REIT - CIMB Research 2016-05-17: Sell in May... and hide in REITs


REIT - Sell in May… and hide in REITs 

  • 1QCY16 results largely in line, and echoed what we projected earlier – anaemic organic growth and rising funding cost environment. 
  • “Lower for longer” underpins Overweight call; S-REITs trading below averages. 
  • Office-REITs still see positives, though rental reversions slowing. Underlying trends supportive of retail REITs but we see short-term pain from AEIs. 
  • Rising vacancy risks for industrial-REITs. For hospitality, the rebound in visitor arrivals did not materialise into RevPAR strength. 
  • KDCREIT, KREIT and MAGIC our preferred picks; least preferred: CDREIT, SUN. 


Results largely in line; organic growth softened 

  • 1QCY16 results were largely in line, though we saw more downside vs. upside. As a result, we had, on average, trimmed our 12-month forward DPU forecasts on our coverage universe by 1.6%. 
  • Beats came from FEHT (its hotel RevPAR has stabilised); MINT (higher occupancies, rental rates across all segments and contribution from the Equinix project) and MAGIC (Sandhill Plaza and Festival Walk continued to deliver). 
  • Meanwhile, misses came from CDREIT (hurt from poor corporate demand); CACHE (continued to be affected by multi-tenant building conversions) and MLT (softer performance at Singapore offset a stronger Hong Kong performance). 
  • With organic growth softening, total reported DPU increased 1.2% yoy but decreased 4.6% qoq. We believe that organic growth in the coming quarters would continue to soften as the gap between passing and market rents narrows, while vacancy risks rise. 
  • Meanwhile, DPU growth would mainly be driven by full-year contributions from acquisitions made in the past 12 months. 
  • Lastly, we note that interest costs in the quarter have inched up by c.5-15bp qoq due to movements in base rates. 

YTD share price performance 

  • YTD, the REIT index (FSTREI) is up 3%, while the FSSTI lost 5.1% and the developer index (FSTREH) lost 10.3%
  • In terms of stocks, the top three outperformers were KREIT (+12%, one of our top-3 picks), MCT (+10%) as well as FCT (+9%). In general, the retail sub-sector has done well as it is perceived to be the most resilient vs. the other sub-sectors. 
  • Our other top two picks, KDCREIT and MAGIC gained c.6% each, and outperformed the FSTREI. 
  • Unsurprisingly, the biggest losers were from the hospitality sub-sector as RevPAR remained uninspiring. We had earlier ranked the hospitality sub-sector as our least preferred. The trio of CDREIT, FEHT and OUEHT lost 6-9% each.


Office: positive, albeit slowing rental reversions

  • Office S-REITs recorded an average 8.8% yoy growth in 1QCY16 DPU. Admittedly, the performance was skewed due to OUECT. The positive in the quarter was still due to positive rental reversions. However, we think the gap between market and average passing rents continued to narrow, and the positive reversion trend would narrow further going forward. Additionally, while appetite for office space has been bite-sized, new demand continues to surface from the Technology, Media and Telecommunications (TMT) sector.
  • The outperformer in 1Q16 was OUECT, with a 30% jump in DPU to 1.3 Scts, thanks to new contributions from its recently acquired One Raffles Place (ORP). Stripping out ORP, growth would have still been at a commendable 7.8% yoy. CCT reported a 3.3% yoy improvement in DPU on the back of positive reversions and higher income from CapitaGreen, which is 92.8% committed at the end of Mar 2016. Portfolio occupancy ticked up 1% pt as the trust adopted a tenant retention strategy.
  • FCOT’s 2.9% DPU growth was driven by new income from 357 Collins St, higher contributions from Alexandra Technopark as well as a S$0.6m capital top-up to defray income vacuum due to the asset enhancement initiative (AEI) at China Square Central. KREIT’s DPU showed a dip of 1.2% owing to the loss of income from the sale of 77 King St. However, this was partly mitigated by a distribution of S$3m from the sale profit.
  • Going into the next few quarters, we are still projecting for office REITs to enjoy positive reversion for this year as expiring rents are still some 10% below current market levels. In fact, we project office REITs to achieve the highest average DPU growth of 5.2% yoy for FY16. Again, OUECT would lead the charge, thanks to a full year’s impact of contributions from ORP. That said, we expect the spread between passing and market rents to narrow, as market rents slide in anticipation of the large incoming new supply.
  • Lastly, we see little renewal risks for 2016 as landlords have been adopting a defensive tenant retention strategy. Most office REITs have minimal leases to be renewed for the remainder of this year.

Retail: traffic and tenant sales still positive, short-term pain from AEIs

  • The performance of retail S-REITs continued to be mixed in 1QCY16, with the more suburban-focused REITs recording marginal growth due to new contributions from acquisitions or organic growth from positive rental reversions. Those with more Orchard Road and overseas assets showed flat or marginal weakness in DPU, owing to adverse FX impact and a slight stress in occupancy.
  • On average, retail REITs reported 2.4% yoy rise in DPU in 1Q16. The improvement was led by SUN (+9.1% yoy). Distributions were boosted by the capital distribution of S$4m from the sale proceeds of Park Mall. Meanwhile, the REIT benefited from higher contributions from the completion of Suntec City Phase 3 and Suntec City Office.
  • CT (+1.9% yoy), FCT (+2.7% yoy) and MCT (+1% yoy) saw shopper traffic and tenant sales growing by low to mid single-digit within their portfolios, which helped push through positive rental reversions for their lease expiries. FCT’s DPU growth was also helped by taking a higher 50% (previously 20%) of its management fees in units. MCT reported smaller DPU growth due to the drag from its office portfolio.
  • For SGREIT (flat yoy), lower occupancy of 96.8% at Wisma Atria offset the marginally higher tenant sales and shopper traffic of +1.7% and +0.3% yoy, respectively. Meanwhile, its Malaysian portfolio was affected by adverse forex movements and delivered an 8.8% decline yoy in NPI. A surge in Australian contributions, due to the acquisition of Myer Centre Adelaide, could only partly offset this income vacuum. SPH REIT (flat yoy) enjoyed an average positive rental reversion of 4.3% across its portfolio and reported a 0.6% rise in its latest 2QFY16 distributions income. However, a similar expansion in its issued unit base negated any DPU hikes.
  • We believe that over the next few quarters, the impact of more AEIs will likely be felt. This will likely disrupt earnings as occupancy becomes adversely affected by ongoing renovation works. As such, we project retail S-REITs to deliver a smaller 1% rise in DPU for FY16. The drag comes largely from CT, which is expected to close its Funan IT Digital Mall for three years starting Jun 2016 to redevelop the property into a larger lifestyle mall. Hence, we anticipate DPU growth decelerating going into 2H.
  • FCT’s Northpoint is likely to see occupancy dip to 76% over the next six months due to renovation works ahead of the property’s seamless integration with the new Northpoint City, currently under development. Hence, earnings growth could be affected.

Industrial: vacancy risks rising

  • Underlying performance of the logistics trusts was not encouraging in 1QCY16. We foresee earnings pressures for the logistics trusts as vacancy risks increase. Moreover, the NPI margins of logistics trusts continue to remain under pressure due to ongoing MTBs (multi-tenanted building) conversions.
  • On average, the industrial REITs under our coverage reported a 2.6% yoy decrease in DPU for 1QCY16. The decline was led by CREIT (-9.2% yoy). However, the trust had S$1.1m capital distribution in 1Q15, and paid 50% of management fees in units vs. 100% of management fees in cash for 1Q16. Adjusting for which, the logistics trusts would report a DPU decline of 1.4%. AREIT’s DPU declined 8.1% yoy due to performance fees of S$9m and a larger unit-base. However, buoyed by acquisitions, income available for distribution rose 7.7% yoy in the quarter.
  • The brighter sparks in the sector came from MINT and KDCREIT. MINT’s DPU climbed 6% yoy due to higher occupancies and rental rates achieved across all property segments, as well as contribution from the build-to-suit (BTS) project for Equinix at 26A Ayer Rajah Crescent (came online in Mar 2015). Despite a client downsizing its space requirements in Citadel 100 during the quarter – which resulted in portfolio occupancy falling by 2.8% pts qoq to 92% – KDCREIT’s distributable income came in 1% higher than its IPO forecast. It registered DPU growth of 3.8% yoy.
  • As for the quarters ahead, we see heightened vacancy risks for logistics trusts which could turn into lower rental rates and margin pressure. 10.9% of CACHE’s GRI is due for renewal in FY16. The expiring leases mainly relate to the Schenker Megahub and Hi-Speed Logistics Centre, due for expiry towards end-Aug and in Oct, respectively. At this juncture, we sense that the likelihood of renewal is low.
  • Meanwhile, CREIT has one of the highest concentrations of expiring leases in the coming quarters. 20.2% of its GRI is up for renewal in FY16. Of which, 65% (translates to 13.1% of GRI) pertain to eight single-tenanted buildings (STBs). It expects four properties to be renewed/replaced, two to be divested, one to be converted to a MTB, and the last one to go through some improvement works.
  • In addition, 14.6% of MLT’s NLA is due for expiry in FY17. Of which, six SUAs (single-user assets), forming 5.1% of NLA, are due for renewal – two in Singapore, three in Korea and one in Malaysia. Our biggest concern revolves around the KPPC facility in South Korea, the lease of which expires in Dec 2016. The facility is MLT’s largest property in South Korea, with NLA of over 100,000 sq m. GRI for the KPPC lease is c.S$8m p.a. The two small SUA leases in Singapore (Kim Seng and 4 Toh Tuck) are also not likely to be renewed.
  • For FY16/17, we now project the DPUs of industrial S-REITs to decrease by 1% yoy (previously +2.8% yoy). We expect KDC REIT to post the highest DPU growth of 7.7%. The stock could also re-rate upon the injection of T27 into its portfolio. Among the big-3, we expect ARIET to deliver 2.1% DPU growth vs. the flattish performance by MINT and MLT. We believe that the group will focus on enhancing its Australia portfolio in FY17, shoring up the portfolio with 1-2 complementary acquisitions. In view of the ongoing MTB conversions and negative rental reversions, we expect headline DPU contraction for CACHE (- 6.5% yoy) and CREIT (-8.5% yoy).

Hospitality: Rebound in visitor arrivals not translating to RevPAR strength

  • The +12.7% yoy rebound in visitor arrivals to 2.74m in 2M16 did not materialise into RevPAR strength for the hospitality REITs. On average, hospitality REITs in our universe reported a 2% yoy decline in RevPAR and 8.6% yoy decline in DPU for 1QCY16.
  • The decrease in DPU was mainly due to OUEHT, which reported a 26% yoy fall in DPU. The negative deviation stemmed from higher weighted average of units (following the completion of its rights issue on 13 Apr). That said, in terms of operations, OUEHT outdid its peers as it recorded a 0.9% yoy improvement in RevPAR, thanks to its two well-positioned properties, Mandarin Orchard Singapore and Crowne Plaza Changi Airport.
  • Examining the rebound in visitor arrivals, we found that recoveries in Chinese (+33.6% yoy) and Indonesian visitors (+10.7% yoy) were the main factors. In terms of origin mix, the Chinese now form the largest source market for Singapore, accounting for 18% of total arrivals. Meanwhile, Indonesia has dropped a rank to become the second largest source market (17% of arrivals).
  • Nonetheless, we believe that a significant portion of Chinese tourists are on group tours with short stays in the city-state; this does not benefit the hospitality REITs. In fact, the hospitality REITs were hurt by the drop in corporate demand.


Sell in May... and hide in REITs

  • 1QCY16 performance echoed our earlier sector update (“Musical chairs begin” 4 Mar 2016) where we project that 2016 will be characterised by anaemic organic growth and a rising funding cost environment. The bulk of growth would be driven by full-year contributions from acquisitions made in the previous year.
  • However, as flight to safety ensues, and as risk of interest rate hike subsides, S-REITs and yield-instruments should remain well supported in 2016. Our top- down house view is that there will be one hike in Sep, or if later, by Dec.
  • In this context, we deem that S-REITs would trade in a tight band, capped in between their historical P/BV average and 1 s.d below their respective means. Alpha generation in 2016 requires investors to be nimble; and we continue to advocate stock selection on relative performance.
  • As we enter into the technically-wobbly May, we reiterate our Overweight call on S-REITs. Supportive valuations also suggest that some of the structural weakness have been priced in.

S-REIT trading slightly below averages

  • In terms of valuations, the sector is trading at 6.7% 12-month forward dividend yield vs. average of 6.3%. It is trading at 0.93x CY16F P/BV vs. its average of 1.04x. Against the 10-year bond yield, S-REITs are trading at a 470bp spread, c.100bp higher than the average 370bp. This also suggests that the market could have priced in the anticipated interest rate hikes.

Sub-sector preference & key stock calls

  • Basing our sub-sector ranking on the DPU growth over the next 12 months, our preference would be in the order of 
    1. office (+5.2% DPU growth), 
    2. retail (+1%), 
    3. industrials (-1% yoy), and 
    4. hospitality (-4.6% yoy).
  • During the 1QCY16 results season, our key rating changes were: 
    • MLT (downgrade from Add to Hold on the back of its relative outperformance and higher earnings risks), 
    • AREIT (upgrade from Hold to Add on the back of its relative underperformance; and it is the only stock among the Big-3 positioned for growth in the next 12-months) and 
    • OUECT (downgrade from Add to Hold as we think that its operating performance would progressively plateau).
  • In terms of stock picks, KDCREIT, KREIT and MAGIC remain our most preferred stocks. Our least preferred stocks are CDREIT and SUN.

Maintain Add on KDCREIT with TP of S$1.18

  • We believe that the near-term injection of T27 could catalyse the stock. Even with 30-70 debt-equity financing, we expect the injection to be yield-accretive, based on our calculations. 
  • We forecast a total return of 16% over the next 12 months.

Maintain Add on KREIT with TP of S$1.08

  • Despite headwinds on the office market, KREIT’s proactive leasing strategy has reduced lease expiries to a minimal 3% for 2016. The under-rented KREIT could continue to enjoy positive reversions this year. 
  • We forecast a total return of 10.7% over the next 12 months.

Maintain Add on MAGIC with TP of S$1.12

  • Thanks to its strong positioning, MAGIC’s Festival Walk continues to enjoy strong rental uplift, despite slowing tenant sales and shopper traffic. 
  • Although we expect renewals going forward to be more moderate, in tandem with the challenging Hong Kong retail market, we still anticipate positive renewals. 
  • We forecast a total return of 21.6% over the next 12 months.

Maintain Hold on CDREIT with TP of S$1.38

  • CDREIT’s operational performance was the worst among peers and de-rating catalysts could come from the continued slide in RevPAR. 
  • With the absence of the Southeast Asian Games this year (held in Jun 2015), we expect RevPAR for 2Q16 to be lower qoq and yoy. 
  • We forecast a total return of 7% over the next 12 months.

Maintain Hold on SUN with TP of S$1.67

  • Deteriorating operating metrics from both retail and office could cap SUN’s share price performance. Its weak organic performance is counterbalanced by capital distributions, keeping DPU steady. 
  • We forecast a total return of 8.1% over the next 12 months.

SREITs Peer Comparison 

YEO Zhi Bin CIMB Securities | LOCK Mun Yee CIMB Securities | http://research.itradecimb.com/ 2016-05-17
CIMB Securities SGX Stock Analyst Report ADD Maintain ADD 1.18 Same 1.18
ADD Maintain ADD 1.08 Same 1.08
ADD Maintain ADD 1.12 Same 1.12
HOLD Maintain HOLD 1.38 Same 1.38
HOLD Maintain HOLD 1.67 Same 1.67