, which implies less exciting growth prospects. For the rest of 2013, there may be potential acquisitions but we believe they are unlikely to provide significant DPU accretions, particularly when placements are required. We take the stance that asset cap rates need to normalize before acquisition activities can gain momentum again. However, MREITs are unlikely to be sold down heavily as we note that those under our coverage have highly institutionalized shareholdings and are tightly held. Furthermore, while we expect the 10-year MGS yields to expand, we do not expect it to be too severe. We have increased our 10-year MGS yield assumption to 3.6% from 3.0% while assuming current MREIT dividend yield spreads, which results TPs being lowered by 2%-9%. The new TPs are KLCCSS TP: RM6.48, SUNREIT TP: RM1.56, CMMT TP: RM1.73 and AXREIT TP: RM3.60, which provides a total return of 5%, 6%, 7% and 3% respectively; hence we maintain MARKET PERFORM on all the MREITs under our coverage. 

Retail landlords underperformed MREIT average returns. 1QCY13 earnings and dividends were mainly within our and market expectations, resulting in no earnings revisions. Retail MREITs (e.g. CMMT, SUNREIT) clearly showed better YoY growth given stronger organic growth rates of 6%-9% p.a. compared to the office/industrial (AXREIT), whereas KLCCSS benefited from its PETRONAS Twin Towers long-term lease renewals. On the other hand, QoQ performances were unexciting. However, it is interesting to note that retail landlords (CMMT, SUNREIT) underperformed the MREITs average YTD returns of 5.2% while the likes of AXREIT and KLCCSS were above average at 19.8% and 9.1%, respectively. We reckon retail MREITS underperformed because they are more sensitive to reversals in bond yields as they command the lowest yield spreads to the 10-year MGS.

Absence of acquisitions implies unexciting growth prospects… There was an absence of acquisitions during the quarter; only SUNREIT completed its acquisition of Sunway Medical Center in 1QCY13 while the rest did not announce any new acquisitions. It was quiet given pre-GE uncertainties (up to end May) and there is also a mismatch between asset pricings vs. rental yields given the rapid compression of cap rates over the last 2 years on the back of listing of new MREITS (e.g. KLCCSS, IGB REIT, Pavilion REIT). Most MREIT managers are eyeing more distress assets or other states outside Klang Valley, Johor and Penang, rather than banking on their parent’s pipeline, as the former provides better cap rate entries with stronger turnaround prospects.  We do not discount the possibility of acquisitions in 2H13, although we reckon completing their target acquisitions over 2H13 will be a stretch.

Yield reversals? Likely. However, this may not overly stiff hence valuation downside risk could be limited. The 10-year MGS reversed from its low of 3.05% in May-13 to 3.66% given threats of capital outflows. Our  Economists expect Malaysia to maintain OPR at 3.0% over CY13-14E, so we do not expect sharp reversals in bond yields. Thus, we revise up our target 10-year MGS yields to 3.5% from initial 3.0%.

Maintain NEUTRAL but lower TPs. We do not expect sharp yield reversals for the 10-year MGS. For now, we are re-basing our target yields due to higher 10-year MGS target of 3.5% from initial assumptions of 3.0% while using current yield spreads. Hence, our MREITs TPs has been lowered by 2%-9%. The new TPs are as followed; KLCCSS TP: RM6.48, SUNREIT TP: RM1.56, CMMT TP: RM1.73, AXREIT TP: RM3.60.



KEY POINTS

1QCY13 results were within expectations. MREITs earnings and dividends were mainly within our and market expectations, resulting in no earnings revisions. MREITs under our coverage (e.g. SUNREIT, CMMT, AXREIT and KLCCSS) have recorded YoY growth of 3%-16%; KLCCSS and SUNREIT experienced the higher growth rates due to timing of long-term lease renewals (PETRONAS Twin Towers) and new acquisitions (Sunway Medical Center), respectively.  However, QoQ performances were less exciting and those under our coverage recorded quarterly NPIs which showed unexciting growth of +2% to +4% (SUNREIT and CMMT respectively) to declining trends of -1% to -12% (AXREIT and KLCCSS respectively).

It is unsurprising to see weaker trends with Klang Valley’s office segment facing flat to weak occupancy rates, while reversions are challenging given the glut of office spaces in the Klang Valley. Industrial spaces are also unlikely to capture any shorter term upswings in rates as leases are on a longer-term basis (5-10 years). MREITs with pure (CMMT) or heavier (SUNREIT) retail space exposures benefited from stronger organic rental growth rates of 6%-9% p.a. as there is still visible demand for well-managed, strategically located and iconic malls given the emergence of more international and home-grown local  brands (e.g. apparels) while it rides on the Malaysian economy continues to register robust GDP growth.

Retail landlords underperformed MREIT average returns. MREIT average YTD share price returns are 5.2% with; 1) AXREIT and KLCCSS being higher at 19.8% and 9.1%, respectively; 2) SUNREIT and CMMT being lower at 0.0% and -1.7%, respectively. We reckon retail MREITs, like SUNREIT and CMMT, underperformed the sector’s average because they are more sensitive to reversals in bond yield curves given that they command the lowest yield spreads to the 10-year MGS. Whereas those that outperformed the average YTD return were; 1) AXREIT as it is riding on potential injections from Johor industrial properties; 2) KLCCSS which was buoyed by its new Stapled REIT structure and expectations that Suria KLCC will also be REIT-ed.

Absence of acquisitions implies unexciting growth prospects… There was an absence of acquisitions during the quarter; only SUNREIT completed its acquisition of Sunway Medical Center in 1QCY13 while the rest did not announce any new acquisitions. It was quiet given pre-GE uncertainties (up to end May) and there is also a mismatch between asset pricing vs. rental yield given the rapid compression of cap rates over the last 2 years on the back of listing of new MREITS (e.g. KLCCSS, IGB REIT, Pavilion REIT). AXREIT is expected to announce up to RM350m worth of new acquisitions this year (out of RM660m worth of assets under negotiation) and so far, none has taken place yet. CMMT has obtained approvals for a potential placement but will likely announce it concurrently with any new acquisitions. SUNREIT is eyeing acquisitions from its parent and third parties, although nothing is concrete yet. There are expectations that KLCCSS will REIT Suria KLCC but the recent share price correction seems to suggest otherwise. 

…meaning less share price catalysts. Most MREIT managers are targeting more third party acquisitions where asset pricings and implied yields are more reasonable plus there is sharper rental growth prospect post refurbishments. Assets from parents tend to be matured i.e. at premium pricings. The preferences are distress or old assets (e.g. Sunway Putra Place) and neighborhood malls in other states besides Klang Valley, Penang and Johor. We do not discount the possibility of acquisitions in 2H13, although we reckon completing their target acquisitions over 2H13 will be a stretch. Even so, these acquisitions are unlikely to provide significant DPU accretions, particularly when placements are required, until asset cap rates normalize.

Yield reversals? Likely. However, this may not overly stiff hence valuation downside risk could be limited. The 10-year MGS yield hit a daily-low of 3.05% in May-13 while MREITs under our coverage saw record low yield spreads +1.20ppt to +1.57ppt. However, the Malaysian 10-year MGS yield curves has since reversed to 3.66% recently as the US intends to cool-off its QEs and may hike their interest rates in the foreseeable future. Since our Economist expects Malaysia to maintain OPR at 3.0% over CY13-14E while our House views that a huge market liquidity crunch is unlikely this year, we do not expect the 10-year MGS yields to reverse to drastically. Hence, we expect the 10-year MGS to move towards 3.5% from initial estimated 3.0%. For now, we expect MREIT spreads to the 10-year MGS to remain at its current levels as there are no major changes in fundamentals; we will review the situation next quarter.

Maintain NEUTRAL but lower TPs. We are re-basing our target yields due to higher 10-year MGS target of 3.5% from initial assumptions of 3.0% while using current yield spreads (range: +1.6ppt to +2.0ppt) as we expect no major changes in MREIT fundamentals. Hence, our MREITs TPs has been lowered by 2%-9%. The new TPs are as followed;           .

Normalization of asset cap rates bodes well for the long-term.  Positively, the reversal of bond yields may be beneficial to MREITs in the medium to longer term. Expansion of bond yields could also mean a reversal of cap rates to more ‘normalized’ levels, i.e. MREITs can acquire properties, which match or are more yield accretive relative to their own NPI yields. However, this will take some time and we will review the matter periodically.  

Risks to our calls/TP. OPR hikes will have negative implications on bond yields, which will adversely affect MREIT valuations. Yield accretive acquisitions will be a booster to our TPs/CALL. Another risk to monitor is the retailers’ performances; we note that fashion retailers are finding rental rates challenging, especially landmark malls, and are looking for cheaper alternatives like smaller or more neighborhood orientated malls outside of Klang Valley. So this could have negative implications on future rental reversions for retail MREITs.

Source: Kenanga