SREITs – ML
All about cost of debt
Downgrading S-REITs
We are increasing our cost of debt assumptions across the S-REIT sector. We reduce our FY09 and FY10 DPU estimates by an average of 5.3% and 6.4% respectively, while our price objectives are cut by an average of 16%. We are now forecasting DPU declines in 2009 for one third of our sector coverage. We reduce our rating on Cambridge Industrial, Ascendas India & First REIT to Underperform.
Increasing borrowing costs
We expect the all in debt costs for REITs to escalate to 5.0% (from 3.6% previously assumed) driven by a combination of factors including: 1) Rising credit spreads; 2) Reluctance of Singapore banks to increase loan book exposure to the property sector and 3) ML view that Asian central banks will need to raise interest rates in response to rising inflationary pressures.
Average debt expiry profiles for S-REITs 2.6yrs
Increasing debt costs are magnified in the context of the S-REIT sector given short debt expiry profiles. We have split out the debt expiry profiles of S-REITs under coverage and estimate that, on average, the weighted average debt expiry profile of the sector is 2.6 years which is half of that developed markets. Earnings will be impacted as early as 2009 as expiring debt is rolled over at higher rates.
Cutting our price objectives by average 16%
In addition to our earnings downgrades we have made changes to our DCF valuations assumptions. On a sector average basis we have increased our cost of debt and risk free rate by over 100bpts to 5.5% and 5.4% respectively. We are reducing our target gearing to 40% which is the level rating agencies begin to downgrade corporate credit ratings for S-REITs.
Sector outlook & valuation
The S-REIT sector is currently trading on FY08E yield of 6.2%, which represents a 280bpts premium to the Singapore 10yr government bond. While valuations are undemanding by historical standards we believe the availability and cost of debt and equity continues to present challenges for the S-REIT sector. We remain cautious on the medium term outlook for the sector which is highly reliant on capital markets for growth and is sensitive to interest rate movements. Our BUY calls continue to support REITs that we believe can deliver on organic growth.
Link – Tables