Singapore REITs - CGS-CIMB Research 2021-03-25: The Game Is Not Over; Keep OVERWEIGHT


Singapore REITs - The Game Is Not Over; Keep OVERWEIGHT

  • We remain positive on S-REITs given robust fundamentals and growth outlook and see any weakness as an opportunity to accumulate S-REITs at attractive prices.
  • We expect S-REITs’ share price performance to be underpinned by the resumption of dividend per unit (DPU) growth in FY21F and inorganic growth potential via strong balance sheets. We continue to like the retail and selective industrial sub-sectors. We turn more upbeat on the longer-term prospects of the hospitality sector in anticipation of reopening of borders on COVID-19 vaccination rollouts and upgrade Ascott Residence Trust (SGX:HMN) and CDL Hospitality Trusts (SGX:J85) to ADD.
  • Reiterate Overweight; our top picks are Ascendas REIT (SGX:A17U), Frasers Logistics & Commercial Trust (SGX:BUOU) and Frasers Centrepoint Trust (SGX:J69U).
  • Key risks include sharper-than-projected interest rate hikes that could negatively impact our cost of equity assumptions assumed for DDM-based stock valuations and slower-than-expected global economic recovery.

Rising bond yields drag on S-REIT performance

  • The recent spike in SG and US 10-year bond yields as well as inflation concerns have led to an underperformance of S-REITs vs the broader Singapore market since Jan 2021. S-REITs are trading at the long-term trailing average P/BV multiple of 1.03x. With the spike in the 10-year SG government bond yield to 1.59%, as at 24 Mar 2021, dividend yield spread compressed to 284bp, marginally below the 2002-20 average spread of 3.37%. Near-term upside momentum in SG long bond yields could mean S-REITs may remain range-bound in the short term.
  • Nonetheless, we stay positive on the sector on robust fundamentals and growth outlook and see any weakness as an opportunity to accumulate at attractive prices. S-REITs’ share price performance is underpinned by the resumption of DPU growth in FY21F and inorganic growth outlook via strong balance sheets. We project the current S-REIT average sector DPU yield of 4.4% to trend towards 5% in FY21F, reverting to the 18- year average spread of ~337bp.
  • We continue to like the retail and selective industrial sub-sectors.
    • We turn more upbeat on the longer-term prospects of the hospitality sector in anticipation of the reopening of borders as COVID-19 vaccination rollouts gain momentum.
    • Near-term outlook for office is underpinned by positive reversions, though long-term prospects remain opaque without clear demand direction on the back of work-from-home (WFH) trend.

S-REITs 4Q/2H20 DPU performance indicates mixed recovery

  • Retail REITs’ occupancy in 4QCY20 improved on a q-o-q basis despite much lower rental support. Rental reversions were negative in 4Q20, except for Frasers Centrepoint Trust (SGX:J69U) (relatively flat reversions on average in 4Q20). Tenant sales continued to recover on a q-o-q basis, with 4Q20 suburban mall tenant sales at -10% to +10% vs 2019, and downtown malls’ at 70-85% vs 2019.
  • In 2H20, office REITs continued to enjoy positive rental reversion, although at a more modest pace vs 1H, as market rents continued to decline. Committed occupancies have remained high, in excess of 90%, on the back of more renewals. Office physical occupancy was at ~25% as employees continued to WFH.
  • Industrial REITs reported fairly in-line results in 4QCY20. Rent reversions were mixed, while portfolio occupancy and rental collection remained high with deferments staying low.
  • Hospitality REITs delivered lower revenue per average room (RevPAR), down 40-60% y-o-y, in Singapore in 4QCY20 but there was q-o-q improvement due to demand for staycation. Overseas operations were weaker y-o-y with RevPAR -11% to -90% y-o-y in 2H2020. q-o-q comparisons were mixed depending on the pace of recovery in different countries.

We project S-REITs to resume earnings growth in FY21F and FY22F

  • While S-REITs may face some near-term headwinds from rising bond yields, we believe improved earnings outlook and strong balance sheets to tap inorganic growth will continue to drive sector performance.
  • Looking ahead, we project S-REITs under our coverage to deliver, on average, 8.1% and 1.3% DPU growth for FY21F and FY22F, respectively, backed by lower tenant relief, positive rental reversions and contributions from new acquisitions completed in FY20.
  • We expect the hospitality and retail segments to show strongest y-o-y DPU growth (vs the overall S-REIT sector) of 22.8% and 25.8%, respectively, in FY21F, due to a low FY20 base and improved operating performance.
  • With sector gearing at ~39% at end Dec 2020, S-REITs still have significant debt headroom to undertake acquisition growth opportunities. Our current forecasts have not factored in pre-emptive acquisition growth.

Evaluating S-REITs’ performance during periods of rate hikes

  • The SG 10-yr bond yield is up 80bp since Nov 2020, mainly since the second half of Feb 2021, at 1.59%, as at 24 Mar 2021. This, and inflation concerns, had put a dampener on S-REITs’ share price performance. In this section, we look at S-REITs’ performance during and after periods of interest rate hikes.
  • Historically, FSTREI’s performance has a high negative correlation with 2Y-10Y yield spreads. In its 2Q21 Fixed Income Navigator, CIMB Treasury and Markets Research team has projected a 30bp and 15bp increase in the 2-yr and 10-yr SG bond yields during 2Q21-1Q22, with our forecasts remaining above market consensus, based on Bloomberg estimates.
  • That said, our in-house projections also show that the 2Y-10Y yield spread is expected to narrow due to a faster pick-up in the shorter end of the yield curve. We believe that the narrowing of the yield spread could be supportive of S-REITs’ share price performance.

Marginal impact from rising bond yield on valuations

  • The impact of rising bond yields can be felt by S-REITs in two ways –
    1. firstly, on valuation as DDM-based target prices are affected by changes in cost of equity assumptions and
    2. on earnings and DPUs through potentially higher debt costs.
  • From a valuation perspective, we value S-REITs using DDM-based methodology. A higher risk-free rate would have a knock-on impact on our cost of equity assumptions and impact our target prices. In our assessment, a 0.1% pt rise in risk free rate would likely result in a mild 0.2-3.8% erosion in our DDM-based target prices.
  • Our current assumed SG risk free rate assumption is at 1.7%, still slightly higher than the current market yield and thus provide some buffer to our valuations.

Assessing the impact of rising funding cost on S-REIT DPUs

  • S-REITs have robust balance sheets. Average S-REIT sector gearing increased slightly to 39% at end-CY2020, on new acquisitions and property revaluation deficits from year-end valuations, but still well below the 50% guideline ceiling. The sector has little refinancing risk with 11% of total sector debt to be refinanced in 2021F while the proportion of floating rate debt increased to 25.2% at end-Dec 2020.
  • That said, while absolute funding costs still remain low, normalisation of the interest rate trend could likely to filter into S-REITs’ earnings gradually.

Marginal impact on S-REIT DPUs from funding cost sensitivity

  • S-REITs’ average debt cost has been declining q-o-q over the past few quarters and remains low. Our sensitivity analysis shows that every 0.1% pt change in floating debt cost and 0.5% pt change in refinancing cost for debt due over the next 12-18 months could erode DPUs by a marginal 0-1.6%.
  • We think higher geared S-REITs, especially those with leverage above 40%, and those with a greater proportion of floating rate debt, will likely be more impacted by the rising interest rate trend.
  • In addition, S-REITs with greater proportion of debt refinancing over the next 12-18 months, may feel the impact of higher debt cost sooner, in our view.

S-REIT Sector Strategy – Maintain OVERWEIGHT

S-REIT Sub-sector Outllook

Retail REITs -

Office REITs -

  • As employees shift from a WFH to a more flexible and hybrid way of working, we think office occupancy may face some volatility as tenants reassess their new office core/flex workspace requirements.
  • Potential upside risk to office rents include delayed new supply and demand from Chinese tech companies.
  • Our preferred pick is Keppel REIT (SGX:K71U) given its high exposure to the Singapore office market.

Industrial REITs -

Hospitality REITs -

Refer to the 37-page report attached below for complete analysis and also the latest peer comparison table of S-REITs.

LOCK Mun Yee CGS-CIMB Research | https://www.cgs-cimb.com 2021-03-25
SGX Stock Analyst Report ADD UPGRADE HOLD 1.200 UP 1.08