Singapore REITs - OCBC Investment 2020-11-27: A Tale Of Two Baskets – Recovery & Resilient


Singapore REITs - A Tale Of Two Baskets – Recovery & Resilient

Position S-REITs with 2 baskets: Targeting Recovery and Resilience

  • Given positive developments over the vaccine front following Pfizer and BioNTech, Moderna and to a smaller extent AstraZeneca and Oxford University’s announcements of their COVID-19 vaccine trial results, we believe the much beleaguered hospitality and retail REITs can finally see some light at the end of the tunnel, although volatility in share prices are expected and the road to recovery ahead is likely to be bumpy.
  • We remain OVERWEIGHT on S-REITs amid a lower for longer interest rate environment, although we are cognisant of the risk of a further potential spike in sovereign bond yields, which could make S-REITs relatively less attractive. With Joe Biden voted as the US President-elect, we see a more multi-lateral approach towards Sino-US relationships, while deglobalisation concerns may also be alleviated. This could support capital inflows to the region, including Singapore given its stable political climate and effective management of the pandemic.
  • Taking macro and vaccine developments into account, we highlight two S-REIT baskets for yield hungry investors to consider.
    • The first, a recovery basket to play the improvement in sentiment and recovery prospects of REITs in beaten down sectors. The optimism over an imminent availability of COVID-19 vaccines has fuelled confidence that the global economic recovery will gain momentum in 2021. This has underpinned a rotation to laggards and value stocks. We believe beneficiaries would include hospitality and retail REITs.
    • The second, a resilient basket comprising of S-REITs which we opine are beneficiaries of secular growth trends which could support outperformance over the medium to longer term. We recommend investors to take advantage of pullbacks to add positions as investors switch to laggards and value stocks. Examples include REITs exposed to data centres, logistics and business parks.

3QCY20 operational updates affirms that worst is likely over, although uncertainties remain

  • Comparison Comparison of financial performance within the S-REITs sector has been made more difficult with the removal of mandatory quarterly reporting, and the level of disclosures also varies for the different REITs for their business updates.
  • For S-REITs under our coverage, there were 11 which reported DPU figures during this reporting period (either for 3QCY20 or period from 1 Apr to 30 Sep 2020). Only one came in slightly above our expectations (Keppel DC REIT (SGX:AJBU)), three fell short and the remaining seven met our expectations. Y-o-y DPU growth was -14.3% for these 11 S-REITs, or -4.4% on a market-cap weighted basis.
  • However, disclosure on operating metrics within the sector remains transparent. Based on observed trends such as occupancy rates, rental reversions and other metrics such as footfall, tenants’ sales and RevPAR, we believe the worst is over with sequential improvement largely seen during this reporting period.
  • That said, a number of REITs are still reporting data which is a distance away from pre-COVID-19 levels, especially for the hospitality sub-sector. New government measures to support the survivability of companies, such as the intention to introduce a Re-Align Framework to help smaller and micro enterprises whose businesses have been severely hit by COVID-19 even after economic and social activities have resumed, also adds to overall uncertainties and does impact earnings visibility of some S-REITs to a certain extent.

Projecting firm recovery in DPUs amid low base and improvement in macro conditions

  • After fine-tuning our assumptions following this earnings season, we now forecast DPU for the S-REITs under our coverage to register a market cap weighted decline of 5.4% for the current financial year, followed by a solid rebound of 15.5% for the next financial year, largely due to a lower base effect from rental concessions and restrictive border closures during 2020.
  • However, investors should be cognisant that the road to recovery ahead is likely to be bumpy and fraught with challenges. Potential manufacturing bottlenecks and logistical difficulties in administering the COVID-19 vaccines to a widespread population for herd immunity could lengthen the recovery period.
  • In terms of valuations, the current forward yield spread between the FTSE Straits Times REIT Index (FSTREI) and the Singapore government 10-year bond yield is now 453 bps, which is approximately 0.6 standard deviations above the 10-year average of 418 bps.
  • We reiterate our OVERWEIGHT rating on the S-REITs sector. As highlighted earlier, we recommend investors to position with two baskets.

Retail REITs: Resilient occupancy but rents under pressure; improved outlook amid positive vaccine breakthroughs

  • Trends observed during the recent 3QCY20 reporting season include stable occupancy rates across retail REITs, with some seeing slightly improved take-up on a q-o-q basis. However, this likely came at the expense of rents as one of the priorities of REIT Managers was the retention of tenants to minimise vacancy risks given the challenges of finding replacement tenants amid a soft leasing environment. Hence negative rental reversions were prevalent across most retail REITs.
  • Singapore’s retail sales excluding motor vehicles fell 12.7% y-o-y for the month of Sep. The magnitude of decline has widened for two consecutive months, a reflection of the still challenging operating landscape.
  • Trade categories which performed well during the month include Supermarkets & Hypermarkets (+17.9%), Furniture & Household Equipment (+10.9%) and Recreational Goods (+6.0%). The former two were also the best performing industries in Aug. On the other hand, the largest declines came from Food & Alcohol (- 41.0%), Department Stores (-39.8%) and Cosmetics, Toiletries & Medical Goods (-30.0%).
  • The weak performance of Department Stores can also be seen in the recent headline news of Robinsons, one of the oldest retailers in Singapore, announcing its decision to close its last two remaining outlets in Singapore. One of the outlets is located in Raffles City Shopping Centre, which is owned by CapitaLand Integrated Commercial Trust (SGX:C38U). However, given the benefits of a diversified portfolio post-merger, the Al-Futtaim Group, which owns Robinsons, only contributed ~1.5% of CapitaLand Integrated Commercial Trust’s monthly gross rental income.
  • Meanwhile, there are also some retailers who are willing to capitalise on the lower rent environment to expand their operation. For example, Marks & Spencer has opened a new “pop-up” store at Waterway Point that will operate for the next six months, according to The Business Times. Timezone will also be opening its largest outlet in Singapore in Westgate in early Dec.
  • Online sales as a proportion of total retail sales in Singapore came in at 11.2% in Sep, and this has been stable around the 11% level for three straight months now. While competition from e-commerce will continue to pose structural challenges for brick and mortar retail, we believe the positive vaccine developments has improved the outlook for the retail sub-sector with a potential return to normalcy soon. The boost in investors’ sentiment could thus lead to a further re-rating, especially for the higher quality retail REITs.
  • Based on Google’s mobility reports, visitation to Retail and Recreation facilities (e.g. restaurants, cafés, shopping centres) in Australia, Hong Kong and Singapore are down 13%, 12% and 14%, respectively, as at 20 Nov, compared to the baseline, versus their respective troughs of -76%, -55% and -70% during periods of lockdowns. Hong Kong’s retail sales remained in negative growth territory on a y-o-y basis, although the magnitude of decline has continued to narrow every month since Mar this year.
  • That said, we note that Sep’s 12.9% y-o-y fall was only slightly better as compared to the 13.1% dip in Aug, while the resurgence in COVID-19 cases since mid-Nov also poses downside risks to the recovery prospects.

Office REITs: Rental downtrend continues, WFH news continue to dominate

  • News surrounding working from home (WFH) continue to garner keen investor interest. This is the elephant in the room for the office sub-sector given the uncertainties of future workspace demands as companies continue to evaluate the situation.
  • According to an article by The Business Times, Mizuho Financial Group is looking to reduce its space requirements by 16% at Asia Square Tower 2, which equates to less than one floor out of four which it is currently occupying at the office building. Nomura, another Japanese financial institution, is also reportedly allowing its overseas staff to be able to work flexibly on a permanent basis.
  • In Singapore, the potential space downsizing by financial institutions would be partially offset by Chinese tech companies seeking to expand their presence here. Based on our channel checks, we believe there is progress made on the backfilling of the UBS space to be vacated at One Raffles Quay (Keppel REIT (SGX:K71U) and Suntec REIT (SGX:T82U) each own a one-third stake), with the possibility of finding replacement tenants for 100% of the space to be vacated by year end.
  • Meanwhile, media reports highlighted that ByteDance has decided to take up more space at the buidling (not part of the UBS space). However, uncertainties surrounding future office space demand remains high, as illustrated by Keppel REIT highlighting that some of its financial institutional tenants may give up 10-30% of their space when their leases expire in 1-2 years’ time.
  • Based on property consultants’ data, the dip in CBD office rents in Singapore has not showed any signs of abating. The decline in 3Q20 was broad-based across all micro-markets as tracked by Savills Research & Consultancy on both a y-o-y and q-o-q basis. CBRE data pointed to q-o-q declines of 4.0% and 3.6% to S$10.70 psf/month and S$8.15 psf/month for core Grade A and B CBD office rents in 3Q20, respectively. Savills Research & Consultancy has forecasted Singapore’s CBD Grade A office rents to fall by 6% in 2020 followed by another 10% decline in 2021 (as at Oct 2020). Meanwhile, islandwide net absorption for office space in Singapore came in at -204,514 sq ft in 3Q20, the third consecutive negative quarter.
  • However, we believe the silver lining could come from a potential faster pace of economic rebound next year following better-than-expected COVID-19 vaccine trials, coupled with potential supply being taken out of the market for redevelopment, such as AXA Tower, Fuji Xerox Towers and Central Mall.

Industrial REITs: Most resilient, but not unscathed

  • The industrial REITs under our coverage largely exhibited relatively resilient operating metrics during the 3QCY20 reporting period. All, with the except of ESR-REIT (SGX:J91U), achieved a slight q-o-q improvement in their portfolio occupancy rates. Rental reversions were more mixed.
  • According to statistics from JTC, overall price and rentals of industrial properties fell 2.2% and 0.9% q-o-q, respectively, in 3Q20. For the latter, all sub-segments saw declines. This came in at -1.1% for Multiple User Factory, -0.7% for Single User Factory, - 1.0% for Business Park and -1.1% for Multiple User Warehouse.
  • On the economic data front, Singapore’s manufacturing and electronics PMI continued to show improvement, coming in at 50.5 and 51.0 for the month of Oct, respectively. The New Orders PMI of 50.6 was the second consecutive month of expansion. However, the road to recovery remains bumpy, as exemplified by the 0.9% y-o-y decline in Singapore’s industrial production in Oct, which was below the street’s expectations and also well below the upwardly revised growth of 25.6% and 16.4% y-o-y in Sep and Aug, respectively. The drag came largely from transport engineering (-31.8%) and general manufacturing (-12.8%), but partially offset by growth in precision engineering (+10.6%) and biomedical manufacturing (+10.2%).
  • Non-oil domestic exports fell 3.1% y-o-y in Oct, reversing four consecutive months of growth and was also below consensus expectations.
  • For China, its manufacturing PMI stood at 51.4 for the month of Oct. This was slightly lower than in Sep (51.5), but remained in expansionary territory since Mar this year. Its New Export Orders PMI continued its recovery momentum, coming in at 51, versus 50.8 in Sep.
  • Our Chief Economist believes that China’s strengthening recovery is keeping it on track to be the only major economy to achieve positive full-year growth in 2020, supported by the rebound in industrial production, retail sales and fixed asset investments.

Hospitality REITs: Recovery to kick-start in 2021; we turn more positive

  • We have turned more positive on hospitality REITs following encouraging developments on COVID-19 vaccine trial results by a number of companies, which could lead to the administration of the first round of vaccines by the end of this year. While recovery in industry RevPAR/RevPAU back to pre-COVID-19 levels is likely to happen only in 2022 or 2023, the forward looking nature of investors leads us to believe the re-rating of hospitality REITs can continue, although volatility in share prices is likely.
  • We have recently increased the fair values of all the three hospitality REITs under our coverage, and our order of preference is Ascott Residence Trust (SGX:HMN), CDL Hospitality Trusts (SGX:J85) and Far East Hospitality Trust (SGX:Q5T).
  • See reports:
  • RevPARs/RevPAUs in 3Q20 were still significantly lower on a y-o-y basis, but mostly showed an improvement on a sequential basis. In Singapore, according to statistics from the Singapore Tourism Board (STB), although international visitor arrivals has increased m-o-m for five consecutive months from May to Sep, overall figures are still a tiny fraction of what it was during the same period last year. Hotel RevPAR dipped 65.0% y-o-y in Sep, the same magnitude of decline recorded in Aug. RevPAR for 3Q20 came in at S$67, representing a 67.5% y-o-y fall but an increase of 81.1% q-o-q.
  • On an encouraging note, STB highlighted that a Brand Health Study across 14 markets conducted in Aug showed that confidence in travelling overseas for leisure and business has been steadily increasing. 76% of leisure travellers and 90% of business travellers said that they are likely to travel in the next 12 months, if possible. The business travellers in the survey also had a strong perception that Singapore was a safe destination to visit despite the COVID-19 pandemic.
  • For the Asia Pacific region, industry watcher STR highlighted that the hotel industry reported its best performance levels since 1Q20, based on Oct data. However, growth unsurprisingly remained negative. For instance, RevPAR fell 51.4% y-o-y to A$73.0 in Australia for the month of Oct in local currency terms. The RevPAR decline was only 12.1% for China.
  • Moving further away to the US, the overall operating environment remains challenging given the rising number of daily infections. Hotel occupancy has been trending down since Oct, and overall RevPAR for the week of 15-21 Nov saw a decrease of 52.2% y-o-y to US$36.5.

OCBC Research Team OCBC Investment Research | https://www.iocbc.com/ 2020-11-27
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