DBS Group Research analysts say that are two possible outcomes of the March US Federal Reserve meeting, with banks set to drive the market rebound in this month and next amid a “fluid” inflation environment.
In their Singapore market focus report dated March 2, analysts Yeo Kee Yan and Janice Chua say that they expect a “more stable” market in Singapore for the rest of the month, as regional currencies have touched near-term support and the USD-SGD rebound has approached near-term resistance at 1.35 to 1.36.
“This suggests a calmer March, even as inflation woes return. The upcoming US economic data and Fedspeak will drive direction in the lead-up to the Federal Open Market Committee (FOMC) meeting on March 23,” they explain.
The analysts note that the Straits Times Index (STI) trades at an attractive forward price-to-earnings (P/E) valuation of 11.3x 12-month forward P/E, 2 standard deviations (s.d.) below its historical mean, with support at 3,250 points. Supported by higher-for-longer rates in the near term, banks should drive a market rebound through March and April, heading toward their ex-dividend (XD) dates, they add.
“The past two Fed rate hike cycles showed strong recovery in sectors such as S-REITs once the hikes came to a stop. However, with a pause in hikes expected only in May, we seek near-term opportunities among companies in net cash positions or with low gearing,” say the DBS analysts.
According to them, DBS economists now expect the Fed Fund Rate (FFR) to peak at 5.25% by May 23, from its previous forecast of 5% in 1Q2023, with 25 basis points (bps) rate hikes in March and May each. “Recent data suggests inflation is to remain sticky, that there will be a rebound in economic momentum, and producers are likely to hike prices amid strong demand by exercising their pricing power,” they say.
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Against the backdrop of sticky inflation, higher-for-longer rates and service sector resilience while the manufacturing sector slows down, they say that they prefer banks, consumer staples, travel and tourism, and energy or commodity related stocks. Their picks to “shelter from” higher-for-longer rates are United Overseas Bank (UOB), Singapore Airlines (SIA), Sheng Siong and Civmec.
For UOB, the analysts continue to expect robust top-line growth, double digit growth in fees going into FY2023 and a return on equity (ROE) of some 14% in FY2023, with the stock offering a dividend yield of over 5% on a forward basis.
They also expect the strong recovery in the momentum of passenger traffic to continue with China’s reopening, which should see SIA’s passenger volumes climb back to 2019 levels in 2QFY2024 with passenger yields remaining at elevated levels for some time. The stock trades at forward yields of over 5%.
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Sheng Siong remains a resilient play against the economic downturn, with the stock benefitting from the $3 billion top-up to the assurance package and new cost-of-living cash pay-out announced at Budget 2023. Sheng Siong trades at or above a 4% forward yield.
Meanwhile for Civmec, customer capex from energy, resources, infrastructure and defence sectors is estimated to expand at a 9% compound annual growth rate (CAGR) up to FY2024. Robust orderbook growth, margins and dividends are positive catalysts. The analysts note that the stock trades below its book value of 72 cents, with an FY2023 P/E of 6.4x and 5.6% yield.
Two possible scenarios at March Fed meeting
With the USD rebound approaching its near-term technical resistance levels, the analysts say they are keeping a close watch on upcoming US economic data and Fedspeak that will determine flows into rate-sensitive sectors such as REITs heading into the March FOMC meeting, at which they anticipate two possible scenarios to develop.
In the first scenario, inflation data continues to be stronger than expected and the Fed stresses there will be no pause in rate hikes anytime soon.” Higher-for-longer interest rates can be near-term headwinds for stocks with high gearing in general. In terms of non-REITs, two stocks under our coverage with net debt/equity of over 1 are ST Engineering and StarHub,” they explain.
The analysts add that they will be cautious on REITs with an aggregate gearing of around 45%, irrespective of yield, namely Suntec REIT, Elite Commercial REIT and Manulife US REIT (MUST), and on REITS with an aggregate gearing of 40% and yield at around 5.5% or less, such as CapitaLand Integrated Commercial Trust (CICT) and CDL Hospitality Trusts (CDREIT).
ST Engineering’s current structure means it has 47% of borrowings at floating rates, which implies higher costs as debt gets repriced in FY2023. While this is below DBS analysts’ earlier forecasts, the company’s weighted average borrowing costs will nevertheless increase from 2.4% in FY2022 to management’s guidance of the low 3% range in FY2023.
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Meanwhile, StarHub’s net debt to equity is expected to inch up from 0.9x in FY2022 to 1.1x in FY2023. DBS analysts expect its earnings recovery to be delayed to FY2024 on the back of higher transformation operating expenses of $60 million to $70 million in FY2023, compared to $31 million in FY2022, with a transformation capex of $140 million $150 million in FY2023.
In the second scenario, February inflation data turns benign again and regional currencies rebound. This will be positive for REITs with a strong earnings per unit (EPU) growth, a yield of at least 6% and an aggregate gearing well that stands below 40%, say the analysts.
According to them, five REITs that meet these criteria are CapitaLand India Trust (CLINT), CapitaLand China Trust (CLCT), Keppel Pacific Oak US REIT (KORE), Daiwa House Logistics Trust (DHLT) and Digital Core REIT.
