REITs – Singapore - UOB Kay Hian 2019-07-04: Well-Balanced Approach To Provide More Flexibility

REITs – Singapore - UOB Kay Hian | SGinvestors.io ARA US HOSPITALITY TRUST (SGX:XZL) ASCOTT RESIDENCE TRUST (SGX:A68U) CDL HOSPITALITY TRUSTS (SGX:J85) FRASERS CENTREPOINT TRUST (SGX:J69U) KEPPEL REIT (SGX:K71U)

REITs – Singapore - Well-Balanced Approach To Provide More Flexibility

  • The MAS has initiated industry consultation on allowing higher leverage of 50% if S-REIT meets the minimum ICR of 2.5x. S-REITs with good financial discipline could have higher leverage of 55%.
  • The slight relaxation, if implemented, will enable S-REITs to respond faster and make more sizeable acquisitions. These new limits remain well below those in many other jurisdictions. S-REITs are unlikely to depart from their culture of prudence in managing capital structure.
  • Maintain OVERWEIGHT.



WHAT’S NEW


Making tweaks to regulations on leverage.

  • The MAS has embarked on an industry consultation to seek feedback on using a combination of leverage limit and interest coverage ratio (ICR) to recalibrate the leverage limit allowed for S-REITs:
    1. The MAS will consider allowing a S-REIT’s leverage to exceed 45% but not more than 50% if the S-REIT has a minimum ICR of 2.5x after taking into account the interest payments arising from the new debt. The leverage limit is not considered breached if the S-REIT’s ICR subsequently falls below the ICR threshold of 2.5x due to circumstances beyond the control of the S-REIT manager.
    2. The MAS is also seeking views on whether it is appropriate for an S-REIT that has demonstrated good financial discipline, such as having a higher ICR threshold, to be allowed a higher leverage of 55%.

Conservative management of capital structure.

  • While the current leverage limit is at 45%, S-REITs usually keep their leverage within 40% (average leverage at 34% as of May 19). The industry practice to maintain a 5% buffer below the regulatory limit is necessary to respond to changing market conditions, such as declining property prices.


ACTION


Maintain OVERWEIGHT.

  • We see the proposed changes in regulations as well calibrated. It maintains an optimal balance to provide S-REITs with more flexibility to expand, while maintaining a prudent capital structure. All S-REITs that will benefit from the slight increase in leverage limit are:
    • Larger S-REITs with backing of strong sponsors, which spells lower cost of debts and higher ICR, would benefit from a potentially higher leverage limit of 55%.
    • Smaller S-REITs could also grow at a faster pace with the higher leverage limit of 50%.

Improve timeliness to acquire larger assets.

  • Recently, S-REITs have been acquiring overseas assets from third parties in search of higher yield spreads. These acquisitions involve a competitive bidding process and are highly time-sensitive. A higher leverage limit provides more flexibility for S-REITs to optimise their capital structure as debt tends to be a cheaper source of capital.
  • In addition, raising equity capital takes more time. Thus, the higher leverage limit would enable S-REITs to respond more effectively to opportunities to acquire good quality assets.

Improve flexibility to acquire larger assets.

  • On many occasions, smaller S-REITs had to acquire larger assets over multiple phases. For example, FRASERS CENTREPOINT TRUST (SGX:J69U) was limited to acquiring just 30% of Waterway Point from its sponsor and would have to consider acquiring the remaining 70% stake at a later stage. Having a higher leverage limit could pave the way for smaller S-REITs to acquire larger assets in one transaction.

Regulations for S-REITs remain stringent and conservative.

  • Malaysia imposes a 50% limit while Thailand allows REITs to leverage up to 60% if they have an investment grade credit rating. Belgium, Germany and the Netherlands have limits ranging from 60.0% to 66.25%. The US, Canada, Australia, France and Japan do not impose any leverage limit. A slight easing in terms of leverage limit would allow S-REITs to expand in a prudent manner.


SECTOR CATALYSTS

  • Interest rates are expected to drift sideways in the foreseeable future.
  • Limited new supply for office, hotel and logistics segments in 2019 and 2020.


ASSUMPTION CHANGES

  • We kept our earnings forecasts unchanged.


RISKS

  • Uncertainties from the US-China trade conflict.


TOP BUYS

REIT Recommendation Share Price Target Price
ARA US HOSPITALITY TRUST (SGX:XZL) BUY US$0.89 US$1.15
ASCOTT RESIDENCE TRUST (SGX:A68U) BUY S$1.28 S$1.46
CDL HOSPITALITY TRUSTS (SGX:J85) BUY S$1.66 S$2.06
FRASERS CENTREPOINT TRUST (SGX:J69U) BUY S$2.64 S$2.72
KEPPEL REIT (SGX:K71U) BUY S$1.28 S$1.37





Jonathan KOH CFA UOB Kay Hian Research | Peihao LOKE UOB Kay Hian | https://research.uobkayhian.com/ 2019-07-04
SGX Stock Analyst Report BUY MAINTAIN BUY 1.15 SAME 1.15
BUY MAINTAIN BUY 1.460 SAME 1.460
BUY MAINTAIN BUY 1.990 SAME 1.990
BUY MAINTAIN BUY 2.720 SAME 2.720
BUY MAINTAIN BUY 1.370 SAME 1.370



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