Retail recovery offset by macroeconomic headwinds
- Occupancy and tenant sales have recovered above pre-pandemic levels.
- Moderately protected from rising interest rates, with 69% of total borrowings hedged to a fixed rate. Every 50bps increase in SOR/SORA is estimated to impact DPU by c.1.3%.
- Maintain ACCUMULATE, DDM TP (COE 7.08%) lowered from S$2.64 to S$2.38. No change in DPU estimates. Cost of equity increased from 6.41% to 7.08% on higher risk-free rate assumption. The current share price implies a FY22e DPU yield of 5.7%. However, the yield spread has narrowed significantly since the start of the year from 4.36% to 2.65%.
Investment Thesis
- Slight positive rental reversions expected. 1H22 reversions came in at +1.7% (FY21 -0.6%) and expected to be similar for the rest of the year. Portfolio tenant retention rate is still healthy at 70-80% of the total portfolio. FCT’s retail portfolio has a well-spread lease maturity profile with a WALE of 1.85 years (by NLA) or 1.78 years (by GRI) and only 5.3% of expiring leases (by GRI) remain in 4Q22 for FY22. Shorter tenancies allow for faster repricing in rent to cope with surging interest rates.
- Occupancy and tenant sales above pre-pandemic levels. Occupancy dipped slightly from 97.8% in 2Q22 to 97.1% in 3Q22, but still above pre-pandemic levels of 96.5%. FCT are in advanced negotiations with replacement tenants to fill the space left by Filmgarde at Century Square, which caused the slight dip in occupancy. Tenant sales in 3Q22 were up 23% YoY, and c.10% above pre-Covid levels. Shopper traffic in 3Q22 was up 32% YoY, and c.80% of pre-Covid levels. We expect the impact from the further easing of community measures, especially the one where mask-wearing is no longer required in indoor settings except for certain situations, to further increase shopper traffic going forward.
- Prudent hedging strategies in place to mitigate risks from interest rate volatilities. 69% of total borrowings are hedged to fixed interest rate and the tenor of the hedge is usually matched with the debt maturity profile. All in, the cost of debt is 2.4%, and green loans account for c.31.6% of total borrowings. FCT has an aggregate leverage of 33.9%. Every 50bps increase in SOR/SORA is estimated to impact DPU by c.1.3%.
Outlook
On good footing to command rental growth. Hybrid work arrangements should benefit FCT’s malls, which are located near transportation nodes. Commute-driven footfall and incidental spending should see an uptick, lifting tenant sales and GTO revenue for FCT. Occupancy cost, at c.16-17%, is at the 5-year pre-pandemic average. Improving tenant sales should lower occupancy cost further, which may support FCT’s ability to raise rents. Utilities represent c.7% of property operating expense and are fully hedged for FY22. Energy contracts will expire in end-FY22 and mid-FY23.
Maintain ACCUMULATE, TP lowered from S$2.71 to S$2.38
No change in DPU estimates. Our DDM-TP is lowered from S$2.71 to S$2.38 as we increase our cost of equity from 6.41% to 7.08% on a higher risk-free rate assumption. P/NAV of 0.98x, which is trading near 5-year lows at -1 standard deviation level, might seem cheap. However, we think this is fair given the rising interest rate environment. The yield spread (dividend yield – 2 years Singapore government bond yield) has fallen from over 4% at the start of the year to 2.65%, and we expect this to fall even further as well. The current share price implies a FY22e DPU yield of 5.7%.