Singapore REITs – Climbing the “higher for longer” wall of worry
The S-REITs sector endured a tumultuous period in Oct 2023, correcting 6.9% before finding some reprieve in early Nov 2023 as share prices rebounded due to weak US payrolls data for the month of Oct 2023 and uptick in US unemployment rates which provided a signal that the Federal Reserve’s (Fed) rate hikes are likely now over. Our house view is for the fed funds rate to stay at 5.25-5.50% until next summer to curb inflation, before turning to rate cuts from Jun 2024, with a fed funds rate forecast of 4.50-4.75% over a 12-month horizon.
During the recently concluded 3Q23/9M23 earnings season, out of the eight S-REITs under our coverage which reported distribution per unit (DPU) data, seven declared lower year-on-year (YoY) DPU. The average and median DPU growth came in at -4.7% and -3.6% YoY respectively, for the reporting period. However, the lacklustre performance did not come as a surprise, as all these S-REITs’ results met our expectations.
Following this round of earnings, we adjusted our DPU forecasts by -0.7% for the current financial year (FY-1) and -0.9% for the next financial year (FY-2) on average, and by -0.2% for FY-1 and -0.7% for FY-2 on a median basis. Following these revisions, we now expect S-REITs under our coverage to register average/median DPU growth of -3.2%/-1.9% for FY-1, followed by a slight rebound of 1.8%/1.3% for FY-2. Our forecasts are 1.1% (average) and 1.4% (median) below the street for FY-1, and 0.5% (average) and 1.4% (median) lower than the street for FY-2. We have cut our fair value estimates by a larger magnitude of 7.5% on average and 6.9% on a median basis. This can be attributed largely to higher discount rates given increased market volatility and lower terminal growth assumptions as risks of a “higher for longer” interest rate environment could curtail both organic and inorganic growth prospects for the sector.
As we moved from 2Q23 to 3Q23, overall balance sheet metrics were stable for the S-REITs under our coverage. On a like-for-like basis, aggregate leverage ratio inched up quarter-on-quarter (QoQ) from 38.3% to 38.5%; proportion of debt hedged increased QoQ from 75.9% to 76.1%; interest coverage ratio declined QoQ from 4.4x to 4.0x; while weighted average cost of debt increased only 6 basis points (bps) sequentially to 3.23%, versus an increase of 9bps QoQ in the preceding quarter.
From a valuation viewpoint, the FTSE ST Real Estate Investment Trusts Index (FSTREI) is trading at a forward price-to-book (P/B) multiple of 0.82x (as at 10 Nov 2023), which is 2.2 standard deviations (s.d.) below its 10Y average of 0.99x. The forward distribution yield of 6.8% is 60bps or 1.2 s.d. above the 10Y average of 6.2%. Given the pullback in the Singapore 10Y government bond yield to 3.10% from a recent high of 3.51%, the current distribution yield spread between the forward distribution yield of the FSTREI and the Singapore 10Y government bond yield increased to 369bps, as at 10 Nov 2023, or 0.6 s.d. below the 10Y mean of 403bps. This current yield spread is close to the 5Y average of 386bps, and is a tad above the 3Y mean (363bps). Based on fund flow data from the Singapore Exchange, we can infer that S-REITs are among the least crowded trades for institutional investors, and reinvestment risks from shorter tenor alternative yield instruments such as the Singapore 6-month and 1Y Treasury bills lead us to opine that S-REITs can still warrant a position within investors’ portfolio.
As such, we reiterate our constructive stance on the S-REITs sector, but on a selective basis. We would avoid painting a broad brush across the entire sector as the macroeconomic environment remains uncertain and risks of a “higher for longer” interest rate environment would still have an adverse impact on DPUs both from an organic and inorganic perspective. From a bottom-up stock picking strategy, we continue to favour higher quality S-REITs with strong sponsors and robust balance sheets that can allow them to participate in more active inorganic growth when opportunities arise, and to better withstand a “higher for longer” interest rate environment. We also like S-REITs with at least some Singapore asset exposure given their relatively more resilient capital values and avoidance of FX translation losses. Besides reiterating our preference for CapitaLand Ascendas REIT [CLAR SP; FV: SGD3.17], Frasers Logistics & Commercial Trust [FLT SP; FV: SGD1.33], CapitaLand Ascott Trust [CLAS SP; FV: SGD1.14] and Mapletree Industrial Trust [MINT SP; FV: SGD2.59], we include Frasers Centrepoint Trust [FCT SP; FV: SGD2.35] as a replacement for Mapletree Logistics Trust [MLT SP; FV: SGD1.72]. We remain cautious on the outlook of Suntec REIT [SUN SP; FV: SGD1.06] and Keppel REIT [KREIT SP; FV: SGD0.84], while ongoing concerns over the financial health of Keppel DC REIT’s [KDCREIT SP; FV: SGD2.02] master lessee in China may continue to cast on overhang on its share price, in our view.
· DPU forecasts and fair value estimates lowered for S-REITs under coverage, but reiterate our constructive stance on the sector, though on a selective basis
· P/B multiple of 0.82x and forward distribution yield of 6.8% compare favourably to historical averages; distribution yield spreads increased to 369bps but still tighter than 10Y average
· Continue to recommend higher quality S-REITs with strong sponsors and robust balance sheets. Our preferred sector picks are CLAR SP, FLT SP, CLAS SP, MINT SP and FCT SP. We remain cautious on SUN SP and KREIT SP, and opine that ongoing concerns over the financial health of KDCREIT’s master lessee in China may continue to cast on overhang on its share price.