Navigating Singapore - CGS-CIMB Research 2018-11-29: Looking To 2019

Singapore Market Strategy - CGSCIMB Research | SGinvestors.io SINGAPORE AIRLINES LTD (SGX:C6L)

Navigating Singapore - Looking To 2019

  • Peak FED tightening, 2+1.
  • What if there are four hikes?
  • Keep calm, trade (is) on.
  • We welcome you, newcomers who can prevail.
  • Bicentennial celebration with early election?

1. Peak FED Tightening, 2+1

  • 2019 is likely to be a year of slower growth while rising interest rates are likely to peak as tightening policies ease.
  • CIMB’s Group Economic and Market Analysis team forecasts US GDP growth to decelerate in 2019 (+2.5% vs. +2.9% for 2018) as trade frictions wear on the economy and fiscal stimulus wanes. The team expects the Fed to continue to hike rates and reach ‘’neutral’’ in mid-2019, with policy rates rising from 2.4% in 2018F to 3.1% in 2019F (+c.70bp). We think this could mean two hikes in 1H19 and one hike in 2H19.
  • The team also projects a potential rate cut and for the policy rate to be maintained at 3.1% in 2020F as the economy slows to a near-stall (+1.7%).

2. What If There Are 4 Hikes?

  • This is a hypothetical question that we have received. Four hikes should filter down to hikes in Singapore interest rates as well, although historically there has not been a full pass-through.
  • Overall funding cost and quantum, particularly for heavy capital commitment entities such as property companies and SREITs, will be affected.
  • In the section below we look at the leverage positions of property companies and SREITs and attempt to assess the effect of higher funding cost on earnings as well valuations. We also look at how each hike could impact banks’ earnings.

(I) Impact on SREITs

  • We assess the impact of rising interest rates on SREITs from two perspectives:
    1. rising interest expense on DPU; and
    2. the knock-on effect of higher interest rates on risk-free rates and the effect on valuation and target prices.
  • To put things into perspective, anecdotal evidence shows that average debt cost for SREITs has changed very little from a year ago, thanks to a competitive lending environment that saw narrowing spreads partly offsetting the higher base effect and a high proportion of fixed debt or diversification overseas which resulted in a different blend of overall funding costs. Hence, we think the trend will only filter down to SREITs earnings gradually.

Effect of rising interest rates on DPU

  • In our analysis below, we bake in two scenarios:
    1. an absolute 0.5% pt hike in spot interest rates in 2019 and 0% beyond 2019, and
    2. an absolute 1% pt hike in spot interest rates in 2019 and 0% beyond 2019.
  • These hikes can come from margin or base rate expansion. The higher interest quantums are worked into current effective rates as and when existing loans are refinanced (based on the individual SREIT’s debt maturity profile) and should filter down to higher blended interest cost going forward.
  • Our analysis shows little DPU erosion impact in FY19F to the tune of 0% to - 3.7% if spot rates rise by 0.5% pt and 1% pt given the well-spread-out debt maturity. The decline is more visible, at -0.6% to -8.9% in FY20-21F, as more loans are re-based to the higher market rates. This could temper our y-o-y sector DPU growth expectations from the current 2.1% to 1.4% (based on a scenario where spot interest rates rise 0.5% pt) and 0.9% (based on a scenario where spot interest rates rise 1% pt). This means that SREITs could continue to tap inorganic growth prospects to drive stronger sector DPU growth.
  • Refer to the PDF report attached for tabular figures of sensitivity analysis. 

Effect of higher rates on valuations

  • From a valuation perspective, a higher interest rate outlook could also mean higher risk-free rates, assuming that the yield curve remains the same. Given that we value SREITs using DDM, any change in cost of equity assumptions will also impact our target prices. In the section below, we detail our cost of equity assumptions and sensitivity of our target prices in the following scenarios:
    1. a 10bp change in the risk-free rate,
    2. a 0.5x change in beta, and
    3. a 10bp change in terminal growth assumptions.
  • Our exercise shows that target prices are most sensitive to changes in beta assumptions. For every 0.5x shift in beta, TPs will change by 2.6-7.1%. Meanwhile, a 0.1% pt change in the Singapore or portfolio geographic-weighted risk-free rate results in a shift of 0.4-7.6%.
  • Changes in terminal growth will lead to movements of 0.9-2.2%. Hence, assuming all else remains constant, any change in the risk-free rate will only impact our DDM valuation marginally. We have penciled in a risk-free rate value of 2.7% into our existing models, which is higher than the current rate of 2.45%.
  • Refer to the PDF report attached for tabular figures of sensitivity analysis. 

Putting it all together

  • Our assessments above show that, individually, rising funding costs and upticks in long bond yields have little impact on DDM-based target prices. In the section below, we back-test our target prices by assuming an amalgamation of both factors. A 0.5% pt and 1% pt increment in spot interest rates as well as a 10bp hike in Singapore long bond yields will only result in a 2.6-11% cut to our current target prices.
  • Essentially, this means that most SREITs still offer upside to our revised target prices from here, indicating that the market could have anticipated the impact of rising interest costs and bond yields at the current market price.

Acquisition growth continues to be an important DPU driver

  • Nevertheless, with a moderated sector DPU growth outlook should the impact of higher funding costs filter down, we reckon SREITs will continue to grow DPUs via new acquisitions in addition to organic rental improvement.
  • SREITs have been highly active in securing new assets, largely in Europe, thanks to low onshore funding costs.

(II) Impact on homebuyers and developers

  • Within the residential market, rising interest rates will affect both consumers and property developers. Higher mortgage rates will erode homebuyers’ mortgage affordability and raise household debt service ratios while higher interest rates will increase developers’ holding costs, especially when asset turn slows, as well as raise the cost of capital. In the section below, we assess the health of the Singapore household balance sheet and affordability assuming interest rates normalise further.
  • From the consumer’s perspective, Singapore’s household balance sheets have remained generally robust, with rising net assets and manageable mortgage-to-residential value ratios. Financial assets, including insurance and pension funds such as CPF balances, account for c.49% of the household sector balance sheet while mortgages make up only c.10% of the total. As at 3Q18, overall mortgages as a percentage of asset values stood at c.26% while mortgages from financial institutions as a percentage of private property values stood at 39%, down from the 4Q16 peak of 43%.
  • Mortgage rates have crept up by 50-60bp over the course of this year (in tandem with firming SIBOR rates) and are currently at c.2.0-2.2% (vs. the total debt service ratio or TDSR evaluation rate of 3.5%). Our scenario analysis below shows that the TDSR of a private property dwelling household with a home, car, credit card and other loan commitments is approximately 45.1%, below the 60% ceiling. In terms of sensitivity analysis, a 1% increase in mortgage evaluation rate from 3.5% to 3.535% will raise TDSR by 0.1% pt while a 1% increase in house price will lift TDSR by 0.4% pt.

Pricing strategy key in a tempered demand environment

  • On the demand front, 10M18 total primary home transactions (excluding executive condominiums) came in at 7,896 units, down 24% y-o-y but appears to be on track to meet our expectation of c.10,000 units taken up this year. The bulk of this was achieved during the market fervor in 7M18 and post the Jul 18 property cooling measure, Aug-Oct volumes made up c.26% of the year’s achievement. We think this initial development reflects the buyers’ knee-jerk reaction to the new cooling measures as buyers assessed the impact on affordability with the higher ABSD and lower loan-to-value rulings in place as well as delayed big-ticket purchasing decisions in anticipation of possible price cuts to move inventory by developers.
  • Looking at new launch prices post the cooling measures, we see that developers have toned down price expectations compared to pre-cooling measure levels to the tune of 10-15% and this resulted in new offerings receiving encouraging take-up rates. To be fair, while take-up rates reflect moderated demand, as expected, they nonetheless remain encouraging, i.e. Whistler Grand’s 27% and Parc Esta’s 24% sell-through rates to date. Hence, we think that a new price equilibrium seems to have been set for now and developers should continue to clear inventory at current levels given that they still have a 4- to 5-year window until the projects are completed.
  • The risk to this view is that a few large-sized projects are scheduled to be launched in 2019, such as Treasure at Tampines (2,225 units), Normanton Park enbloc (1,882 units), Silat Avenue (1,074 units) and Florence Regency enbloc (1,450 units), where developers may have to adopt a price-sensitive strategy under the current market environment.

High supply has been well flagged

  • On the supply front, the large incoming wave of supply following the record S$17bn worth of enbloc transactions and government land sales transacted YTD has been well flagged and is starting to filter down to data points. Unsold stock (with planning approvals) stood at 31,295 units as at end-3Q18 compared to the low of 15,085 units at end-2Q17.
  • Going into 2019, there could be up to an estimated 50 projects ready for launch, totalling c.20,000 units. Although there does not appear to be a sense of developers panicking to release their launches given the competitive environment, we think developers will continue to adopt a price-sensitive strategy to move their inventory.
  • Refer to the PDF report attached for listing of estimated schedule of new launches in 2019.

Expect 0-3% increase in prices in 2019, demand at 9,000-10,000 units

  • Private home prices rose by a solid 7.4% in 1H18 amid strong transaction volumes on optimistic expectations of replacement demand from enbloc sellers and potential capital appreciation. With the introduction of cooling measures in Jul 18, the price growth trajectory moderated significantly to a 0.5% q-o-q uptick in 3Q18. We expect price hikes in 4Q to be very modest as well.
  • For 2019, we expect private home prices to move between 0% and 3% and primary volume transactions to range between 9,000 and 10,000 units. At the same time, with the slower price growth trajectory and the non-remittable ABSD of 5% for land purchases as well as the change in ruling for larger average unit sizes, we think developers are likely to bid more realistically for land bank, hence enabling them to preserve operating margins in a slower capital appreciation environment.
  • More importantly, should property prices remain at the current level, the probability of land bank provisioning remains low at this point.

Developers’ balance sheets remain healthy

  • Developers’ balance sheets are healthy, with the net debt-to-equity ratio of small-and-large-cap listed developers standing at 56% at end-3QCY18. For large-cap developers only, the ratio is slightly lower at 49% for the same period. We expect this ratio to rise over the next two years on capex commitments for new projects but it should remain healthy, nowhere close to the 1x ratio seen during the early-2000 period.
  • Debt maturity profiles are also well spread out, with 22% of debt due within one year and another 46% maturing over the next 1 to 3 years.

(III) Impact on banks

  • Singapore banks witnessed a steady pick-up in NIMs as at 9MFY18 as the SIBOR and SOR reacted to the Fed rate hikes on the back of an appreciating US$. The three hikes this year have translated into a +63bp/+83bp increase in SIBOR/SOR since Jan 2018 as the US$/S$ strengthened.
  • While we expect further upside on NIMs to come from continued rate hikes, we remain cognisant of several moving parts that could arrest this trend.

Pass-through of US$ rates to SIBOR and SOR

  • The pass-through of US$ rates to SIBOR and SOR have a close relationship to US$/S$ given the Monetary Authority of Singapore’s (MAS) policy of pegging the exchange rate to a basket of currencies rather than directly controlling interest rates; a stronger US$ correlates with higher SIBOR and SOR rates.
  • The MAS increased the slope of the S$ nominal effective exchange rate policy (NEER) slightly while keeping the width and centre of the policy band unchanged in Oct 2018, thus marking a second successive tightening of the monetary policy following its Apr review and further steering the S$ into an appreciation pace. In this respect, our mildly positive view of US$/S$, with our forecasts of 1.37 by end-2018F and 1.35 by mid-2019F, sets our expectations for the pass-through rate to broadly hold steady, albeit with a slight negative bias if it materialises.
  • We assume that 3M US$ LIBOR will continue trending at a term premium above the Fed rate by c.30-40bp given our US$/S$ expectations and hold the 3M US$ LIBOR to 3M SIBOR pass-through rate at the current 12-month moving average of c.70%. The flow-through repricing effects from higher rates also tend to take effect with a 3-6 month lag. These variables as well as our estimate of three rate hikes in FY19 form our base case for Singapore banks’ NIMs to improve by 6-9bp.
    • DBS (SGX:D05)’s NIMs stayed the course to chart continuous q-o-q improvement throughout the year. Despite having observed US$ 3M LIBOR increasing over the past few months, DBS notes a considerable lag in the pass-through to 3M SIBOR and consequently to its asset yields (about 4-6 weeks from the movements in 3M SIBOR). With funding costs set to trend upwards in tandem with interest rates, DBS’s superior 62% CASA deposit composition will enable deposit costs to be sticky downwards, which provides it with a significant advantage over its peers (OCBC: 48%, UOB: 44%). The bank’s 90% S$ CASA proportion further cements its funding cost shield. As with its peers, DBS projects loan growth to slow to the mid-single digits in FY19 (from 6-7% in FY18). The bank de-emphasised the growth of trade loans in 3Q18 and guided that this stance would remain until pricing picked up. DBS’s NIMs are likely to benefit the most from the rising rates given its funding cost advantage and effects of the previous hikes on SIBOR, SOR and HIBOR coming through. Incorporating the three potential hikes into our model, we estimate DBS’s NIM to climb 9bp to 1.96% in FY19 (FY18E: 1.87%).
    • OCBC (SGX:O39)’s NIM stayed unchanged at 1.67% over the past three quarters before turning for the better in 3Q18 (to 1.72%). Notably, the bank had taken a pre-emptive approach in its funding strategy, choosing to buff up its liquidity beginning 2H17 amid escalating trade tensions; OCBC’s funding costs have risen the most since the Fed rate hikes went into full swing in 4Q16 (+51bp vs. DBS: +47bp and UOB: +43bp). Alongside the release of excess liquidity of c.US$3bn, the repricing of its Singapore mortgage book gave its NIMs a boost in 3Q18. The bank guides for continued NIM upside in FY19 from the full repricing impact as well as a lift in margins in its Hong Kong portfolio from the HIBOR and prime rate increase. With LDR trending at c.83-86% over the past year, we think that maintaining the ratio at around the current 88% will bode well for OCBC’s margins given weaker sentiment in FY19 amid the ongoing trade tensions. The bank still guides for mid-to-high single-digit loan growth in FY19, albeit slightly softer than this year’s. While OCBC expects growth in Greater China to slow as a whole, the bank is optimistic it can gain market share given its relatively smaller stature in the region. We estimate OCBC’s NIM to increase by 7bp to 1.77% in FY19 (FY18E: 1.7%).
    • UOB (SGX:U11) saw its NIM dip over the past two quarters as it started to shore up its funding base in view of costlier funding as interest rates rose. The bank had sought to fund ahead of its anticipated loan pipeline – largely in the form of more expensive S$ and US$ fixed deposits – but was ultimately let down by delayed drawdowns as manufacturers pushed back capex commitments. In 9M18, the 35bp rise in its asset yields was overcome by the 37bp increase in funding costs. While UOB is relatively shielded from the effects of the US/China trade war given its relatively smaller exposure to this region (15% of gross loans), loan growth in FY19 is likely to be impacted nonetheless and is guided to moderate towards a mid-single-digit figure (from high-single-digits in FY18). While the bank is well poised to benefit from its ASEAN footprint as customers consider moving their manufacturing plants into SEA with trade tariffs coming into effect, we believe that this is a longer-term prospect. As the bank has had to endure more expensive funding, we think that it is in a comfortable position in terms of liquidity (currently with the lowest LDR compared to peers) and stands to gain from its funding strategy as higher-priced loans are drawn down in quarters to come. We forecast UOB’s NIM to rise 6bp to 1.9% in FY19 (FY18E: 1.84%) on the back of three potential rate hikes.
  • As we expect asset yields to rise further on the back of the sustained upward momentum in SIBOR and SOR, the banks’ chosen funding strategies will be a key differentiator in driving NIM expansion in FY19, especially in view of lower regional loan growth, particularly from Greater China. In our view, an additional rate hike above the 3 assumed in our narrative will increase NII for the local banks by c.S$148m-317m, which will flow into FY20 earnings.
  • As mentioned above, DBS’s large proportion of CASA deposits allow it a relative funding cost advantage over its peers. Our sensitivity analysis shows the additional rate hike will increase banks’ earnings by a pro-forma c.3-5%.

3. Keep Calm, Trade (Is) On

  • We appreciate that the trade war is not going to reach a cease fire anytime soon. It is clear that trade tension has affected business confidence but the actual impact is difficult to quantify. We think pressure will remain unabated going into 1H19 with the full blown 25% tariff kicking in on imports from China. This could exacerbate the ongoing supply chain shortages for electronic components in the tech/manufacturing industry.
  • However, this does not mean investors should completely steer away. Instead, we advocate staying calm and isolating company-specific growth drivers and fundamentals. Valuations for the tech/manufacturing sector have been pummelled and are now at -1 s.d. from its 15-year historical mean. We see opportunities to consider the sector from 3Q19F onwards as the rollercoaster price movements ease with greater clarity on the impact of tariffs.
  • Figure 40 in the PDF report attached are observations on Singapore corporates in the past year in response to trade tension in the aspects of customer product launch timelines and volume demand, pricing and margin pressure, earnings and sentiment.
  • Singapore Airlines (SGX:C6L)’s cargo load factors trended lower y-o-y in the past three quarters as some customers did not fully load chartered freighters. Freight tonne kilometres (FTK) fell y-o-y in the latest 2QFY3/19 results as demand across most of the route regions declined.
  • In general, Singapore banks’ Greater China loan growth tapered y-o-y, albeit managing to stay on its upward trajectory, in 3Q18 from an average of 4-7% in the previous three quarters to only 2%. We expect the anaemic growth pattern to persist over the next few quarters.
  • Y-o-y, most of the tech/manufacturing companies under our coverage delivered lower growth, mainly due to a high base in 2017. The impact of the trade conflict has not been very pronounced, which we suspect could be due to lucrative margins enjoyed by US brand owners coupled with an appreciating US$. Most of the manufacturers were still able to pass on the first batch of tariff hikes.
  • Among our coverage, only Valuetronics (SGX:BN2) was forthcoming enough to quantify the potential impact of the tariff and said recently that it widened the estimated impact of the tariff on its overall revenue to 20% from its original guided 10%. Its recent 2QFY3/19 earnings miss was company-specific (impairment provision for flash floods at the Danshui plant).
  • Venture Corp (SGX:V03) did not quantify the impact of the trade war but cited delays in orders from key customers (Phillip Morris and Ilumina) as reasons for its 3Q18 earnings disappointment.
  • Memtech International (SGX:BOL) also saw customers in the consumer electronics space (Apple/Beats) pushing back launches, which could be due to the trade war.

Operating statistics for some large-cap industrial SREITs

  • Ascendas REIT (SGX:A17U) and Mapletree Industrial Trust (SGX:ME8U) are showing early signs of ripple, although these were still not concrete enough to identify as the result of the trade war as trends diverged between Singapore and overseas assets. Occupancy rates are on a slight downward trend for multi-tenanted buildings (MTB)/flatted factories and logistics properties in Singapore for Ascendas REIT and Mapletree Industrial Trust.
  • Back-filling of vacated space is also taking slightly longer than expected. Surprisingly, overseas assets from past acquisitions outperformed and filled the gap, including Ascendas REIT’s Australia and logistics portfolios as well as Mapletree Logistics Trust (SGX:M44U)’s South Korea, China and Vietnam properties. These assets are largely used to support domestic consumption.

The impact on capital goods is more driven by sentiment due to oil prices.

  • Oil prices are supposed to be soaring around now on the back of American sanctions against Iran. Instead, it has gone ‘trumpsy turvy’ on the back of lower global economic growth. Trouble in emerging markets suppressed by falling local currencies has curbed demand for dollar-denominated oil. While all eyes are on the production cuts promised by Saudi Arabia, we think oil majors could pace themselves in contract award momentum.
  • We consider the contracts secured by the Singapore yards to be lacklustre YTD and believe they could be better without the trade strain. Both yards are likely to disappoint in meeting our 2018 order targets as Sembcorp Marine (SGX:S51) only won S$1.2bn vs. our S$1.5bn and Keppel O&M S$1.4bn vs. our S$2bn.

Commodities are directly affected but more from sentiment

  • Commodities are directly affected but more from sentiment for now for the stocks under our coverage. China has slapped a 25% import tariff on soybean imports from the US. This has led China-based soybean crushers to source more soybeans from other South American producers. However, this could result in higher soybean prices and its related products in China due to additional taxes or transportation costs, which could be passed on to consumers.
  • The higher prices of soybean meal could lead to lower demand and crushing activities and indirectly benefit palm oil. China operations could affect Wilmar International (SGX:F34)’s and Golden Agri Resources (SGX:E5H)’s soybean crushing business but could also be partially offset by higher palm oil prices.

The green zones:

  • Property, telco, consumer/gaming and healthcare are relatively insulated with little or no direct impact. However, these sectors are battling sector-specific issues, such as regulatory changes, a highly competitive landscape and gestation costs.

4. We Welcome You, Newcomers Who Can Prevail.

  • Historically, we have seen cash-generative industries attracting foreign brands to attempt to steal a slice of the pie in the perceived ‘open’ market in Singapore. Our conclusion is many have tried and many have failed. The aspirants include Swissport, a Swiss-based ground handler that was awarded the third operating concession for Singapore’s Changi Airport after a thorough tender process in 2005 but was forced to leave in 2009 because of long-established competitors, SATS (SGX:S58), Changi International Airport Services (CIAS) and DNATA. The baton was passed to US-based Aircraft Service International Group (ASIG) in 2011, which also failed to take off after facing a shortage of labour to service flights of its maiden airlines, Jetstar Asia, in 2014.
  • The list goes on to include online retail giant Amazon Prime, which attracted major publicity ahead of its launch but failed to gain market share. We look forward to the next two brave entrants in 2019: TPG (potential fourth telco) and Go-Jek (potential second ride-hailing company).


  • Australian TPG is on track to meet its licence obligations for 95% outdoor coverage by 31 Dec 2018 (road tunnels and in buildings by 31 Dec 2019, MRT underground stations/lines by 31 Dec 2021). We believe the incumbents are somewhat prepared to welcome the new kid on the block, thanks to several measures put in place over the past two years. These include competitive offerings from four mobile virtual network operators (MVNOs):-
    1. Circle.Life (host: M1)
    2. ZeroMobile (host: Singtel)
    3. Zero1 (host: Singtel)
    4. MyRepublic (host: Starhub)
  • The introduction of SIM-only plans and data upsize options are strategies implemented by incumbents to crowd out or make it harder for TPG to achieve its target of positive EBITDA when it reaches 5-6% market share in the short term. However, it is too early to conclude that TPG will drop out of Singapore given its spectrum and network rollout investment ploughed in thus far worth c.S$199m.
  • We believe the substantial de-rating in share prices among the Singapore telcos - SingTel (SGX:Z74), M1 (SGX:B2F), StarHub (SGX:CC3) since 2015 somewhat reflects the risk of more intense competition. However, we believe investors can afford to wait till after 1Q19 to assess the impact of TPG’s entry on the incumbents.


  • Go-Jek, an Indonesia-based ride hailing company backed by deep pockets (Tencent, Google, et al), is set to enter the market by end-Dec 18. The competition to lure drivers from Grab and ComfortDelgro (SGX:C52) will once again step up the pressure in the private hire car segment. We think that, without a sizeable domestic app user base providing ample demand to lure taxi drivers to switch over, Go-Jek will need to go after Grab’s private hire car driver base first to form the supply.
  • We also do not think an immediate exodus of taxi drivers could happen. We believe that ComfortDelgro, having been beaten once, is not going to be a sitting duck and could strike back. We believe the US$100m venture capital fund set up by ComfortDelgro to invest in technology start-ups is a step forward vs. five years ago.

5. Bicentennial celebration with early election?

  • In a recent interview in early-November-18, Singapore’s Prime Minister told the media that “it’s always possible” for an early election in 2019. The last election was in September 2015 and the next election must be held by Jan 2021. 2019 will mark 200 years of history for Singapore, commemorating Sir Stamford Raffles’s arrival in Singapore in 1819, which has been marked as one of the ‘key turning points’ that changed Singapore’s trajectory as a country.
  • It may not be as eventful as SG50 but there are still a series of “feel good” events, including the opening of Changi Airport Jewel lifestyle destination and the partial opening (three stations) of the Thomson-East Coast line. The hospitality sector could still some uptick coupled with a tapering hotel supply. We think the two cooling measures in property introduced this year could be sufficient as asset price expectations by the developers have toned down by 10- 15% vs. before the measures.
  • The Singapore election may not be as exciting as in its neighbouring countries but it is worthwhile tracking to see the next generation of leaders in place as the current prime minister Lee Hsien Loong has signaled his intention to retire by 70 years old (2020).

LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2018-11-29
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