Singapore REITs - DBS Research 2020-09-01: Turn Of The Tide


Singapore REITs - Turn Of The Tide

  • Time to venture out of safe industrials S-REITs as valuation disparity stretches beyond 1SD.
  • Channel checks and macro datapoints signal broadening recovery across various sectors.
  • Financial metrics for S-REITs pass the litmus test; downside risk dissipating.
  • Yield disparity attractive except for Industrial and Healthcare S-REITs.

Valuation discount for “COVID-19 impacted” sectors too wide to ignore.

Financial metrics stable; book value deterioration lesser than expected.

  • We see risk abating as financial metrics remain stable (gearing has inched higher but remains < 38%, ICR healthy at > 4.0x) despite one of the worst quarters in S-REITs’ history. Supported by government incentives and managers’ proactive cash preservation strategy and access to capital markets has enabled S-REITs’ balance sheets to pass the litmus test.
  • We estimate that revenues will have fall by > 80% before ICR hits 1.0x, a remote scenario in our view. In addition, strong liquidity and low interest rates have kept the decline in book valuations at a marginal 1.5%-3.0%.

Yield disparity attractive at -1SD to mean except for Industrial and Healthcare.

  • Our overall FY20F DPU estimates are -1% to +2% of FY21 DPU, led by industrial (excluding potential acquisitions) and retail (+1% to +2%) followed by office ex-hospitality (+0.5% to +1%) supported by contributions from new assets. As such the yield disparity is attractive at -1SD of the mean except for Industrial and Healthcare which are trading close to above +1SD.

Time to venture out

Divergent share price performance among S-REITs.

  • While the S-REITs have been strong performers year to date (YTD), the share prices are still 9% lower compared to the start of 2020 but have outperformed the Straits Times Index (STI) which is down 21%. However, compared to the lows in 1Q20, the FSTREI has rebounded 38% (vs 13% rise in the STI).
  • We note that the share price rebound since the low in March 2020 has seen divergence across 2 broad categories – the “COVID resistant” subsectors i.e. Industrial and Healthcare S-REITs. The COVID resistant subsectors have done well (industrial S-REITs have turned in flat) or up 12% (Healthcare S-REITs), and have hit new highs in terms of valuations at P/NAV of 1.6x-1.7x. That said, if we look at the top 5 industrial S-REITs in terms of market cap (Ascendas REIT (SGX:A17U), Mapletree Logistics Trust (SGX:M44U), Mapletree Industrial Trust (SGX:ME8U), Keppel DC REIT (SGX:AJBU) and Frasers Logistics & Commercial Trust (SGX:BUOU)), their share prices are 8-40% higher compared to the start of the year. Valuations of these large caps are now between 1.6x -2.3x P/NAV.
  • On the other hand, the “COVID impacted” sectors (retail, office and hotels are 18% to 27% lower YTD. However, retail and hospitality S-REITs are still 25% to 27% lower due to the more significant disruption to earnings and operations.

Valuation disparity too large to ignore.

  • Investors have rightfully stuck and been rewarded with positive returns in Industrial S-REITs (especially large cap S-REITs) given their relative earnings resilience against the COVID-19 pandemic coupled with acceleration in medium term structural drivers. That said, the performance disparity is noteworthy as the valuation gap between these industrial S-REITs and the other sub-sectors has broadened to 0.75x, the widest since the start of the pandemic. This is unwarranted in our view, given the positive market datapoints that point to a gradual recovery in the economy.

Economy is on a gradual mend, further support from government is positive for “risk trade”.

  • According to our DBS economist, Irvin Seah, the steep contraction of Singapore’s economy in 2Q20 marks a turn for the better starting from 3Q20, as per DBS Economics & Strategy: Singapore: The economy has bottomed out. With the economy on the mend coupled with the recent extension of the Jobs Support Scheme (JSS) till March 2021 and selective opening of the borders with a focus on “green lanes” to kickstart travel, these will be positive for firms and consumers, especially within the commercial and hospitality sector in the medium term.
  • With low or no expectations, valuations for COVID impacted sectors are below mean. We believe this is an opportune time to re-look at these subsectors.

Financial metrics stand the test

Financial metrics stable.

  • S-REITs’ overall financial metrics were stable in 1H20, despite the weakening operating environment, and impact on cashflows due to landlords offering rental assistance programs to their tenants. While gearing has crept up and some weakening in interest coverage ratios (ICR), overall, we feel that the impact of the crisis is well managed with assistance from government grants that have helped to sustain landlords’ financials.

Modest decline in valuations – better than expected.

  • Valuations during 2Q20 declined by 1.5-3.0% for commercial properties, which was better than market expectations, resulting in gearing levels remaining at comfortable levels.
  • On the back of improving operating conditions expected in 2H20, we believe downside risks for S-REITs are minimal.

Healthy ICR ratios.

  • Overall S-REIT sector ICR ratios was around 4.38x, a decline from 4.81x as of end December 2019. The range was rather wide, from 3.35x for hotels to 6.1x for industrials/15.8x for healthcare. We estimate that EBIT would have to fall by 77% (range 61% to 94%) before ICR drops to 1.0x, implying that the current financial positions remain strong as ICR ratios will most likely be above financial covenants and MAS requirements of 2.5x (which is similar to an investment grade rating) even if REITs raise their gearing to 50%.

EBIT projections on track despite COVID-19 hit.

  • EBIT projections remain on track, with 1H20 EBIT at 46.6% (ranging 37%-52%) of our full year forecasts, impacted by 1H20 rental rebates. This implies that even if the rebate program tapers off, we may not need to trim our estimates if economic recovery takes hold.
  • We highlight that industrial S-REITs and US Office REITs are in fact tracking ahead of our forecasts, driven by acquisitions. Thus, if the momentum continues, full year projections are likely to come in ahead of expectations.

A rebound back to pre-COVID levels

Where is the rebound trade?

SREITs FY21F DPU growth ranges from -1% to 3%; industrial (ex-acquisitions) and retail to lead.

  • While the impact of the COVID-19 pandemic on FY20F DPU is well expected by the market and our estimates have factored in a decline in DPU ranging from -0.4% to -54% vs FY19 DPU, we expect a gradual recovery in 2H20 (vs 1H20) leading to some level of normalcy in FY21F.
  • Broadly, our estimates point to SREITs’ FY21F DPU growing by -1% to 3% vs FY19A DPU. Any growth is mostly driven by full-year contribution of newly acquired assets in FY19 / FY20.
  • By asset classes, our estimates for Industrials appears to have the strongest growth of c.5% in FY21F vs FY19 led by assumed potential acquisitions. Excluding these potential acquisitions, the rebound is estimated to range between +1% to +2%. As such, among the four major asset classes, retail and industrial would lead the rebound at +1% to +2% while office lags at -1% dragged down by hospitality portfolio.
  • Excluding the hospitality portfolio, we estimate FY21F DPU estimates could range between +0.5% to +1% of FY19 DPU. Given the extended travel restrictions, we expect recovery in hospitality to be the slowest.
  • Similarly, FY21F DPU in healthcare, US office SREITs and overseas retail (China) is estimated to rebound by c.3% vs FY19 DPU, mainly driven by full-year contribution of newly acquired assets.

Yield disparity is attractive - FY21F yield at -1SD to mean except for industrial and healthcare.

  • FY21F dividend yield of all asset classes are trading at -1SD to mean levels except industrial and healthcare which are currently trading at close to or above +1SD given the projected inorganic growth profile for industrial and earnings visibility of healthcare. As such, we maintain our stance that the yield disparity between the ‘COVID resistant’ (industrial, healthcare) and ‘COVID impacted’ (retail, office and hospitality) is attractive as the latter ride on a gradual return to normalcy.

Recent analyst reports on S-REITs

Derek TAN DBS Group Research | Rachel TAN DBS Research | Dale LAI DBS Research | https://www.dbsvickers.com/ 2020-09-01
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