CFA Institute Research Challenge Hosted by CFA Society Malaysia Sunway University CFA INSTITUTE RESEARCH CHALLENGE Sunway University Student Research This report is published for educational purposes only by students competing in the [Financials Sector, REIT Industry] CFA Institute Research Challenge. Sunway REIT Date: 22 February 2014 Current Price: RM 1.30 (as of 21.2.14) Recommendation: BUY Ticker: SREIT:MK (Bloomberg) USD/RM: 3.29 Target Price: RM 1.56 (20% upside) Market Profile 52-week high (RM) 1.65 52-week low (RM) 1.23 Previous close 1.30 Market Capitalization 3800 Highlights (RM million) Outstanding units 2923.7 We issue a BUY recommendation with a target RM 1.56, an upside of (million) 20% from current stock price. Sunway REIT (SunREIT) is one of the Free Float 42.6% largest REIT in Malaysia in terms of its property value. SunREIT is a EPS (2014F) (sen) 7.5 diversified REIT with a portfolio of primarily retail properties and P/E (FY2014)(Target 24 diversification into hotels, offices and others segments. px/EPS) ROE (FY2014) 7.5% Main growth drivers – (1) Sustainable organic growth from vibrant township. (2) Positive rental reversion rates from retail sector. (3) Upside Source: Team’s estimates potential from future post-refurbishment of Sunway Putra Place in Kuala Lumpur. (4) Future yield-accretive acquisitions available from pipeline assets. Stable financial position – (1) Low gearing is maintained, and is expected to remain constant in the near future, in line with management’s current strategy of managing capital structure. (2) Frequent rental reversion in retail malls and office buildings will increase projected earnings. (3) Increasing cash balance ensuring liquidity of the company. Risks issues – (1) Halted revenue and increased costs from current refurbishment exercise. (2) Increases in base lending rates increase interest rate and refinancing risks. (3) Rising costs due to various factors impacting profitability. Forecast 2011 2012 2013 2014F 2015F 2016F Summary Net Property 244,015 299,198 309,196 307,284 332,659 363,172 Income (RM’000) Profit for the 166,059 188,992 217,433 201,729 224,090 251,261 year/period (RM’000) Earnings per unit 6.2 7.1 7.9 7.5 8.3 8.7 (RM) Distribution per 6.6 7.5 8.3 8.0 8.4 8.8 unit (sen) SUNWAY UNIVERSITY 1 Important disclosures appear at the back of this report. CFA INSTITUTE RESEARCH CHALLENGE Diagram 1: Breakdown of Business Description Revenue for 31 December 2013 Sunway Real Estate Investment Trust (SunREIT) is a Malaysian-based real Revenue breakdown estate investment trust company managed by SunREIT Management Sdn Bhd. SunREIT is a subsidiary of Sunway Berhad, a giant conglomerate engaging 6% primarily in properties and construction. The investment objective is to Retail provide unit holders with exposure to a diversified portfolio, as evident in its 23% Offices investments which includes retail, hospitality, office and other real estate assets. Revenues generated are mainly from the retail segment, which is more than 63% Hotel 60% of total revenue (refer Diagram 1). 9% Others Currently, SunREIT has 3 growth strategies as follows: Source: Company data, Team’s Organic growth – Comprises of vibrant township factors such as having estimates a large population catchment and high commercial activities that enable sustainable asset management and asset enhancement opportunities. Asset Diagram 2: Unitholders’ management initiatives (AMIs) include rental reversion, optimisation of Composition tenancy mix and operational efficiency enhancement. Asset enhancement initiatives (AEIs) include an increase in the net lettable area (NLA) for retail Unitholders' Composition and office properties, reconfiguration of space available and refurbishment of properties. 19.9% Acquisition growth – Maintains an active acquisition strategy by Foreign acquiring yield accretive assets based on a foundation of sustainability in 80.1% Domestic growth. The main consideration for acquisition are the retail and mixed use assets, located in high growth cities and townships in Malaysia, which are compatible and synergistic to the assets portfolio. Source: Company data, Team’s Capital and risk management – Through optimising the capital estimates structure and cost of debt, diversifying its sources of debt funding, hedging strategies to manage interest rate risk and minimising refinancing risks by Diagram 3: Unitholders’ managing debt maturity profile. Composition There are marginal changes in the unitholders’ composition of SunREIT as at Unitholders' Composition 31 December 2013. Institutional investors remain a majority unitholder, comprising 54.9% of the total units issued. However, there had been a decrease Individual 10.6% in the percentage of institutional investors as a result of an increase in retail unitholders (refer Diagram 3). Foreign unitholders of SunREIT consist of Sunway 54.9% 34.5% Berhad 19.9%. This has declined from 20.2% as at 30 September 2013, clearly indicating a decrease in foreign investors in SunREIT. There is a correlation Institutions with the decrease of foreign investors with the depreciation in ringgit (refer Diagram 2). Source: Company data, Team’s estimates Industry Overview and Competitive Positioning Compelling Retail Market In 2012, Kuala Lumpur was ranked as the second best shopping destination in Asia Pacific according to the latest Globe Shopper Index by the in-house research unit for The Economist, which augurs well for the retail market. Chart 1: Retail Sales Growth, Furthermore, with unemployment rate of below 3% and household income 2010-2013 growth of 7.2% per annum since 2009, consumer confidence is picking up and subsequently the growth of the industry. Retail sales growth for 2013 was forecasted at 6.0%, generating sales of RM 93 billion (refer Chart 1). These factors had made it an appealing option for investors. However, due to an imbalance between completion and take-up rates of new spaces, the retail sector saw a slight moderation as average occupancy rate of shopping complex declined marginally from 79.5% in 2011 to 79.1% in 2012. This imbalance is expected to heighten competition between existing and new Source: shopping centres. Thus, for existing shopping malls to remain relevant, they Malaysian Retailers Group, DTZ would have to take proactive measures such as AEIs, promotional activities and Consulting & Research, May 2013 events to attract shoppers. Nevertheless, prime retail centres are not substantively threatened by new competition due to their strong location and experienced management teams. SUNWAY UNIVERSITY 2 CFA INSTITUTE RESEARCH CHALLENGE Chart 2: Supply of Office Space Challenging office sector Supply of office spaces in Kuala Lumpur and Petaling Jaya have been rising in recent years. In 2012, office space in Petaling Jaya and Subang Jaya stood at a total of 18.2m sq. ft., an increase of 6% from 2011 (refer Chart 2). In Kuala Lumpur, the proposed built office space is 67.4m sq. ft., an increase of 4% from 2011. This resulted in a decrease in occupancy rates in Kuala Lumpur and Subang Jaya, while Petaling Jaya’s occupancy rate only shows a marginal increase (refer Table 1). It is likely that occupancy rate will continue its downward trend due to oversupply. Source: DTZ Consulting & As a result, current rental rates are expected to remain flat, resulting in Research, May 2013 difficulty of maintenance in light of rising costs (refer Chart 3). This had resulted in a pressurized sector with competitive rates. However, REITs with Table 1: Occupancy Rates of strong leases would be able to maintain occupancy and ride out the storm Offices until the market stabilized. Offices in a highly strategic location, especially in Occupancy 2011 2012 high growth cities and townships will not be affected as much. Rates Petaling Jaya 75% 76.4% Stable Hospitality Market In 2012, a total of 25.03 million tourist arrivals were recorded compared to Subang Jaya 67.9% 61.3% 24.71 million recorded for the same period in 2011, representing a growth of Bandar Sunway 95% 95% 1.3% in tourist arrivals (refer Table 2), showcasing the enhancement of the Kuala Lumpur 86.1% 84.5% hospitality and leisure sub-sector. As a result, the national average occupancy rate of three to five star hotels performed better with 54.5% in 2012 (2011: Source: DTZ Consulting & 51.4%). Furthermore, Visit Malaysia Year 2014 is expected to promote Research Malaysia further as a tourism destination, stimulating the hotel segment and boosting revenue with the higher tourist visitation. Chart 3: Rental Rates in Kuala Lumpur Emphasis on organic growth Organic growth plays an important role in the improvement of distribution per unit (DPU). This is further emphasized in 2013 as it is getting tougher for REITs to find good-quality and yield accretive acquisitions, leading to limited buying opportunities. This is due to demanding prices from sellers and stiffer competitions from other asset owners. This led to the emphasis on organic growth. This is advantageous for existing REITs with an established portfolio. Although there are several potential REITs with the possibility of getting listed, Source: CBRE Research existing REITs, being the incumbents of the industry are more experienced in terms of management skills. Table 2: Tourist Arrivals & Receipts to Rising Bond Yield Malaysia The yield of Malaysian Government Securities has risen with the outflow of Year Arrivals Receipts funds following the US Federal Reserve’s impending move to reduce its asset (mil) (RM ‘bil) purchase that has been in place since 2009. A comparison shows that a REIT 2012 25.03 60.6 company is still producing a higher distribution yield than the others apart 2011 24.71 58.3 from the Employees Provident Fund (refer Graph 1). It could be argued that Source: Tourism Malaysia REITs are more similar to bonds, meaning that in order to maximize income; investors should consider a buy-and-hold strategy. As a result of the increasing Graph 1: Comparative Yield of bond yield, investors may tend to shy away from REITs as due to a higher risk, long-hold assets investors still require a higher yield than bond.