Management shared that retail sales of mall tenants remained stable in 3Q22 vs 1H22, even after when a slew of festive holidays took place. Encouragingly, rental contribution from Sunway Carnival Mall came on stream starting end-July (achieved >90% committed occupancy rate as at end-Sep). For hotel segment, management has been proactive to tap on the healthy recovery of the domestic leisure market along with the phased opening of Sunway Resort hotel. Despite the interest rate upcycle, management maintains its stance of adopting active capital management to optimize its costs of debt and capital structure. On balance, we nudge up our FY22-24 core net profit forecasts by 5.3%-5.0% as we anticipate stronger rental contribution from its retail and hotel assets. Reaffirm BUY, with higher TP of RM1.68 (from 1.67) based on FY23 DPU on targeted yield of 5.3% (from 5.1%).

We recently hosted a conference call with Sunway REIT’s key management with the following key takeaways:

Retail sales remain strong. To recap, 1H22 tenancy sales of its retail malls have exceeded pre-pandemic level, though footfall still hovered slightly below 2019 level. From the conference call, we understand that overall retail performance remained stable in 3Q22 vs 1H22 when a slew of festive holidays took place, contesting the notion of the retail boom in 1H22 was primarily attributed to revenge spending and festive seasons. Separately, Covid-19-related rental assistance has come to an end while rental reversions for those that renewed their tenancy in 1H22 stood at a healthy positive mid-single digit growth on a blended basis.

Sunway Carnival Mall. Rental contribution from the new wing of Sunway Carnival Mall came on stream starting end-July, translating to 2 months of rental contribution for an NLA of nearly additional 350k sqft to its retail segment for the rest of 3Q22 (Aug and Sep) and moving forward. From our ground checks, the committed occupancy rate was above 90% with physical tenancy of 85% as at end-Sep 2022. More stores are expected to open in the next few months closer to the committed occupancy rate.

Gradual return of foreign tourists. On its hotel segment, the return of foreign tourists has been gradual, due to prolonged border closures in some countries. As such, hotels situated in Sunway City did not enjoy the influx of tourists from the Middle East region as it used to during this summer season. Nonetheless, management has been proactive to tap on the healthy recovery of domestic leisure market. Notably, the phased reopening of Sunway Resort hotel is progressing well with 238 out of 460 rooms opened as at end of Sep. Based on those available rooms, the occupancy is picking up at higher ADR compared to pre-refurbishment’s rate. To recap, Sunway Putra Hotel’s master lease was renewed in September 2021 for a period of 10 years. It no longer has a minimum guaranteed rent. The rental is computed based on 90% of gross operating profit (GOP). Based on our estimates, the hotel requires an average occupancy rate of 55% to 60% to achieve the previous minimum guaranteed rent.

Capital management strategy. As at 1H22, Sunway REIT’s gearing level stood healthily at 36.8% while having one of the lowest average cost of debt of 2.7% among M-REITs. In view of the prevailing interest rate upcycle, we expect sequentially higher financing costs as 68% of debt are on floating rate basis. Notwithstanding, management maintains its stance of adopting active capital management – employing shorter tenure financing with floating rate, which translates to lower coupon rates and cost of debt as well as greater flexibility in managing their capital structure.

Forecast. We nudge up our FY22-24 core net profit forecasts by 5.3%-5.0% as we anticipate stronger rental contribution from its retail and hotel assets.

Maintain BUY; TP: RM1.68. In light of the rising MAG10YR yield (now trading at 4.4%), we take this opportunity to tweak our average MGS assumption to 4.5% (from 4.25%). All in all, our TP increases marginally to RM1.68 (from 1.67). Our TP is based on FY23 DPU on targeted yield of 5.3% (from 5.1%), derived from -1SD below 5-year historical average yield spread between Sunway REIT and MAG10YR in view of its diversified portfolio and robust track record. Reaffirm BUY.

Source: Hong Leong Investment Bank Research - 7 Oct 2022