SREIT – DBS

Facing headwinds

Sector outlook and valuation: The S-reit sector is currently trading at average FY08 yield of 7%, a 360bps spread over the 10-year bond yield and at 0.79x P/book NAV. We believe that much of the rising interest rate expectation and slower economic outlook is likely factored in the current share price. While the sector is likely to continue seeing headwinds from the negative newsflow from the tight credit and sluggish capital markets, valuations are not excessive by historical standards, as yield spreads are trading above their longterm average levels.

Raising cost of capital assumptions. Using higher debt and equity costs have eroded S-reit returns. Even then, Sreits are trading at steep 24% discounts to DCF-backed price projections, which are based on these greater cost of capital assumptions. Essentially, we have lowered our price targets by 19% by increasing our equity discount rates by 107bps. Another issue surrounding the S-reit sector is the relatively short debt expiry profile, estimated at 2.9 years. S-reits have an estimated $5.1b (43% of total) debt to be renewed in the next 12-18 months. However, with more than 75% of total debt on fixed rates or are hedged, the impact of the hike would likely be moderated.

Stock selection is key. Under the present dampened acquisition growth environment, we would be selective in our S-reit picks and would prefer those with strong organic growth potential to drive DPU expansion, such as retail reits as well as those with long lease expiry profiles such as industrial reits. Amongst our top picks are CMT and A-reit. CMT has a multi-pronged growth strategy through organic and asset enhancement activities. A-reit has a relatively long weighted lease expiry profile of 5.5 years that would enable them to have earnings certainty and visibility. There is potential for more rental hikes given that industrial rents have not appreciated significantly from the low. Share price of A-reit had declined 23% since May 08 and is currently offering 7.4- 7.5% FY09 and FY10 yields.