Retail REITs Still On Sale
MREITs are still down by 7-13% since bond yields started to rise in Jul 13, thus creating a shopping list of retail MREITS for long-term investors. We favour retail and industrial MREITs and would avoid office MREITs due to risk of potential oversupply of office space. 2014 is also a good year to shop for future MREIT beneficiaries. Top picks are CMMT, Pavilion REIT and Sunway REIT. Initiate coverage with MARKET WEIGHT.
• Adequate yield play is the new theme. Since late Jul 13, share prices of Malaysian REITs (MREIT) have fallen 7-13%, raising their prospective dividend yields from 5.7% to 6.5%. Current valuations have discounted an anticipated rise in bond yields, and the present economic climate is still supportive of below-historical average yields for MREITs – ample domestic liquidity, lack of alternate investment alternatives that provide modest income growth at low-risk, continuing low interest costs (which are locked into long maturity period at relatively low levels), and a stillbenign global interest rate environment anticipated in 2014.
• Retail REITs attracting strong investment interest. The sector has continued to attract brewing interest after the listing of mega MREITs, namely Pavilion REIT, IGB REIT, Sunway REIT and KLCC REIT. Large market capitalisation coupled with higher trading liquidity and retailfocused REITs appeal to investors.
• Be on the lookout for emerging REIT beneficiaries. We have identified a few companies that could “REIT” their investment properties or sell them to other REIT managers. These include Tropicana Corp, WCT, MRCB, KSL and Tiong Nam Logistics. The potential values that could be unlocked by these companies are almost significant towards their respective market capitalisations.
• Initiate coverage on MREITs with MARKET WEIGHT. We favour CMMT (Target: RM1.61), Pavilion REIT (Target: RM1.41) and Sunway REIT (Target: RM1.43) as they offer the best prospective dividend yields, while directly benefit from the MRT rail network as rental rates may further increase. CMMT and Pavilion REIT would see modest growth next year given about 44% and 17% of its tenancy is slated to expire next year, which we believe would able to fetch greater yields. For Sunway REIT, the improvement of connectivity surrounding Bandar Sunway (where 70% of its assets are located) via the Bus Rapid Transit would re-rate the rental rates and asset values within the area.
• We also initiate coverage on Axis REIT (Target: RM3.29) and IGB REIT (Target: RM1.25) with a HOLD. Axis is one of the key proxies in the industrial Iskandar REIT theme. Also, the REIT is in negotiations to acquire about RM300m worth of assets to be injected into the REIT. Both REITs are currently supported by a net dividend yield of 5.9% and 5.8% respectively.
• Narrowed yield spreads sustainable. Yield spreads between MREITs and the 10-year MGS have been steadily narrowing for the past four years, especially after the entry of the large cap MREITs (ie Pavilion REIT in Dec 11 and IGB REIT in Sep 12). MREITs’ dividend yields were exceptionally high in 1Q09 to 2Q11, as the US subprime collapse created a climate of high-risk aversion. Subsequently, as the threat of a global systemic financial crisis was effectively eliminated, risk aversion eased and MREITs’ yields normalised. Looking forward, we expect MREITs’ yield spreads to remain at around the current levels of 2.3ppt- 3.2ppt so long we have expectations of a protracted period of slow economic growth and benign interest rate environment.
• Retail REITs’ growth is sustainable, driven by both the local patrons and foreign tourists, and would continue to stay resilient even amid a general consumption slowdown. For instance, footfall in reputable malls in Kuala Lumpur City Centre and suburbs continue to grow at average rates of 3-5% yearly. This phenomenon would continue as we see evidence of increasing inflow of tourist and shopper traffic (refer to RHS Figure).
• Growth given a boost by improving public transport system. Future long-term growth will be boosted upon the completion of the MRT network, which will bring in higher shopper traffic into the core city centre, especially Pavilion REIT and CapitaMalls Malaysia Trust (CMMT). On the other hand, although Sunway REIT would benefit from the upcoming proposal of Bus Rail Transit (BRT), which would link the new residential areas expanded from the established townships outside the city centre, this should continue to support growth.
• Office segment to continue to be under pressure. We expect rental rate to remain under pressure at least over the next three years. Although there is an improvement in tenancy in recent months (improving by a marginal 3ppt from 2012 to 1H13), the oversupply of office space will take time to be absorbed by the market. Outside the central region, the oversupply of office space is not as excessive, and due to more accommodative rental rate and better traffic conditions, the decentralisation effect helps alleviate the concern. Additionally, with the gradual rollout of the Tun Razak Exchange (TRX) from 2016 onwards, we believe that it would continue to exert pressure, as supply will still outpace demand.
• Notable future REIT beneficiaries. We have identified a few property developers with the potential to either “REIT” their investment properties or to sell them to existing REIT managers. These undervalued properties include properties owned by developers such as Tropicana Corp, WCT, MRCB, KSL and Tiong Nam Logistics. The potential values that could be unlocked are significant to both companies’ current market capitalisations. Another significant point of these “REIT-able” assets is that they have the potential to fetch values that imply forward PEs of 12- 18x. (ie inverse of retail MREITs’ yields).
• The next emerging REIT player target. Tiong Nam Logistics (TNL) is slated to be the first logistics REIT in the country. We understand that TNL is reportedly planning to launch Malaysia’s first logistics REIT with an asset value of about RM1.4b next year. This REIT, which could raise about US$120m-150m and provide an attractive IPO yield of around 7- 8%, should significantly enhance TNL’s valuations, since the listing value of the REIT would greatly exceed TNL’s present market cap of about RM440m.
• Improving rental rates.
• Rising bond yields.
Publish date: 11/11/13