Malaysia REITs - Catalyst From Proposed Guideline Changes

Maintain OVERWEIGHT. Top picks – Pavilion REIT and IGB REIT

 We maintain our OVERWEIGHT rating on the M-REITs sector as we anticipate a more exciting outlook subsequent to the proposed guidelines changes, particularly the proposal to enable M-REITs to undertake property development activities, resulting in better yields to shareholders. Our top picks – Pavilion REIT and IGB REIT.

M-REITs still a resilient sector – 2Q16 results in-line with expectations Overall, M-REITs under our coverage saw retail REITs such as Pavilion REIT and IGB REIT and diversified M-REIT KLCC Property reporting 1H16 results in-line with our expectations, with the exception of Axis REIT due to higher-than-expected operating expenses. In-line with our views, Pavilion REIT and IGB REIT continued to exhibit resilient income stream with steady occupancy rates at their shopping malls. Coinciding with the cut in the OPR, we had recently revised the target prices higher for the M-REITs.

Positive impact expected from SC’s proposed amendments  Of the 16 proposed changes to the existing REIT guidelines, we believe that the proposal to enable M-REITs to undertake property development including acquiring vacant land (not exceeding 15% of total asset value) will have the most material impact on existing players. As overall cost of development will be lower vis-à-vis a direct acquisition of a property, it should enable shareholders to benefit from more attractive yields in future.

M-REITs remain an attractive asset class despite yield compression Although the M-REITs sector saw a further yield-compression of 30bps from end-Mar16 to 4th Sept16, with total ytd yield compression of 64bps, we note that the spread vis-à-vis the 10-year MGS yield has remained relatively steady at 188bps since the start of 2015 despite the cut in the Overnight Policy Rate (OPR) by 25bps (July 2016). 

Maintain OVERWEIGHT. Top picks – Pavilion REIT and IGB REIT  We currently maintain our sector OVERWEIGHT and continue to prefer the retail M-REITs (Pavilion and IGB REIT) over the non-retail or diversified MREITs. We believe that investor appetite will remain strong for these stocks due to its low-risk factor (stable occupancy and rental rates) coupled with recovering consumer sentiment. IGB REIT (IGBREIT MK, BUY, TP: RM1.72) should be supported by stable occupancy rates of ~100%, being a key suburban super-regional shopping destination. 2016-18E DPU yields are at 5.7-6.1%. Pavilion REIT (PREIT MK, BUY, TP: RM2.11) remains a key shopping destination in the heart of KL and attracts a significant market of higher-income visitors. Yield-accretion of recent acquisitions should gradually improve in the long term. 2016-18E DPU yields are at 5.4-6.2%.

source: Daiwa Securities 07/09/2016