Rising Risks But Slower Growth

In 1Q13, the FSTREI performed slightly better than STI, with a YTD appreciation of +12% vs the latter +7.5%. During this period, the low interest rate and high liquidity environment have prompted investors to continue their chase for yield plays. In this report, apart from providing a recap and an outlook on the sector, we also examine the effects in the event if any/all the three main drivers of the S-REITs sector changes.

Stable results – grew through AEIs and acquisitions. The latest SREITs results posted market cap weighted average growth of +3.5% y-o-y and +1.4% q-o-q in DPU for the sector. Among the 23 REITs (excluding MAGIC) listed in Singapore, only four REITs reported a lower y-o-y DPU. Among the REITs that recorded a positive growth in earnings, 61.1% of them grew as a result of AEIs (16.7%) and new acquisitions (44.4%).This is inline with our earlier view that most REITs will focus on growing their earnings inorganically, on the back of a low interest rate and high liquidity environment.

Flattish outlook in the various subsectors of SREITs. Although the rental market continues to be well-supported by the various industries, the outlook for possible positive reversion appears dampen in the industrial, hospitality and retail market as the global economy remains uncertain. Coupled with ample supply of commercial buildings over the next two years, we retained a flattish outlook on these sub-sectors. However, in a mid-term timeframe, we remain positive on the outlook of the Grade-A office sector in Singapore as demand remains limited coupled with an expected uplift in rental rates as the economy recovers.

Risk in the SREITs sector increases. Although we do not expect the i) global outlook, ii) high liquidity and iii) prolonged low interest rate environment to change in the near term, a closer examination indicated that if any of these factors are to change, it could potentially result in a sell-down in SREITs. In our view, given the high sector valuations, the risk-reward profile is less sanguine than before. We, therefore, introduce a new return gearing metric that takes these factors into account to study the relationship between share price, risk and return.

Maintain NEUTRAL on rich valuations; positive bias remains. On the back of i) flattish outlook in the various SREITs subsectors; ii) high valuations of S-REITs; iii) lack of growth catalysts in the near term; and iv) rising risks in the SREITs sector, we maintain our NEUTRAL view in the SREITs sector. However, positive bias remains if more liquidity flows into the market due to the latest QE program from Japan.

THE BURGEONING MARKET

• S-REITs continue to perform
  
• Sector currently trading at 1.24x P/B
  
• Prefer S-REITs with strong fundamentals and compelling valuations
  

Firm 1Q13 performance; mostly in line

In our latest assessment of the S-REITs sector, we continue to see familiar trends. REIT managers have generally maintained firm growth in their trusts’ rental income, on the back of contributions from past investments and improved operational performance. Of the 16 SREITs under our coverage, 10 of them reported results that were in line, three exceeded our expectations, while the remaining three fell short of our forecasts.

Leasing activities remained largely healthy

1Q13 operating metrics for most of the S-REITs had stayed resilient. Average portfolio occupancy was stable at 96.9%, whereas the weighted average lease to expiry improved from 4.3 years in 4Q12 to 4.5 years. In addition, positive rental reversions were also clocked. This clearly illustrates the healthy rental market demand and proactive lease management on the part of the REIT managers, in our view.

Active capital management

We also observe that S-REITs have been very active in refinancing its existing debts and maintaining an optimal capital structure. There were a slew of private placements in 1Q, which helped keep the aggregate leverage healthy at 32.1%. Going forward, we believe that the sector’s aggregate leverage is set to trend upwards. As such, SREITs may continue to tap the equity capital market to fund their proposed investments. The cost of debt is expected to maintain at current levels or increase marginally, as S-REITs trade possibly higher interest costs for diversified funding sources, longer term debt, and/or an improvement in their unencumbered asset ratios.

Sector outlook remains sanguine

For 2013, we are maintaining our view that S-REITs are likely to continue to deliver firm performance. All the S-REITs are either involved in asset enhancement initiatives/development projects, pursuing yield-accretive acquisitions, or enhancing their portfolio metrics through active leasing efforts, which should lead to continued strong numbers for their financial scorecards. For our coverage, we expect the S-REITs to post 6.6% growth in aggregate DPU for the current fiscal year, before experiencing another 8.6% growth in the next year.

Prudent to be selective

Nevertheless, the S-REIT index has been enjoying a good run-up, raking up 36.7% gain in 2012 and another 12.7% increase YTD. Given that the S-REITs are now trading at a 24% premium to book value on average, we feel that it is prudent to be selective on S-REITs. We continue to prefer S-REITs with good growth potential, strong financial position and compelling valuations (relatively lower P/B and decent DPU yields). In this respect, we continue to pick CapitaCommercial Trust [BUY, S$1.80 FV], Fortune REIT [BUY, HK$8.64 FV] and Starhill Global REIT [BUY, S$1.05 FV] as our preferred BUYs. Reiterate our OVERWEIGHT view on the broader SREITs sector.