SINGAPORE (June 2): With the Singapore economy set to gradually re-open over three phases from this month, DBS Group Research analysts Derek Tan and Dale Lai believe the manufacturing sector will be the fastest to recover from the virus.
In a Tuesday report, Tan and Lai say industrial REITs are likely to tap on a recovery in global economies from 2021 onwards, and will also benefit from various government assistance schemes that have been doled out to cushion the impact of the virus.
For a start, Tan and Lai identify how the operational metrics of these REITs remains “healthy” with resilient occupancies across major industrial subsectors.
“While the Circuit Breaker during April-May 2020 has resulted in landlords making provisions for rental deferments to assist tenants in their cashflow needs, the impact is marginal at 2%-7% of portfolio rental revenue,” the analysts say.
“Impact to industrial tenants have been more contained as majority of them are operating as they are considered part of essential services that were exempted from the shutdown,” he adds, noting that property tax rebates from the government will also be fully passed on to tenants as a form of rental relief.
In addition, Tan and Lai observe that various government assistance programmes are “positive” for the sector. In particular, the government has been quick to infuse impacted businesses with liquidity through various loans, subsidies and grants to support small and medium enterprises (SMEs), or the “lifeblood of the manufacturing sector.”
“While landlords may have to cough up one month of rental rebates to their SME tenants, the downside risks to earnings is likely one-off,” they say.
However, amid a period of volatility, Tan and Lai are paying special attention to rent arrears. This is especially crucial since some industrial REITs with Singapore-centric exposures have retained some income in 1Q2020 in light of potential rent deferments and rebates down the road.
“Amid structural changes in the economy, we note minimal deterioration in arrears ratios for now, but are mindful of any potential weakness in the medium term,” say Tan and Lai.
Apart from that, the analysts are looking out for balance sheet recapitalisation risks especially since cashflows may be impacted in the near term, subsequently increasing the REITs’ gearing ratios which currently range between 34-42%.
“ A worse than anticipated drop in cashflows could lead to lower asset values,” Tan and Lai state.
“A potential drop of 15% in asset values may see most of the S-REITS, especially the mid cap names, looking to recapitalise their balance sheets to keep gearing within 40%,” they add.
In terms of valuations, Tan and Lai say large cap industrial S-REITs are trading at “wide premiums” to mid cap ones. However, the brokerage favours the industrial subsector over other ones amid the pandemic for its relative resilience in times of uncertainty and economic slowdown.
“Since falling to their multi-year lows in March 2020, the industrial REITs have rebounded with some of them trading close to levels seen in late 2019,” say Tan and Lai.
For instance, both analysts note that larger cap industrial REITs are trading at an average of 1.51 times price to net asset value (P/NAV), while the other mid-cap REITs are trading at 0.89 times P/NAV.
“The distinction between the large cap and mid cap S-REITs are now at the widest that we have seen as investors focus on the larger names for their liquidity, scale and ability to deliver stable earnings amid current market uncertainties,” they add.
As far as 2020 and 2021 are concerned, Tan and Lai say acquisitions are set to be a growth driver for industrial REITs, and has factored in an estimated $1.6 billion to $2.0 billion worth of deals to be concluded close to the end of the respective financial years.
The brokerage’s top picks for the sector include Aims APAC REIT, Frasers Logistics and Commercial Trust and Ascendas REIT.
For Aims APAC REIT, Tan and Lai say rental contributions from its property at 3 Tuas Avenue 2 have commenced on Mar 1, while gearing has improved “marginally” to 34.8%. In addition, the REIT has retained some $2.9 million of its distributable income, and has fully committed its borrowings due this year to being refinanced,
Following the merger of Frasers Logistics and Industrial Trust and Frasers Commercial Trust, the analysts note that the behemoth has inked three leases in Australia and Germany while maintaining portfolio occupancy at 100%.
Meanwhile for Ascendas REIT, Tan and Lai say its portfolio occupancy has improved 0.8 ppt to 91.7%, with a positive rental reversion of 8.0% for its portfolio. The REIT also has minimal provisions for F&B and retail tenant rebates, with income retention being deemed unnecessary at this juncture.
DBS Group Research has reiterated its “buy” call on all three REITs with target prices of $1.40, $1.40 and $2.93 respectively.
