STRAITS TRADING CO LTD - OCBC Investment 2017-04-10: A FORMIDABLE REAL ESTATE ECO-SYSTEM

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STRAITS TRADING CO. LTD S20.SI

STRAITS TRADING CO LTD - A FORMIDABLE REAL ESTATE ECO-SYSTEM

• Initiate with BUY and S$2.73 FV
• Wide network of RE partners
• Multiple potential growth catalysts 

Rated BUY with a S$2.73 fair value estimate 

• We initiate coverage on Straits Trading Co. Ltd. (STC) with a BUY rating and fair value estimate of S$2.73. 
• We use a sum-of-the-parts methodology and conservatively apply a 15% discount to its RNAV of S$3.21 to derive our fair value estimate. 
• We believe STC’s core competitive strength lies in the group’s sharp ability to allocate capital while leveraging on synergies across a wide-reaching eco-system of real estate partners. As a result, STC has developed a solid track record in creating value for shareholders while providing a stable dividend yield, notwithstanding the group’s involvement in seemingly disparate sectors (i.e., real estate and resources) and its participation across various real estate investment vehicles.

Section A: Company Background 

Investment company with diversified exposure to Asia-Pacific 

• The Straits Trading Company Limited (STC) was incorporated in 1887 as an investment company. It is involved in the businesses across the real estate, hospitality and resources sectors, with investments spanning the Asia-Pacific region.

Unique real estate eco-system 

• With its business model, STC has developed a strong real estate eco-system with a wide network of partners. This is achieved via 
  1. its 89.5% stake in Straits Real Estate Pte Ltd (SRE), a co-investment vehicle incorporated in Nov 2013 with a committed capital of up to S$950m, 
  2. a 20.1% stake in ARA Asset Management (ARA), which is listed on SGX-ST but undergoing a privatization exercise from a consortium which includes STC, 
  3. a direct c.4.0% interest in Suntec REIT, which owns prime commercial properties in Singapore and Australia, 
  4. and a 30.0% stake in Far East Hospitality Pte Ltd, one of the largest hospitality operators in Asia-Pacific.
• More details about STC’s real estate related entities are as follows: 

  • SRE – 

    • SRE is a real estate investment company with a focus on real estate related investments and opportunities globally. SRE is 89.5% owned by STC and 10.5% owned by the John Lim Family Office, the investment holding group of companies founded by Mr John Lim, Group Chief Executive Officer and Executive Director of ARA. 
    • SRE has the flexibility to invest in direct real estate as well as real estate backed instruments and securities. Its investment approach is to work with local experts and to deploy capital efficiently by emphasising on market timing and making use of low correlation between markets.

  • ARA Asset Management – 

    • ARA is one of the largest real estate fund managers in the region. As at 31 Dec 2016, ARA had an AUM of approximately S$35.6b, of which S$22.8b was contributed by REITs, S$10.7b from private real estate funds (real estate assets), S$1.2b from private real estate funds (unutilised capital commitments) and S$0.9b from real estate management services. This represented a robust growth of 19.4% YoY in AUM as compared to end-FY15. 
    • On 8 Nov last year, ARA announced that a consortium, which comprises JL Investment Group Limited, affiliates of STC, Cheung Kong Property Holdings Limited, Warburg Pincus LLC and AVIC Trust Co. Limited, has proposed to privatise and delist ARA from SGX-ST via a Scheme of Arrangement at a Scheme Consideration price per share of S$1.78. This was subsequently approved by Scheme Shareholders and sanctioned by the Court. 
    • STC would hold an effective stake of 20.95% in ARA upon completion of the transaction, versus 20.1% prior to completion. This would allow STC to continue tapping on ARA’s network and growth opportunities.

  • Suntec REIT – 

    • Suntec REIT was listed on SGX-ST (SGX Code: T82U) on 9 Dec 2004 with the aim of investing in income-producing real estate primarily used for retail and/or office purposes. 
    • Key assets that Suntec REIT holds include properties in Suntec City, Singapore’s largest integrated commercial development, a 60.8% stake in Suntec Singapore Convention & Exhibition Centre, a one-third interest in One Raffles Quay, Marina Bay Financial Centre Towers 1 and 2 and the Marina Bay Link Mall, and a 30% interest in 9 Penang Road. 
    • Suntec REIT is currently managed by an external manager, ARA Trust Management (Suntec) Limited, which is a wholly-owned subsidiary of ARA.

  • Far East Hospitality – 

    • Far East Hospitality (FEHH) is STC’s 30%-owned associate (remaining 70% owned by Far East Orchard Limited, SGX Code: O10) which owns and operates a portfolio of ~ 13,500 rooms under management across 90 hotels and serviced residences (SR) in seven countries: Australia, New Zealand, Denmark, Germany, Hungary, Malaysia and Singapore. It is one of the largest hospitality operators in Singapore with 18 hotels and serviced residences. 
    • FEHH also has a 50-50 joint venture with Australia’s Toga Group called Toga Far East Hotels, which is a leading hotel operator across Australia, New Zealand and Europe. 
    • STC has the aim of leveraging on this large, scalable and sustainable hospitality platform to reap the inherent synergies to grow its portfolio in ASEAN, Australia, New Zealand and Europe.

54.8% ownership in Malaysia Smelting Corporation 

• Besides the real estate space, STC also has exposure to the resources industry via its 54.8% ownership in Malaysia Smelting Corporation (MSC).
• MSC is currently the largest independent custom tin smelter in the world and one of the world’s leading integrated producers of tin metal and tin based products. It has a custom tin smelting facility in Butterworth Penang, and an open pit mining of tin in Perak, Malaysia. It also acquired a production facility in Klang, Malaysia last year with more advanced manufacturing technology. 
• MSC was listed on the Main Market of Bursa Malaysia since 1994 and also has a secondary listing on SGX-ST since 2011 (SGX code: NC9). In terms of strategic direction, STC has implemented ongoing initiatives to optimise efficiency throughout the MSC group.

Section B: Investment Merits 

Strong real estate eco-system with wide network of partners 

• Following Tecity Group’s takeover in 2008, STC has grown into a major player in the real estate sector regionally. It has since embarked on creating a sustainable real estate eco-system by leveraging the Group’s wide business network for deal flows, and to access investment opportunities that create value. At the heart of this is the group’s real estate subsidiary Straits Real Estate (SRE), which operates like a private equity fund to invest both in direct real estate, as well as real estate backed instruments and securities.
• A significant piece of the group’s eco-system is dependent on its relationship with ARA. ARA presents a unique investment proposition to STC, offering exposure to primarily REITs and private real estate funds.
• ARA has been posting strong results – its FY16 performance witnessed 8% growth in recurrent management fees (which constitutes 80% of its total revenue) and contributed to a 14% improvement in PATMI. ARA has been growing its AUM consistently due to its strategic partnerships involving established entities such as the California Public Employees’ Retirement System and Cheung Kong Property Holdings. 
• STC has successfully leveraged on ARA’s strengths and participated in ARA vehicles such as ARA Harmony Fund III (32.2% effective stake) and Greater Tokyo Office Fund (GTOF) (40.3% effective stake).
• STC also has c.4% and 30% stakes in Suntec REIT and Far East Hospitality Holdings (FEHH) respectively.

Stable and diversified portfolio across various sectors 

• STC has built up a significant portfolio of assets that span across various real estate segments such as office, retail and hospitality.

  • Real Estate 

    • While real estate constitutes a sizeable component of the overall portfolio (72% of assets), STC has diversified its exposure geographically across Asia-Pacific, participating in growth across various markets.
    • In particular, STC has been growing its Japanese portfolio aggressively. The group’s expansion into the office sector in Tokyo is particularly timely, given the encouraging upward trend in office rents and low vacancy rates. 
    • STC also has a firm track record of identifying attractive investment opportunities, as evident from a recent acquisition of an office building in Melbourne for A$125m in August 2015 and subsequently disposed for A$161.5m.
    • The stake in Suntec REIT also provides STC with significant rent-derived recurring income. As highlighted in our report on 26 Jan 2017, Suntec REIT has been proactively managing its leases, achieving occupancy levels of 99.3% and 97.9% in its Singapore office and retail portfolios respectively. Consequently, the REIT has achieved a DPU of 10.003 cents for FY16, which has been fairly consistent over the past 5 years.

  • Resources 

    • STC has a 54.8% stake in Malaysia Smelting Corporation Berhad (MSC), which is the largest independent custom tin smelter in the world. 
    • We believe MSC will see higher profits in FY17 due to a recovery of tin prices and improved supply-demand dynamics in the tin market ahead. 
    • In addition, with at least two more rate hikes by the Federal Reserve anticipated this year, the appreciation of the USD against the MYR could be a potential tailwind for MSC’s bottom line. 
    • MSC will also benefit from its commitment to efficiency optimization and adoption of technology, with its acquisition of an advanced production facility in 2016.

  • Hospitality 

    • In the hospitality sector, STC has a 30% stake in FEHH, a premier hospitality assets owner and operator, with the other 70% owned by Far East Orchard Limited. This gives STC access to assets comprising ~90 hotels and serviced residences across 7 countries. FEHH also has exposure in Australia, New Zealand and Europe through its joint venture with the Toga Group.
    • Value of real estate in Singapore and Malaysia could be unlocked STC has eight Good Class Bungalows (GCB) in Singapore, of which five are on Cable Road and three on Nathan Road. STC also has nine units in Gallop Green, a freehold condominium project. We are forecasting for domestic residential prices to bottom and recover in FY18, and believe STC could potentially explore a divestment of these assets as the market improves ahead. This could unlock more than S$260m in cash which can be redeployed into further investment opportunities.
    • There is also the possibility of value being unlocked from a potential redevelopment of the land site in Butterworth that MSC currently owns in Penang. Market speculation has been rife about the possibility of a relocation of current smelting operations, given the Penang government’s reported interest in having the area dedicated to the Penang Sentral project. This project involves the construction of a northern transport hub, integrating various modes of transport such as rail, ferry and bus services. 
    • Given the positive impact these infrastructure improvement projects could have on the value of MSC’s land, we believe MSC could potentially relocate their operations to the recently acquired facilities at Port Klang.

Privatization of ARA to catalyze next stage of growth 

• In our opinion, the developments surrounding ARA’s privatization are largely positive for STC. The proposal involves STC swapping its 20.1% stake in ARA for a 20.95% stake in a company that indirectly owns ARA.
• Further, based on the offer price of S$1.78 per share, STC will be able to unlock c.S$48.2m in cash, which can be redeployed for other accretive investments. Critically, this arrangement allows STC to retain exposure to ARA’s unique growth proposition, as there is no other SGX-listed entity that is able to provide a proxy to ARA’s business model.
• The result of this privatization exercise will also see AVIC Trust and Warburg Pincus taking an indirect equity stake in ARA. We see this representing the next stage of ARA’s growth, as the two new shareholders, with a combined AUM of over US$91b, will grant ARA access to efficient sources of capital in support of future growth. AVIC Trust and Warburg Pincus also possess deep experience and distribution capabilities, as well as a wide network of business relations in China.

New income stream through NikkoAM-STC Asia ex Japan REIT ETF 

• Launched on 29 March 2017, the NikkoAM-STC Asia ex Japan REIT ETF aims to replicate the performance of the FTSE EPRA/NAREIT Asia ex Japan Net Total Return REIT Index, with a focus on industrial, office and retail sectors. The ETF also has a strong Singapore focus, with over 60% exposure to the domestic market. 
• With S-REITS being a popular sub-asset class, offering some of the highest dividend yields globally, we are positive on the ETF’s potential to attract AUM on a consistent basis. 
• STC, through its subsidiary, will act as the investment advisor to Nikko Asset Management Limited with respect of the ETF for advisory fees. This represents a promising avenue for STC to diversify its income streams, given the potential for the ETF fee income business to grow further as AUM increases over time.

Attractive valuations at current share price 

• At its current share price of S$2.27, the company trades at an attractive 29.3% discount to our RNAV estimate of S$3.21. Investors also enjoy a solid 2.6% yield, which is supported by significant recurring income from a diversified portfolio of assets and a healthy balance sheet.
• In addition, STC has in the past demonstrated a track record of paying above-average dividends after major asset sales. In FY08, a special dividend of S$1.50 per share was paid out following the sale of S$222m of investment and marketable securities prior to the GFC. 
• Similarly in FY13, following STC’s divestment of its 40.6% stake in WBL Corporation Limited, a special dividend of S$0.50 was made to shareholders. 
• Given the company’s sizeable portfolio, we are optimistic about potential upside surprises, in terms of dividends, should any major divestments occur ahead.

Section C: Industry Outlook 

• We believe STC’s modus operandi is to seek opportunistic investments within the real estate, hospitality and resources industries when they arise, while ensuring adequate diversification in its asset portfolio across geographies and business segments. 

REAL ESTATE 

• Severe dip in Singapore residential prices unlikely 

  • We believe a severe decline in Singapore residential prices is improbable, given the high price elasticity of demand in the housing market, coupled with the Government’s recent move to relax some parts of the seller’s stamp duty (SSD) and total debt servicing ratio framework (TDSR) measures. 
  • We forecast physical home prices to dip 1% to 5% in 2017, before reaching a bottom and rebounding in 2018. With residential prices currently down 11.3% over the past 13 quarters from the last peak, we believe there is the potential for further curb reversals going forward, especially if housing prices decelerates and/or the economic outlook deteriorates rapidly from here.

• Singapore office rents could bottom out in 2017 

  • Core Grade A CBD office rents dipped for the seventh straight quarter on a QoQ basis, coming in at S$9.10 psf/month in 4Q16 (-2.2%), versus the last peak of S$11.40 psf/month achieved in 1Q15, according to CBRE statistics. However, the magnitude of decline was almost similar to 3Q16, which registered a 2.1% QoQ fall. We believe the office market is showing signs of stabilising, and forecast a smaller pace of rental decline of 5%-10% in 2017, as compared to the 13.1% fall in 2016. 
  • One of the key market concerns stems from the upcoming office supply amounting to an estimated 2.3m sq ft this year, which is above the average annual net supply and demand of 0.7m sq ft and 1.0m sq ft from 2011 to 2015, respectively. This is contributed largely by Marina One, which is expected to have an NLA of 1.9m sq ft. Notwithstanding the ominous supply figures, ‘flight to quality’ and ‘flight to efficiency’ trends have been observed in the market, as corporates have taken advantage of the soft leasing environment to secure Grade A space with modern specifications and large floor plates in prime locations.
  • For Suntec REIT, which STC has a direct c.4% interest, the average rent for its Singapore office portfolio for 4Q16 was S$8.65 psf/month, versus Retail environment challenging, but not all doom and gloom Economic uncertainties and structural issues such as manpower shortages and competition from e-commerce have weighed on the performance of retailers. According to data from URA, the prices of retail space in Central Region increased marginally by 0.2% QoQ, while rentals fell 1.5% in 4Q16. The latter was the eighth straight quarter of sequential decline, a reflection of challenges in the leasing market.
  • Looking ahead, we expect prime Orchard Road rentals to experience a 3.0%-5.0% dip in 2017; while suburban rents are projected to fall 2.0%- 3.0%. However, not all is doom and gloom, as Singapore’s retail sales excluding motor vehicles recently showed an improvement, increasing 2.0% YoY for the month of Jan and beating the street’s expectations.
  • This was the second consecutive month of YoY increase, following 10 months of decline. We believe retail sentiment may be on the cusp of recovery. For Suntec REIT, occupancy for its Singapore retail portfolio stood at 97.9%, as at 31 Dec 2016, with overall committed rents at Suntec City Mall relatively stable at S$11.20 psf/month, versus S$11.19 psf/month, as at end 3Q16.

• Slower China retail sales growth ahead, but soft landing expected 

  • Total retail sales of consumer goods in China grew 10.4% to RMB33.2t in 2016, based on data points from the National Bureau of Statistics (NBS).
  • For the first two months of the year, aggregate retail sales rose 9.5% YoY to RMB5.8t. Specifically for Chongqing, where STC owns a retail mall, annual retail sales outpaced the national average, growing 13.2% in 2016. For that year, Chongqing’s retail market saw steady demand with improving vacancy rates although supply levels were relatively high. The average vacancy rate fell 0.3 ppt to 10.7% in 4Q16.
  • Looking ahead, based on the median consensus projections from Bloomberg, China’s retail sales is forecasted to grow 10.1% in 2017, before increasing by a further 9.8% and 9.6% in 2018 and 2019, respectively. 
  • Although retail sales growth momentum is expected to slow, we believe China is not likely to experience a ‘hard landing’ ahead as the Chinese authorities focuses on pushing through its reforms and managing the systemic risks in its financial system.

HOSPITALITY 

• Singapore’s hospitality sector remains challenging, but conditions likely to stabilise in 2018 

  • Singapore’s tourism sector’s performance exceeded the Singapore Tourism Board’s (STB) expectations in 2016. Tourism receipts jumped 13.9% to S$24.8b (preliminary estimate), while international visitor arrivals increased 7.7% to 16.4m, versus STB’s projections for a 0%-2% and 0%-3% growth, respectively. 
  • However, we believe this robust performance did not translate into similarly strong operational results for hotel operators in general, which continued to face pressure on their revenue per available room (RevPAR). This was likely underpinned by largely soft sentiment within the corporate segment, especially for the financial and oil & gas project groups, coupled with intense competition amongst operators in light of the 4.3% increase in 2016 supply.
  • Looking ahead, the STB is forecasting a 0%-2% increase in tourist arrivals and a 1%-4% increase in tourism receipts in 2017. However, supply pressures are unlikely to abate this year, as market watchers are projecting another 5.9% increase in hotel rooms for 2017. In addition, we believe corporate sentiment remains cautious. As such, we expect RevPAR to continue its decline in 2017. 
  • Notwithstanding the challenging near-term outlook, we believe RevPARs could potentially improve in 2018 given our expectations of a better supply-demand dynamic.

• Australia’s hospitality outlook appears sanguine 

  • We believe the outlook for Australia’s hospitality sector remains sanguine, with growth expected to be driven by both international visitors and domestic travel. According to Tourism Research Australia (branch within the Tourism Division of Austrade), Australia’s total visitor nights is projected to increase at a CAGR of 4.4% from 548.3k in 2015 to 681.3k in 2020. 
  • Meanwhile, Deloitte Access Economics is expecting Australia’s hotel room rates to grow at an average of 2.5% per annum to A$170 per night for the next three years, while RevPAR growth is projected to come in at 3.1% to a national average of A$123 by 2019.

RESOURCES 

• Prices of tin expected to be driven by recovery in global economic growth and improved demand and supply dynamics 

  • Based on Bloomberg consensus’ median forecasts, the price of tin is projected to come in at US$20,475/metric tonne (mt) in 2017. Although this is lower than the US$21,125/mt achieved on 30 Dec 2016, it is higher than the current spot price of US$20,240/mt according to the London Metal Exchange (LME) and also above the average price of US$17,896/mt in 2016. For 2018, tin prices are projected to increase to US$20,500/mt, before rising further to US$21,175/mt in 2019.
  • In terms of demand for refined tin, the Economist Intelligence Unit has forecasted consumption to increase from 347k tonnes in 2016 to 351.5k tonnes in 2017 and 353.5k tonnes in 2018. On the other hand, production of refined tin is forecasted to come in at 344.5k tonnes and 348k tonnes in 2017 and 2018, respectively, which is below the projected consumption levels. This implies favourable demand and supply dynamics within the refined tin industry, which augurs well for MSC, in our view.
  • We believe the expected stronger demand would be driven by a recovery in global economic growth. According to the IMF World Economic Outlook published in Jan this year, world output is projected to grow 3.4% in 2017 versus 3.1% in 2016, before accelerating to 3.6% in 2018. This is unchanged from IMF’s Oct 2016 forecast.

Section D: Key Risks 

• Any of the events or conditions below, besides others not mentioned here, could materially and adversely affect the business, financial condition and results of operations of STC.

1. The results of STC’s operations may be affected by the cyclical nature of the property market and tourism industry in the countries which the Group operates and tin prices which are subject to significant fluctuations 

• Real Estate Segment 

  • The property sales and rental rates of assets in which STC is directly or indirectly invested in are affected by demand and supply factors in relation to the property market in multiple countries such as Singapore, Malaysia, Australia, Japan, and China. 
  • If there were a prolonged depression of the property market in any of these countries, it could have a material adverse effect on STC’s property revenue. Such conditions would have a material adverse effect on the business, financial condition, profitability and results of operations of the group.

• Resources Segment 

  • MSC’s revenues and profitability are highly dependent on the prices that it pays for tin concentrates and the prices which it receives for the sale of its refined tin metal products. These prices can be subject to significant fluctuations and are affected by various factors, including the supply and demand for tin concentrates and refined tin metal, currency movements and speculation. 
  • In addition, MSC’s refined tin is traded on the Kuala Lumpur Tin Market (KLTM) and the London Metal Exchange (LME) and is therefore susceptible to volatility in tin prices arising from speculative activities by third parties. 
  • Other unpredictable factors which affect the prices of tin concentrates and the refined tin metal include economic growth rates, foreign and domestic interest rates and trade policies.

• Hospitality Segment 

  • The number of guests at the hotels held under subsidiaries and associates of STC are affected, to a large extent, by the tourism industry in the Asia-Pacific region. Tourism may be affected by factors such as economic downturns, currency fluctuations, social and political unrests, acts of terrorism, adverse weather conditions and natural disasters, new visa requirements or seasonal factors, which may materially disrupt travel activities and have a negative impact on the financial results of STC. 
  • In addition, the nature of the hospitality business is such that guests are sensitive to room rates and the group’s revenue may fluctuate when it reacts to competition from other operators.

2. The business, financial condition and results of operations of the Group may be adversely affected by fluctuations in exchange rates 

• STC operates mainly in Asia-Pacific and has exposure to foreign exchange risk as a result of sales or purchase transactions that are denominated in a currency other than the functional currencies of the respective Group entities. These foreign exchange risk exposures are mainly in Australian Dollar, United States Dollar, and Japanese Yen.
• STC’s shares are quoted on the SGX-ST in SGD. Dividends, if any, will be declared in SGD.
• To the extent that the receipts and payments of the group are not matched in the same currency, the Group may be susceptible to foreign exchange losses.

3. STC is subject to interest rate fluctuations 

• STC faces risks in relation to interest rate movements. As at 31 Dec 2016, the group has an aggregate of S$434.0m in short term borrowings and S$185.8m in long term borrowings. An increase in interest rates may adversely affect the ability of STC to service its loans and other borrowings, and could also impair its ability to compete effectively in its businesses relative to competitors with lower levels of indebtedness.
• Difficult conditions in the global credit markets could adversely impact the cost or other terms of its existing financing, as well as its ability to obtain new credit facilities or access the capital markets on favourable terms. Increases in interest rates would also affect the ability of potential buyers to finance purchases of the properties of STC which would, in turn, affect the demand and prices of its properties.

4. Hedging transactions intended to manage its foreign exchange and interest rate risks, and price fluctuations of its raw materials can increase its exposure to losses and limit gains 

• STC uses derivative financial instruments such as forward currency contracts, interest rate swaps and forward commodity contracts, to manage its foreign currency risks, interest rate risks and commodity price risks, respectively. 
• There is no assurance that the group’s hedging strategies may be able to hedge against future losses arising from such fluctuations successfully.

Section E: Financial Analysis and Forecasts 

Overview of FY2015 and FY2016 Financials 

• FY16 total revenue including other income increased 6.1% YoY to S$584.7m, while total expenses dropped 6.0% to S$534.7m. The share of results of associates and joint ventures also improved from S$28.5m in FY15 to S$45.0m in FY16.
• As a result of improved performance across all business segments, PATMI increased from S$8.5m in FY15 to S$67.3m in FY16.
  • Resources: Profit after tax was higher for FY16 mainly due to higher tin prices and lower foreign exchange losses.
  • Real Estate: The group’s real estate revenue for FY16 was higher due to higher rental income from its overseas properties. Profits in FY16 were boosted by higher contribution from associates and joint ventures and a net gain from the sale of a property in Australia.
  • Hospitality: The profit after tax of S$4.3 million for FY2016 was mainly from a gain on sale of a hotel by the associate in 1Q16.
• We are forecasting total revenues over FY17-18 to increase marginally YoY by 1.1% to S$519.0m and S$524.7m, respectively. This is mainly due to a projected recovery in tin prices, driven by an improvement in supply-demand dynamics. We similarly expect gross tin mining margins for the group to rise from 9.7% in FY16 to 10.0% over both FY17-18.
• On the bottom line, however, FY17 PATMI is forecasted to dip 18.1% due to the absence of one-time divestment gain booked in FY16 and smaller contributions from the property segment. We see a negative impact on profits from softening residential and retail rental rates in Singapore and China, respectively.
• FY18’s PATMI is expected to grow by 8.5% YoY to S$59.8m. We see rental rates at STC’s Chongqing retail mall stabilising after one full year of operations and similarly forecast a 1.0% increase in Singapore property revenues due to a recovery in residential rental rates.
• For both years ahead, urbanization trends continue to be beneficial to the central Osaka residential market, which will support occupancy rates at STC’s Japanese residential apartments (with average forecasted occupancy rate at 98% for FY17 and FY18, respectively).

Strong performance and potential acquisitions from associates 

• One of STC’s core strengths lies in capital allocation and there is significant growth potential from their co-investments with associates and joint venture partners. Going forward, we see GTOF’s net property income bolstered by rising rental rates and low vacancy levels in Tokyo.
• There is also potential for growth through future acquisitions, after the acquisitions of Bright East Shibaura and Omori Park in 2016.
• In addition, ARA will continue to contribute to the group’s PATMI moving forward. In FY16, ARA registered a 9.5% improvement in adjusted net profit, coupled with a 15.2% increase in adjusted AUM. The entry of Warburg Pincus and AVIC Trust will also enable STC, through ARA, to gain exposure to further opportunities in China and a greater investor base, thereby building on ARA’s current platform for further resilience in earnings.

Balance sheet positioned for growth 

• STC’s enjoys a firm balance sheet with a relatively healthy net gearing of 24% and cash and equivalents at S$291.1m as at end FY16. 
• We believe the group’s gearing will remain within comfortable levels over FY17-18, particularly given the S$48.2m in cash proceeds from the impending privatization of ARA and the potential for recycling capital from stabilized assets.

Section F: Valuation and Recommendation 

Initiate BUY on STC with a fair value estimate of S$2.73 

• We initiate coverage with a BUY rating and a S$2.73 fair value estimate.
• Our fair value estimate translates to a price-to-book ratio of 0.82 and a forward FY17 price-earnings multiple of 20.2x.
• To derive our fair value estimate, we use a sum-of-the-parts methodology and conservatively apply a 15% discount to STC’s revalued net asset value (RNAV) of S$3.21. Despite the group’s involvement in seemingly disparate sectors (i.e., real estate and resources) and its participation across various investment funds, we believe STC’s core competitive strength lies in the group’s sharp ability to allocate capital while leveraging on significant synergies across its real estate eco-system with wide network of partners.
• Looking ahead to FY2017-18, we expect firm profits from key associates such as ARA, Suntec REIT and MSC. To arrive at our RNAV, we value STC’s current 20.1% stake in ARA at S$1.78 per share – the current offer price for its privatization bid. In addition, we value the group’s Suntec REIT shares at our S-REITs team’s fair value estimate of S$1.54 per unit. We also expect improved conditions in the tin industry going forward and conservatively value STC’s 54.8% stake in MSC at its book value as at end Dec 2016.
• We are forecasting that residential home prices will dip 1%-5% in 2017 before reaching an inflection point in 2018 and, for our RNAV calculations, value the group’s wholly owned portfolio of Singapore homes at S$269.4m, slightly lower versus the S$278.4m conducted by an independent valuer as at end 2016.
• Investors should also keep in mind that there are various potential growth catalysts for STC that we have conservatively not accounted for in our valuation exercise. After the completion of ARA’s privatization, STC has the flexibility to redeploy c.S$48.2m of cash into accretive opportunities. As discussed earlier, there is also the possibility of a positive revaluation and redevelopment of MSC’s land site in Penang.
• Finally, STC is the investment advisor for the newly listed NikkoAM-STC Asia ex Japan REIT ETF, and there is meaningful potential for recurring fee income growth for STC should the ETF’s AUM increase significantly ahead.

Eli Lee OCBC Investment | http://www.ocbcresearch.com/ 2017-04-10

OCBC Investment SGX Stock Analyst Report BUY Initiate BUY 2.73 Same 2.73