SREIT – UOBKH

Risk-reward balance tilted negative as yield curve steepens

Long-term interest rates pulling SIBOR higher. Benchmark 10-year Singapore government bond yield has further increased from 3.3% to 3.61% last week. 3-month SIBOR has remained relatively stable to 1.25% but 6-month, 9-month and 12-month SIBOR have trended marginally higher. 3-month SIBOR is likely to have bottomed and a move towards 1.5% by end-2008 is highly likely.

Crude oil prices continue to climb despite signs of demand attrition. Indonesia has cut fuel subsidies and raised petrol prices from Rp4,500/litre to Rp6,000/litre on 24 May. Malaysia has just raised petrol prices by 41% to RM2.70/litre and diesel prices by 63% to RM2.58/litre on 4 Jun. Similar adjustments are also implemented in Bangladesh, India, Sri Lanka and Taiwan. Current high level of energy prices is starting to curb consumption. Airlines have started to cut frequency of flights. Logically, consumers will also start to moderate consumption. However, crude oil prices continue to climb by 4.5% last Thursday and 8.4% last Friday to end the week at historic high US$138.54/barrel despite signs of demand attrition.

Fighting inflation with higher interest rates. Bank Indonesia has raised 1-month interest rate by 25 basis points to 8.5%. The Philippines central bank has similarly raised overnight rate by 25 basis points to 5.25%. The European Central Bank has also signalled possible hike in interest rate in Jul 08 due to mounting inflationary pressures. Interest rates are on the rise on a worldwide basis, except maybe the US, as central banks combat inflation.

Mounting challenges for Singapore REITs from higher interest rates. MAS has raised CPI inflation forecast to 5-6% in 2008, an upward revision from previous 4.5-5.5%. Although downside risk has heightened in recent months, MAS has maintained Singapore GDP growth forecast of 4-6%. The strong S$ is expected to provides some cushion again inflation.

The steepened yield curve pose challenges for Singapore REITs as it hamper efforts to secure longer-term funding. Investors will be concerned that REITs may face difficulties refinancing short-term borrowings and to grow via acquisitions. We have further adjusted our target prices for Singapore REITs to factor in a higher risk-free rate of 3% vs previous 2.50%. We are using required rate of return of 8.5% for our dividend discount models.

We have cut our target prices for Singapore REITs by another 4% to 6%. We have also downgraded our recommendation for CapitaMall to HOLD as the stock provides upside of only 2.1%.

Ascendas REIT (BUY/S$2.44/Target: S$3.00)

• A-REIT has benefitted from strong demand for suburban office space as Business & Science Park accounted for 25% of its portfolio by property value. Renewal rate for Business & Science Park was S$3.76psf pm in 4QFY08, 68.8% higher on a yoy basis.

• A-REIT had a portfolio of 84 properties and total assets of S$4.2b as at Mar 08. The weighted average lease to expiry is 5.9 years. A-REIT has a well-diversified tenant base of over 790 international and local companies.

Parkway Life REIT (BUY/S$1.21/Target: S$1.52)

• The minimum rent payable by each hospital is set at Consumer Price Index + 1% above rent payable in the preceding year. Assuming CPI is 5.5% in 2007, the minimum rental increase for Gleneagles, Mount Elizabeth and East Shore hospitals is 6.5%.

• Parkway Life REIT will be acquiring two nursing homes Yokohama City and Ibaraki City in Japan for S$34.9m. Nursing home operator ZECS Community Co Ltd will lease back the properties for 15 years with option to extend for an additional five years. The properties provide net operating income yield 6.1% and 6.7% respectively and rental income is indexlinked to inflation with rent reviews every five years.