Tuesday 10 July 2012

Reits Sector - Clever strategy to fill earnings vacuum Neutral


- We have downgraded the REIT sector to a NEUTRAL, strictly because distribution yields have compressed significantly, making M-REIT much more expensive than S-REIT.

(1)  CapitaMall Trust Malaysia (HOLD, FV: RM1.68/unit): We downgrade CMMT to a HOLD, with an unchanged fair value of RM1.68/unit. At the current price of RM1.60/unit, distribution yield is compressed to 5%. Even though we continue to like CMMT’s medium growth trajectory, we do not see much room for yield to compress further. For comparison, CMMT’s sister company, CapitaMall Trust Singapore, is trading at a more attractive yield of 5.4%, based on the latest trading price of SGD1.90/unit. This is despite having a lower Singapore risk free rate than Malaysia’s. Given its well-diversified and strategically located quality retail portfolio and strong parentage, the re-rating catalysts in the short-medium term will be driven by a retail mall freeze in Penang and upcoming MRT station in Jalan Bukit Bintang.

(2)  Pavilion REIT (HOLD, FV: RM1.33/unit): We also downgrade P-REIT to a HOLD, with an unchanged fair value of RM1.33/unit mainly for the same reason as CMMT. Distribution yield have compressed to 5% at the current price of RM1.26/unit from 5.4% previously. Nonetheless, more tangible earnings are anticipated from the potential acquisition in the pipeline – Fahrenheit, Pavilion Extension and USJ mall. Additionally, the upcoming MRT station in Jalan Bukit Bintang will lift footfall for Pavilion Mall. Hence, we envisage a stronger earnings trajectory in the near term due to the exposure in prime retail assets and upcoming asset injections.

(3) Al-‘Aqar Healthcare REIT (HOLD, FV: RM1.39/unit): We are maintaining our HOLD, with an unchanged fair value of RM1.39/unit. Distribution yield stands at 5.5% at current price of RM1.40/unit. We do see room for earnings revisions in the near term underpinned by the right of first refusal to a pool of KPJ Healthcare’s hospitals and management is on an active look-out for third party acquisitions in aged-care and retirement villages. Nonetheless, we still continue like CMMT and P-REIT over the medium to longer term.

- Significant compression in distribution yields: By historical standard, M-REIT is expensive given the current distribution yield compression to 5% vis-a-vis 7%-8% previously. Yields of CMMT and P-REIT are 5%, which is lower than CapitaMall Trust Singapore and Frasers Centrepoint at 5.4% and 5.7%, respectively. On a 5 year average, the 10-year Singapore Government bond of 2.7% is lower than the 10-year MGS of 3.9%.  Furthermore, the spread of the 10-year MGS for M-REITs has narrowed to 150bps. This is even tighter than the current spread in the S-REIT of 380bps. The narrowing of spread suggests that valuations of M-REIT are high. Not forgetting, the risk free rate in Singapore at 1.6% is lower than the 10-year MGS of 3.5%. As such, M-REIT is more expensive than S-REIT.

- Flipside of distribution yield compression: On the flipside, the compression in yield may lead to more active acquisitions because of greater scope of accretion. Furthermore, inflation has more than halved to 1.7% in June 2012. This may either accentuate the current low interest rate regime (3.3%) or potentially cut interest rate if the economy decelerates. Given weak inflation, this would provide downside support, notwithstanding the lofty valuation underpinned by yield compression. Our conversations with managements suggest acquisition to gain momentum by M-REITs. The potential lower hurdle rates make acquisition more attractive based on a lower cost of funding.  In the near term, we expect REITs to trade sideways due to its rich valuation at least until more accretion in distribution yields arising from acquisitions.  

- Increasing representation of M-REIT: Market capitalisation of the 13 M-REITs stand at RM26bil. Reported yield of the upcoming listing of IGB REIT is at 5.5%, estimated at RM4bil-RM4.5bil, bringing market capitalisation to circa RM30bil (+15%). There has also been recent talk of KLCC Property looking at a REIT for its asset in the near term. The listing of a such large REIT will more than broaden and lift the sector as well as progressively develop it as a distinct asset class.

Source: AmeSecurities

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