SINGAPORE (Mar 6): Analysts have upgraded Singapore REITs (S-REITs) following the ‘emergency’ 50 basis point rate cut by the US Fed, but banks were downgraded on expectations of thinner interest margins.
“We believe as interest rate outlook continues to remain benign, there is room for S-REITs to refinance their existing debts at cheaper rates, or extend debt maturity at minimal incremental cost,” says CGS-CIMB analyst Lock Mun Yee. Moreover — with lower funding costs and higher valuations — it will be an opportunistic time for SREITs to explore new acquisitions, says Lock, who on March 5 upgraded the S-REITs sector from “neutral” to “overweight”.
She believes investors will continue to remain risk-off and prefer REITs because of their more resilient earnings profile. As a whole, the sector is trading at P/B of 1.1 times price to book and at a 4.5% forward dividend yield, which is a significant 310 basis points over the benchmark 10-year Singapore government bond yield. Lock expects DPUs of S-REITs to grow by 2.2% this year, and a further 2.6% the following year.
Unfortunately, the hospitality REITs will suffer this year as tourists stay away. Yet, a rebound is seen come 2021. Industrial, commercial and selected retail such as suburban malls are the “key performing sectors” this year, says Lock.
The broader operating conditions are not the most ideal, but the S-REITs are able to lean on their “robust” balance sheets. As at 4QFY2019, the average gearing of the S-REITs is just 35%, although the range of their interest cover varies from just 2.9 times to as high as 14.1 times. Lock’s picks for this sector are CapitaLand Mall Trust, Frasers Centrepoint Trust and CapitaLand Commercial Trust. Her target prices are $2.75, $3.10 and $2.28 respectively.
The Fed’s cut on March 3 added to an already volatile mix of politics and worrisome pandemics. The decision first sent US markets down — only to rebound strongly by more than 4% on March 4, as punters cheer Joe Biden’s strong showing at the Democratic primaries. The former vice president is preferred by Wall Street over the left-leaning Bernie Sanders.
Market watchers are expecting the US Fed to cut further. Nomura, for one, sees another 50 basis points off as a base scenario. “In terms of rapid policy response, the Fed is really the only game in town,” says Nomura.
However, the Japanese bank also recognizes the extent to which rate cuts can do. “This is an abnormal global economic slump. The most effective immediate policy response is not monetary or fiscal policies; it’s health security controls. If health security controls fail to contain the spread of Covid-19, financial markets may soon have to accept that a global recession is a foregone conclusion,” warns Nomura.
UBS’s chief economist Paul Donavan agrees. “Lower interest rates will not give consumers the courage to step into a mall or onto a plane. Grand fiscal gestures take time to change demand. Monetary and fiscal policy may reduce fear about the economy.”
In contrast to the S-REITs, the rate cuts aren’t good news for the banks. When they reported their full-year earnings a few weeks earlier, investors were more concerned with effects on their loan books this year as a result of the falling off in economic activities.
The rate cut threw worries over compressed net interest margins into the spotlight instead.
“While the impending decline in cost of funds will cushion a decline in loan yields, we believe overall NIM will still see further pressure,” says DBS analyst Lim Rui Wen, who has trimmed her FY2020 ending Dec 31, 2020 earnings forecast of the banks by between 1 - 2%, based on NIM reduction of between one and two basis points. “We believe the ongoing competition in mortgages as well as the flight to quality loans will further compress loan yields,” adds Lim.
Meanwhile, beyond this rate-sensitive sector, investors might take comfort seeing how China — the epicentre of the outbreak — has made progress dealing with the situation.
“The challenge Chinese equities face is that the extraordinary measures China’s government employed to contain the virus have come at a high economic cost,” says Credit Suisse’s John William Huia Woods, its CIO for Asia Pacific.
There is also a heartening, resilient showing of Asian equity markets in recent weeks, despite the pullback in developed markets, observes Woods. “The Fed’s overnight interest rate cut should allow such resilience to continue, creating opportunities for investors.”
