Singapore Industrial REITs - Phillip Securities 2018-08-17: Sub-sector Remains Lacklustre & Recovery Could Be Delayed

Singapore Industrial REITs - Phillip Securities Research 2018-08-17: Sub-sector Remains Lacklustre And Recovery Could Be Delayed CACHE LOGISTICS TRUST SGX:K2LU ASCENDAS REAL ESTATE INV TRUST SGX:A17U KEPPEL DC REIT SGX:AJBU MAPLETREE INDUSTRIAL TRUST SGX:ME8U

Singapore Industrial REITs - Sub-sector Remains Lacklustre And Recovery Could Be Delayed

  • Maintain Equal Weight view on Industrial REITs sub-sector.
  • Sector occupancy ticked down q-o-q; Rental Index stabilising but inched lower as well.
  • Rental in general has yet to bottom, but Business Park was the lone bright spot with its fifth consecutive quarter of higher rental.
  • Tapering of new supply in 2018 is a tailwind for the sector, but absorption of vacant space remains slow – evident from occupancy not picking up.
  • Manufacturing and export data already moderating, and the outbreak of a full-blown trade war could be the proverbial last straw.
  • Slight change to our view from the previous quarter: Now opine that bottoming of rent might be delayed to 2019, instead of by end-2018.

What is the news?

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Key takeaways from the quarter

The Positives

+ Maintained tapering pipeline of space.

  • JTC reports 2.0 million sqm of space expected to come on-stream in 2H2018 and 2019, compared to the historical 3-year average annual supply and demand of 1.7 million sqm and 1.2 million sqm respectively. Examples of trade sectors where demand came from during the quarter were Precision Engineering, Electrical and Machinery Products, and Transport and Storage.

The Negatives

Occupancy across all segments dipped q-o-q.

  • The worst hit were Multiple-User Factory and Business Park – both also lower y-o-y. The rest of the segments were stable y-o-y.

All Industrial Rental was lower, both QoQ and YoY.

  • It was dragged down by Single- User Factory and Warehouse. The Warehouse segment has been particularly weak in recent years, due to oversupply.

Mostly negative rental reversions reported by the industrial S-REITs.

  • Negative renewal rates were in the single-digit range, with one outlier of -21%. A star-performer was Ascendas REIT, which reported weighted average +10.5% reversion on renewals. Managers remain hopeful for rents to bottom by the end of this year.

We have turned slightly negative from our previous view.

  • Our previous view was for rents to bottom by the end of this year. We now do not discount the possibility for rents to continue downward into 2019, instead of bottoming by end-2018. Our belief stems from the continued weakness in the Industrial Properties statistics from JTC, moderating of manufacturing and export data, and escalating trade tensions.

What would make us turn positive on the industrial sub-sector?

  • We would want to see evidence of higher rents, led by broad-based recovery in occupancy. This would signal that demand is actually able to absorb supply.

What would make us turn negative on the industrial sub-sector?

  • Further moderation of manufacturing and export data into contraction would lead us to downgrade our view on the sub-sector. Re-flooding of excess supply would also make us turn negative.

Investment Action

We maintain our "Equal Weight" view on the Industrial sub-sector.

  •  The tailwind for the sector is the tapering of supply of Industrial space in 2018. However, negative rental reversions are expected to persist in 2H2018, in varying degrees across the various REIT portfolios. We have also turned slightly negative from our previous view. We now raise the possibility that rents may only bottom in 2019, instead of by end-2018.
  • Our previous Industrial REITs sector report was published on May 21. See: Singapore Industrial REITs - Stabilising Average Occupancy, Average Rent Decline Slowing

Strategic top-down view (unchanged from previous quarter)

Maintain exposure to Business & Science Park properties and Hi-Tech/Hi- Specification buildings. 

  • Singapore is evolving towards higher value-added manufacturing and there is a push with the Smart Nation initiative. We like REITs that can capture this opportunity with Business & Science Park properties and Hi-Tech/Hi-Specification buildings. 
  • At the same time, Business & Science Park rents are expected to be stable, underpinned by limited new supply.

Tactical bottom-up view

Bottom-up stock pick: Keppel DC REIT for better-than-average capital management. 

  • In view of market expectations of a rising interest rate, we have focused on five indicators relating to capital management and compared how each REIT fares relative to the sector average.
    • gearing,
    • weighted average cost of debt (WACD), 
    • weighted average debt maturity (WADM),
    • interest coverage and
    • debt hedged on fixed rate.
  • Only Keppel DC REIT has all five indicators which fare better than the average.

Key points for the REITs under our coverage

Rating change: Cache Logistics Trust (Accumulate to Neutral).

  • Our rating and target price downgrade was triggered by higher than expected property expenses. We had previously under-estimated the impact from the conversion of CWT Commodity Hub from a master lease to a multi-tenancy lease structure.

Cache Logistics Trust – Portfolio rebalancing: work in progress

  • CWT Commodity Hub converted to multi-tenancy on April 12 at 86% occupancy, and the manager has brought committed occupancy up to 92.7%
  • Gearing has been lowered to 35.3% – marginally lower than sector average of 35.6%
  • Renewal risk for 2H 2018 is only 3.1% of gross rental income (GRI), but lease expiry of 28% by GRI in 2019 is a concern

Ascendas REIT – Operationally stable

  • Portfolio occupancy slightly lower q-o-q to 90.5%, but WALE of 4.1 years is healthy and higher than the sector average of 3.7 years
  • 55% of A-REIT's net property income is derived from Business Park and Hi-Specs properties in Singapore
  • Maiden entry into UK through a portfolio of 12 logistics properties diversifies exposure outside of Singapore and Australia

Keppel DC REIT – Strengthened balance sheet to fuel inorganic growth

  • Investment properties portfolio value is now S$1.94bn and the manager has effectively achieved its objective of growing AUM to S$2.0bn by the end of 2018
  • Sources of inorganic growth that contribute in 2018: are KDC DUB 2 (acquired September 2017), maincubes Data Centre (acquired in March 2018) and KDC SGP 5 (acquired June 2018)
  • Currently the best-in-class among the Industrial S-REITs in terms of capital management and interest rate risk management

Mapletree Industrial Trust – Ramping up in Hi-Tech

  • 30A Kallang Place (Hi-Tech Building) is ramping up its occupancy, following the completion of its asset enhancement initiative in February 2018
  • Build-to-suit data centre (Hi-Tech Building) at 12 Sunview Drive obtained its temporary occupancy permit on July 13; renamed to Mapletree Sunview 1
  • Acquired 7 Tai Seng Drive on June 27; to be upgraded to Hi-Tech Building (likely data centre)

Richard LEOW CFA Phillip Securities Research | https://www.stocksbnb.com/ 2018-08-17
SGX Stock Analyst Report NEUTRAL Maintain NEUTRAL 0.820 Same 0.820
ACCUMULATE Maintain ACCUMULATE 2.960 Same 2.960
ACCUMULATE Maintain ACCUMULATE 1.450 Same 1.450
NEUTRAL Maintain NEUTRAL 2.090 Same 2.090