MQREIT’s proposed deal to be funded via equity and debt

MRCB-Quill Real Estate Investment Trust (Dec 4, RM1.12)

Upgrade to buy with an unchanged target price (TP) of RM1.23: MRCB-Quill Real Estate Investment Trust (MQREIT) has entered into a heads of agreement with its sponsor, Malaysian Resources Corp Bhd (MRCB), for the potential acquisition of Shell Tower for RM640 million.

Barring any unforeseen circumstances, a formal sale and purchase agreement is expected to be signed within the next 60 business days. The acquisition will be funded through a combination of equity and debt due to MQREIT’s relatively high gearing of 0.43 times.

If the deal goes through, its total investment asset value will breach the RM2 billion mark (from RM1.56 billion as at end of third quarter 2015).

We are positive on the prospects for the asset due to its strategic location and full occupancy. Based on our checks with management, Shell, which takes up 60% of the total net lettable area of 556,468 sq ft, has signed a long-term lease largely to minimise future vacancy risks.

Refurbishment expenses will also be minimised as the building is only two years’ old. Although the impact on its bottom line should be positive, we believe that the distribution per unit growth will likely be slower than the net profit growth due to the placement of new units.

We maintain our financial year ending Dec 31, 2015 (FY15) to FY17 earnings forecasts. Note that should the deal go through, at an assumed gross yield of 6.5% (similar to that of Platinum Sentral), we believe that MQREIT’s top line could see an increase of about 10% to 33% for FY16 to FY17.

We upgrade our call to “buy” (from neutral). We maintain our dividend discount model-based TP of RM1.23. Our call upgrade (13% upside) is on the basis of MQREIT’s stable growth prospects as most of its tenants are on long-term leases (more than five years), high relocation costs for some tenants ensure tenants’ “stickiness”, and MRCB and Quill Group could provide inorganic growth opportunities.

Key risks include slower-than-expected rental reversions, and competition from an influx of new office space. MQREIT’s implied FY16F (forecast) price earnings ratio (PER) of 14.5 times is at a significant discount to our sector’s FY16F implied average PER of 16.6 times. — RHB Research Institute, Dec 4

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This article first appeared in The Edge Financial Daily, on Dec 7, 2015. Subscribe to The Edge Financial Daily here.