Reits Sector - Implications on funding strategy with yield converging to cost of debt NEUTRAL

Investment Highlights

- Distribution yields converging close to cost of debt: In this report, we look at the potential implication on funding strategy for REITs, in respect of future acquisition given that distribution yields have converged close to the cost of debt. This is because we have witnessed significant yield compressions from the steep and sustained run-up in unit prices.

- Equity vs. debt funding: We run a scenario analysis whereby the REITs under our coverage are assumed to acquire a RM300mil asset, with an underlying property yield of 6.5%. As shown in Table 1, acquisition by debt is accretive to DPU because cost of debt is lower than the property yield.  Nevertheless, we believe there is a likelihood of the REITs using more equity funding to leverage on the market’s insatiable appetite for high yielding stocks because of other considerations:-

(1) Enlargement of market capitalisation: Equity funding is able to accelerate market capitalisation expansion and thereby, create greater liquidity for the REITs. This, in turn, would eventually generate more investor interest in the sector. 

(2) First-mover advantage from expansion in shareholders’ fund: The REITs which are able to capitalise on equity funding now would have a strong first-mover advantage when it comes to future asset acquisitions. Through equity funding, the REITs would be able to better manage their gearing level, which is set at a 50% threshold. This provides ample debt room for future acquisitions, if required. Notwithstanding this, investors generally prefer lowly-geared companies during uncertain times. As it is, gearing for P-REIT, CMMT and Al’Aqar is at 18%, 28% and 42% for FY12F, respectively.  

- Acquisitions should gain traction: Given the current search for yield, we believe that REITs may accelerate their acquisition plans to take advantage of their lofty valuations.

CMMT has right of first refusal for QueensBay Mall, currently parked under its parent CapitaMalls Asia. Having successfully completed its assets’ enhancement initiatives with the debut of Fashion Avenue at Pavilion Mall, P-REIT may soon explore the acquisition of Fahrenheit 88 as its tenancy appears to have stabilised. Given the success of Jeta Gardens – Al’ Aqar’s first third-party acquisition and venture into the aged-care and retirement village – we reckon that it will start embarking into similar acquisitions. In addition, Al’-Aqar is backed by a  strong sponsor, KPJ Healthcare, which is currently  constructing seven hospitals that will eventually be injected into Al’Aqar upon completion over the next 3 years. 

- P-REIT remains as top pick: We expect FY13 to be a good year as the key driver would come from higher rentals driven by:-

(1)  67% of NLA expiring – translating into higher rental reversions ranging between 12%-15%; and (2) Recent launch of Fashion Avenue (NLA: +5%) is expected to boost rentals by twice compared to the previous anchor tenant, Tangs.  Catalysts for future growth:- (1) Anticipated asset acquisitions which are expected to kick in from FY14 onwards – Fahrenheit 88, da:men mall in USJ and Pavilion Extension; (2) Upcoming MRT at Jalan Bukit Bintang will result in a better catchment for Pavilion Mall; and (3) Potential underground linkage between Fahrenheit 88 and Pavilion Mall, allowing shoppers more comfort between malls and in turn, improving shoppers flow. 

- Maintain NEUTRAL:  We maintain our  NEUTRAL stance on the sector with  HOLD ratings for  Pavilion REIT (FV: RM1.33/unit), CMMT (FV: RM1.68/unit) and Al’-Aqar Healthcare REIT (FV: RM1.39/unit) until we see the key valuation variables turning constructive in the sector. Although we see limited growth in the near term, we opine that the long-term growth of M-REITs remains positive and intact

Source: AmeSecurities