Retail REITs – DBSV

Staying on top of the game

• Stronger earnings growth from 2H12 as AEI works bear fruit

• Healthy pre-commitment rates with strong tenant mix to continue to drive strong organic growth

• Top pick – CMT for its strong earning visibility

Better performance from 2H. Competition for the consumer dollar over the last two years has prompted landlords to undertake refurbishment and repositioning initiatives to remain competitive and relevant to changing consumer taste. As the malls move towards the tail end of their development schedule, we believe the gradual completion of AEI, coupled with the positive rental reversions, should support strong FY13 DPU growth of 6% y-o-y for the retail reits vs the other reit sectors. More importantly, we note that malls that have post AEI works are able to achieve higher average annual rental growth of at least 8% vs the average reversionary rental reversion of 2-3% p.a.

Reaping the benefits of AEI works. Supporting our positive outlook is the strong earnings growth of 15-16% q-o-q for FCT’s 2Q results upon the completion of Causeway Point’s AEI works (Phase 1) in Dec 2011. CMT’s JCube, which opened in April this year, was almost 100% occupied and we should expect higher contribution from 2Q onwards. Our recent visit to Causeway Point and JCube malls also reaffirmed the REIT managers’ asset enhancement execution ability. We were impressed with the mix of tenants that the malls have brought in and the higher foot traffic they attract.

Attractive tenant mix supports healthy rental reversion and pre-commitments. We are pleased that reit managers have traded up the mall’s tenant mix featuring new-to-market brands and concept stores. Meanwhile, some of these malls will also see higher F&B components upon the completion of the AEI works. We like this strategy because popular F&B joints are high yielding tenants, much like fashion retailers. They also double as crowd pullers. This would enable landlords to drive rental reversion and occupancies in the longer term. Apart from that, leasing activities have been healthy resulting in strong leasing pre-commitments of >70%, way ahead of the AEI completion dates.

Stock picks. We continue to like the retail reits for its visible earning drivers and low earning volatility, backed by the more resilient nature of nondiscretionary consumption. Within this space, we like CMT (BUY, TP S$2.05) for its strong earning visibility. We expect the AEI works that are completing progressively to underpin earning growth, while proceeds from its recent divestment of Hougang Plaza could be deployed to higher yielding sources.