As the US Federal Reserve (US Fed) lifted interest rates by 75 basis points (bps) for the third consecutive time on Sept 22, CLSA Research analysts Neel Sinha, Yew Kiang Wong and Horng Han Low are expecting several industries such as the property and REITs sector to take a hit, with the exception of banks being the only net beneficiary of rising rates.
After the most recent Fed rates announcement, CLSA chief economist Eric Fishwick raised his outlook to 4.75% by February 2023. The estimate is before any easing, and with 75 bps, 50 bps and 25 bps hikes yet to come.
“This is approximately 50 bps to 75 bps higher than the estimates in our company forecasts, though the actual impact will be lower based on hedging ratios,” say the analysts. “We expect an approximate 2.5% to 3% mid-teen 2023 consensus index earnings growth to be shaved.”
For Singapore, the Fed funds rate transference to local interest rates is not as direct, considering how the Singapore dollar nominal effective exchange rate (S$NEER) is the primary monetary tool used by the Monetary Authority of Singapore (MAS), with interest rates being a secondary tool. The MAS has already tightened quite substantially through this year and expectations are for further tightening in next month’s bi-annual meeting, the analysts point out.
At its current level, Singapore’s benchmark Straits Times Index (STI) is trading at around 0.5 standard deviations (s.d.) below its 10-year mean. To this end, the analysts believe that the STI is likely to trade at around 0.5-0.7 s.d. below its 10-year average P/E with no clear near-term mean-reversion catalysts.
According to market estimates, the STI is expected to grow by around 15% for 2023, although the analysts at CLSA are expecting downward revisions to this expectation over the coming weeks as the market adjusts to an outlook for higher rates than initially expected.
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In particular, REITs and the wider property sector can expect higher refinancing costs to result in distribution per unit (DPU) erosion for companies with low hedges for fixed rates and high gearing.
“Ascott Residence Trust (ART), Keppel REIT (KREIT) and Suntec REIT are the most vulnerable in this aspect with potential 3.7%-7.8% DPU erosion for every 100 bps rate rise,” write the analysts.
Additionally, the analysts note that rising rates over an extended period will result in higher cap rates for assets, lower book values and higher gearing, where Suntec REIT, Manulife US REIT and KREIT are likely to be the most susceptible to rising cap rates.
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At this juncture, growth proposition will be derailed for now, say the analysts. “The higher cost of capital environment will rein in acquisitions for Singapore REITs (S-REITs) and result in slower DPU growth,” they add.
For property developers, higher mortgage rates will eventually impact housing affordability.
“Recent launches have seen healthy take-ups, but secondary volume has started to ease,” the analysts observe. “That said, several rounds of property cooling measures have kept household gearing in check and should avoid a hard landing in the residential segment.”
Other affected industries include sectors that are traditionally capital intensive such as manufacturing and production that could face some earnings pressure from the rising rates.
ST Engineering and Sembcorp Industries stand out with regard to their gearing levels, observe the analysts, with net debt to equity at 1.83x and 1.48x for FY2022 ended December. “These ratios would slide down approximately 20% over the next two years if business targets and forecasts are achieved however,” say the analysts.
Meanwhile, SembMarine has de-geared since its capital raise. Yangzijiang Shipbuilding is also in a net cash position, as are transport related companies, SATS, ComfortDelGro and Grab as of their results last quarter.
Banking a net beneficiary of rising rates
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The banking industry is perhaps one of the only fields that is a net beneficiary of rising rates, say the analysts. “We expect a 100 bps Fed rate rise to lift DBS’s pre-impairment profit by approximately $1.8 billion to $2 billion and for both OCBC and UOB, at around $1.0 billion to $1.2 billion over a 12 to 15 month asset book repricing cycle,” write the analysts.
The analysts also expect net interest margins (NIMs) to hit four to five year highs by FY2024 and return on equity (ROE) levels to hit decade highs.
“While banks suggest that various stress test scenarios do not indicate specific segment asset stress at approximately 5%-7% levels, we would not be surprised at an approximate 20 bps to 30 bps uptick in NPLs going into FY2023 as higher rates bite,” the analysts write.
Meanwhile, the analysts also push back on the idea that mortgages are a “weak link” in this climate. “This is considering how Singapore mortgage defaults have held steady through the periods of SARS, the Global Financial Crisis (GFC) and the rising Fed rate cycle of 2005-2007 to over 5%,” they explain, adding that consumers tend to protect hard assets, the largest component of household balance sheets, where approximately 70% of household debt is in mortgages. Instead, the analysts consider the next pressure point to be small-medium enterprises (SMEs) in Asean, excluding Singapore.
The analysts’ top picks are DBS, UOB, Singtel, Capitaland Integrated Commercial Trust (CICT), City Developments (CDL), Sembcorp Industries, Yangzijiang Shipbuilding, Mapletree Industrial Trust (MINT), Mapletree Logistics Trust (MLT) and Venture Corp (VMS).
As at 2.12pm, the STI is trading at 21.35 points or 0.68% down at 3,160 points.
