AREIT – CIMB
Key takeaways from Singapore Corporate Day
Highlights from Corporate Day
At our recent Corporate Day, A-REIT’s management updated investors on its rent outlook, investments and capital management. Questions thrown to the management mainly related to the impact of a slowing Singapore economy and manufacturing sector, the sustainability of rents and management’s intentions to acquire outside Singapore.
Demand for industrial space to stay resilient. A-REIT expects demand for industrial space in the near to medium term to stay resilient even if the economy slows further. Management explained that occupancy costs for industrial tenants typically form not more than 5% of their total operating costs. Moreover, the early termination of leases does not exempt tenants from rent payment for the remaining portions of their leases. Thus, companies typically resort to reducing shift work and labour costs before cutting back on their demand for space. The lag time is typically 18-24 months, from a business slowdown to the pinch on real-estate demand. Hence, it will take a recession exceeding 18 months or so for demand for industrial space to be hurt. Additionally, tenants in manufacturing industries account for only 24% of A-REIT’s portfolio and default payments have been minimal at 0.5% of gross revenue so far (vs. 1.8% during the recession in 2004).
Pre-commitments for projects under development add certainty to earnings. All of A-REIT’s projects under development have been built to suit tenants. To date, more than 75% of pre-commitments have been secured, and construction costs locked in prior to commencement, adding certainty to earnings in the mid-term.
More room for rental reversions in Science & Business Park and Hi-Tech segments. Historically, rents of these two segments (catering to R&D and high-valueadded manufacturing) are about half of prime office rents. With the sharp jump in office rents, rents in these segments are now at less than 25% of prime office rents. Management expects office rents to normalise over the next 1-2 years and the ratio to return to the historical 50%. Thus, even if prime office rents fall to S$10-12psf, there is upside for rents in these segments from their current S$3.50-4.00 psf. Demand is likely to be supported by high-value-added manufacturing (including R&D), which is close to the government’s heart. Growth for light industrial space is expected to be stable with most leases being sale-and-leaseback leases incorporating either a fixed portion of stepped-up rent or rental increases pegged to the CPI. Rental growth for logistics space is expected to be flat as strong upcoming supply is likely to affect rate increases for new take-up.
Expansion plans
Acquisition opportunities in Singapore still available. Management shared that there are still sizeable acquisition opportunities in Singapore, with about 6m sq m of investment-grade industrial space (or 17% of islandwide industrial space supply) not held by REITs. Yields for logistics and light industrial space have trended moderately up to 6.7-7.0%, above A-REIT’s trading yield of 6.7%. Gearing limitations and rising interest rates have attenuated competition for assets from other REITs and opportunistic funds.
Venturing overseas? A-REIT is unlikely to acquire overseas assets in the near term in view of the sufficient domestic opportunities and development projects in progress. In the medium term, if it acquires outside Singapore, it is likely to begin with South- East Asia.
Capital management
Ease of fund access. Management is in the process of completing a S$1bn mediumterm note programme (estimated in October). Short-term debt of S$255.4m forms 14% of its total debt of S$1,841m, and should be refinanced with existing bank lines. AREIT’s weighted average cost of debt had declined from 3.42% in Jun 07 to 3.16% in Jun 08, reflecting its ability to secure favourable rates even in the current environment.
Asset leverage to stay within 45%. Management intends to keep asset leverage at a self-imposed 45% and rules out any rights issue in this financial year.
Valuation and recommendation
No surprises; maintain Outperform. We continue to like A-REIT for its long lease tenures and earnings visibility in the medium term, as well as the relative resilience of the industrial sector to slowing macro conditions. No change to our FY08-10 estimates and DDM-derived target price of S$2.60 (discount rate 9.6%).