Singapore Industrial REITs - Phillip Securities 2018-11-20: Industrialists’ Outlook Clouded By Trade Protectionism


Singapore Industrial REITs - Industrialists’ Outlook Clouded By Trade Protectionism

  • Maintain Equal Weight view on Industrial REITs sector.
  • 9M 2018 sector occupancy has been stable and Rental Index trend lower in smaller increments.
  • Demand-side looks fragile, as manufacturing and export data are moderating.
  • Maintaining our view that rental bottom is likely to be delayed to 2019, and generally negative reversions to persist for at least 1H 2019.

What is the news?

The Positives

Sector occupancy has remained stable and is at its highest YTD. 

  • Leaders were the Business Park and Warehouse segments which made q-o-q improvement in occupancy, but Multi-User Factory occupancy continues to make a new low.

Tapering supply pipeline in 2019.

  • JTC reports 1.8 million sqm of space expected to come on-stream in 4Q2018 and 2019, compared to the historical 3-year average annual supply and demand of 1.6 million sqm and 1.2 million sqm respectively. Examples of trade sectors with sustained demand during the quarter came from Precision Engineering and Transport and Storage (supply chain management, third-party logistics and freight forwarding).

The Negatives

Rental Index remains weak.

  • Sector Rental Index continue to trend lower and Business Park rent appears to have peaked. The silver lining is that Factory and Warehouse rents are bottoming.

Lower Singapore occupancy for bellwethers A-REIT and MINT.  

  • Singapore occupancy at Ascendas REIT (A-REIT) was lower q-o-q mainly due to non-renewals at logistics properties. However, total portfolio occupancy was stable q-o-q, aided by the Australia portfolio and addition of the UK portfolio which is effectively fully occupied.
  • Singapore occupancy at Mapletree Industrial Trust (MINT) was lower q-o-q mainly due to Flatted Factories (HGST departure in 1Q FY18/19 from Kaki Bukit Cluster, who was the ninth largest tenant in MINT's portfolio) and Hi-Tech Buildings segments (effect of addition of Mapletree Sunview 1 (time lag between obtaining temporary occupancy permit and actual occupancy) and 7 Tai Seng Drive into the portfolio (completed speculative asset enhancement initiative and ramping up occupancy)).

Mixed bag for rental reversions with negative bias.

  • Rental reversions reported by the various industrial REITs ranged between -10% and +4%. However, this is only an indicative range, which does not take into account the floor area of space being renewed at these reversions.

Key takeaways from the quarter

Slower growth from trade tariffs to be expected, but pockets of opportunities exist.

  • Direct impact from trade tariffs have not been felt yet by landlords. Escalation of trade protectionism will be a negative, as trade and growth slows, but there will be pockets of opportunities. Opportunities arising in places such as Singapore and Vietnam, as companies relocate out of China to nearby Southeast Asia.
  • Multinational corporations have been relatively unaffected, as they already have a wider supply chain network. They have contingency plans and will be able to divert/re-allocate resources to maintain operations, albeit with some transitional down-time.
  • Our view: This desire to relocate out of China is not a new trend. The original catalyst was wage pressure in China. The new macro-political factor of trade tariffs is just hastening the impetus for companies to take action.

Market condition is still challenging – industrialists are uncertain about their own outlook.

  • Despite the tapering supply, existing excess supply still needs to be absorbed. We sense that landlords are now not as confident compared to six months ago about a rental bottom in 2018. Some managers are now expecting rents to bottom in 2019. In our previous report, we had opined that the rental bottom would be delayed to 2019. We also expect rental reversions to be generally negative for at least another two more quarters, depending on the pace of the rental recovery.
  • The sensing we get through channel checks is that industrialists are hesitant to commit to new leases as escalating trade protectionism is clouding their own outlook and adding uncertainty. Industrialists are also cautious over placing new orders and this has a cascading effect on the supply chain.

Major events during the quarter

Completed: Merger of VIT and ESR-REIT.

Active capital raising.

  • Mapletree Logistics Trust raised S$375mn through a Private Placement to partially fund the acquisition of five warehouses in Singapore (acquisition price of S$778mn).
  • Ascendas REIT raised S$452mn through a Private Placement to partially fund the acquisition of its second UK portfolio, partially fund the development of a build-to-suit facility in Singapore and repay debt.
  • Soilbuild REIT issued S$65mn 6.0% Perpetual Securities and A$45mn was drawn down from term loan facility to fund the acquisition of two Australia properties for A$116mn/S$116mn.

Investment Action

  • We maintain our "Equal Weight" view on the industrial REITs sub-sector.
  • Now that the year is coming to a close, the theme of tapering supply in 2018 has largely run its course. We take stock of how that has panned out: occupancy has been range-bound over the three quarters, but Rental Index has trended lower, albeit in smaller increments.
  • We believe negative rental reversions to persist into 2019, in varying degrees across the various REIT portfolios. We think that the bottom in rents to bottom within the next two to four quarters.

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? 

  • 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.
  • 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.

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 (unchanged from previous quarter)

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.
  • In the figure below, gearing and weighted average cost of debt (WACD) are coloured green if it is lower than average (red if higher than average); weighted average debt maturity (WADM), interest coverage and debt hedged on fixed rate are coloured green if it is higher than average (red if lower than average).
  • Only Keppel DC REIT has all five indicators which fare better than the average.

Summary of Industrial REITs under our coverage

  • We downgraded Cache Logistics Trust from Accumulate to NEUTRAL, and kept our ratings unchanged for the other industrial REITs under our coverage. We also lowered the target prices (by -1.4% to -8.5%) for industrial REITs under our coverage, except for Keppel DC REIT (target price unchanged).

Cache Logistics Trust – High yield pricing in 2019 risks

  • Minimal renewal risk in 4Q18, but lease expiry of 28% by GRI in 2019 is a concern.
  • Non-renewals, master lease conversions and negative reversions are key risks in 2019.
  • Raised the discount rate to 7.8%; long-term growth rate kept at 1%.
  • See report: Cache Logistics Trust – Highlighting 2019 risks

Ascendas REIT – Operationally stable

  • Singapore portfolio: Lower occupancy, but positive rental reversion.
  • Total portfolio occupancy marginally higher q-o-q to 90.6%, aided by maiden entry into UK through a portfolio of 12 logistics properties.
  • WALE of 4.3 years is healthy and higher than the sector average of 3.8 years.
  • See report: Ascendas REIT – Increasing footprint in the United Kingdom

Keppel DC REIT – Data centre demand remains robust

  • S$2bn AUM target for 2018 achieved; manager intends to maintain the pace of acquisitions in 2019 (no AUM target given).
  • WALE of 8.5 years is the longest among industrial REITs.
  • Best-in-class among the industrial REITs in terms of capital management and interest rate risk management.
  • See report: Keppel DC REIT – Portfolio remains stable

Mapletree Industrial Trust – Unattractive valuation

  • Singapore portfolio marred by rental and occupancy weakness, mitigated by inorganic contribution from portfolio of US data centres.
  • Resumption of Distribution reinvestment plan (DRP) to strengthen balance sheet and fund development projects.
  • Current yield spread is at its tightest ever, making the it expensive.
  • See report: Mapletree Industrial Trust – Operational weakness

Richard LEOW CFA Phillip Securities Research | https://www.stocksbnb.com/ 2018-11-20
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