Singapore REITs - UOB Kay Hian 2022-10-10: Europe Almost Overcoming Energy Crisis; S-REITs Valuation Attractive After Panic Selling


Singapore REITs - Europe Almost Overcoming Energy Crisis; S-REITs Valuation Attractive After Panic Selling

Germany almost overcoming blackmail by Russia.

  • Germany plans to reduce its reliance on imports of natural gas from Russia from 55% to 10% by 2024. It has sourced imports of LNG from the US and natural gas from other European countries, such as Norway. Germany has signed an agreement with Qatar to expand trade in LNG. It has expedited the construction of five floating LNG terminals, which are targeted to be completed by Dec 22.
  • Germany has ramped up the supply of electricity from coal-fired power stations. It has put two out of the three nuclear power stations due to shut down by end-22 on standby. Germany has also stepped up investments in renewable energy.

Europe is prepared for winter.

  • EU states have voluntarily cut their gas usage by 15% since Aug 22. Germany’s stockpile of natural gas in storage tanks has hit 85% as of Sep 22. On an EU-wide basis, gas reserve has reached 80% of total capacity, two months ahead of the target set for 1 Nov 22.
  • Europe is able to sail through winter without rationing if the forecast of mild weather materialises. The prices of electricity in Germany have collapsed by two thirds to €187/MWh, compared with the peak of €683/MWh set in Aug 22.

UK made fiscal policy blunder.

  • Chancellor Kwasi Kwarteng unveiled a £45b mini budget on 23 Sep 22, comprising unfunded cuts in corporate tax, income tax, stamp duty and national insurance. Separately, the government will be spending £150b to subsidise energy costs for businesses and consumers. The expansionary fiscal policy undermines Bank of England’s (BOE) efforts to tighten monetary policy.
  • The violent sell-down in gilts caused margin calls and a liquidity crisis for pension funds, which triggered emergency intervention by BOE to purchase long-dated gilts.

Anxiety abated after policy U-turn.

  • Chancellor Kwasi Kwarteng made a humble tactical retreat and removed the dreaded cut in top rate for income tax from 45% to 40%. To shore up confidence and reassure financial markets, he will be bringing forward the announcement of his 5-year plan to reduce government spending and lower public debt.
  • Fortunately, the financial turmoil was confined to the UK.

Euro hurt by Russia-Ukraine war.

  • The Euro depreciated 13.8% against the US dollar and 8.7% against the Singapore dollar on an year-to-date basis. Yield for 10-year German Bund surged 57bp to 2.08% in Sep 22. According to UOB Economics & Markets Research, EUR Refinancing Rate is expected to hit 1.75% by end-22, compared with current 1.25%.

Pound sterling hurt by untimely pursuit of supply-side reforms.

  • The pound sterling plummeted 15.6% against the US dollar and 12.6% against the Singapore dollar on a year-to-date basis. See Singapore dollar exchange rates. Yield for 10-year UK gilts surged 129bp to 4.17%. BOE is expected to respond to the government’s expansionary fiscal policy by jacking up interest rates.
  • According to Markets Research, GBP Repo Rate is expected to hit 4.25% by end-22, compared with current 2.25%.

Composure gradually restored after panic selling.

CapitaLand Ascendas REIT (SGX:A17U)

CapitaLand Ascott Trust (SGX:HMN)

CDL Hospitality Trusts (SGX:J85)

Elite Commercial REIT (SGX:MXNU)

  • Benefitting from higher inflation. The leases with the UK government are full repairing and insuring triple net leases whereby operational expenses are borne by tenants. Thus, Elite Commercial REIT is insulated from negative impact from higher inflation and higher cost of electricity. The leases provide high NPI margin of 97.1% in 2021. They have rent reviews every five years benchmarked against the UK Consumer Price Index (CPI). The built-in rental escalation is subject to an annual minimum increase of 1% and a maximum of 5%. Based on consensus estimate of 9.0% for the UK’s CPI in 2022, we estimate the step-up in rents at 15.4% for Apr 23.
  • Overhang from break clauses resolved. Majority of 136 DWP leases have no break clauses. 27 of the DWP leases are straight leases without break clauses. Break clauses were removed from 108 leases, of which rents for 97 leases were maintained while rents for 11 leases were reduced. The reduction in rents for the 11 commercial properties is estimated at 36% (before positive impact of rental escalation). DWP also signed a new 5-year lease for one commercial property at East Street, Epsom. Properties with rental income secured till Mar 28 contributed 87.5% of gross rental income as of Jun 22. Elite Commercial REIT has a long WALE of 5.2 years as of Jun 22.
  • Affected by rate hikes. Pound sterling is the appropriate functional currency for Elite Commercial REIT because its revenue, expenses, assets and liabilities are all denominated in Pound sterling. Elite Commercial REIT has hedged 63% of its borrowings to fixed rates. We expect Elite Commercial REIT to refinance borrowings of £88m due Jan 23 at a cost of debt of 6.0% (three-month Sterling Overnight Interbank Average Rate (SONIA) at 4.25% plus spread of 1.75%). We estimated average cost of debt of 4.6% for 2023. We have cut our 2023 DPU forecast by 13.6% to 4.1 pence.
  • Maintain BUY on Elite Commercial REIT. Our target price of £0.65 is based on DDM (COE: 8.5%, terminal growth: 2.25%). We have increased risk-free rate from 3.00% to 3.75%.
  • See

Frasers Logistics & Commercial Trust (SGX:BUOU)

Lendlease Global Commercial REIT (SGX:JYEU)

Suntec REIT (SGX:T82U)

  • Recovery strongest at West End. Suntec REIT opportunistically acquired Nova Properties (West End) and Minster Building (City of London) during the COVID-19 pandemic in 2021. London has since weathered Brexit and the COVID-19 pandemic. The recovery in take-up for office space in the past 12 months was broad-based but was strongest for the West End at 24% above the 10-year average. The recovery was driven by the financial services sector. The impending overhaul of financial regulations could help London reclaim the title as the busiest financial centre in the world.
  • Manageable exposure to London in UK. London accounted for only 11.5% of Suntec REIT’s portfolio valuation. The UK portfolio provides stable contribution with long WALE of 10.1 years. It has borrowings of £375m denominated in Pound sterling, which provides natural hedge of 47%.
  • Maintain HOLD on Suntec REIT. Our target price of S$1.57 is based on DDM (COE: 7.25%, terminal growth: 1.8%).
  • See

Sector Catalysts

  • Hospitality, retail and office REITs benefitting from the reopening of the economy.
  • Limited new supply for office, logistics and retail segments in 2022.

Sector Risks

  • Escalation of the Russia-Ukraine war beyond Ukraine.
  • Persistent and elevated inflation causing more rate hikes in 2023.

More on S-REITs

Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2022-10-10
SGX Stock Analyst Report HOLD MAINTAIN HOLD 1.570 SAME 1.570