New report: Has the sector been oversold?
● In light of recent sell-offs, we stress-tested 11 S-REITs. Conclusions: (1) Stress-testing DDM for cost of equity—if the risk-free rate rises 100 bp (from our 3% assumption), target prices would be c.11-16% lower. (2) DPU would be hit 4-14%, depending on gearing, if interest rates rise 100 bp in T+3 (CDLHT, AREIT, CMT least impacted). (3) MCT and KREIT are most at risk, if cap rates expand in a rising interest rate cycle due to higher LTVs.
● We believe S-REITs’ share prices have sufficiently corrected to factor in the higher cost of equity currently and the conclusions of our stress-test suggest that parts of the sector have been oversold.
● S-REITs are still attractive in the medium term, but we believe investors should be selective given different underlying sector fundamentals. Retail & logistics are fundamentally most resilient
● We believe in picking quality and prefer defensive REITs—CMT, MCT and MLT. Risk-reward also looks attractive for CDLHT/MINT at 7.4%/7.2% yields. We maintain our UNDERPERFORM on SUN; and NEUTRAL on KREIT and CCT due to slow pre-leasing and supply risks within the office sector. Click here for full report.
Has the sector been oversold?
With the recent correction, S-REITs have fallen 15% since end-April, underperforming the STI by 9% (YTD S-REITs have fallen 4.5%, and 4.1% relative to the STI). Even defensive names, such as CMT and MLT, have not been spared, falling 16% and 20% (since 30 April). However, yield spreads have remained relatively unchanged throughout the sell-offs, with share prices correcting to reflect the sharp spike in bond yields.
What if ten-year bond yields stayed this high
Many investors are asking about the implications of higher bond yields for the S-REITs sector. We have conducted various scenario analyses to stress-test S-REITs in this report with a hope to provide more colour on the impact of higher bond yields. Our analyses/conclusions:
1) Stress-testing DDM for cost of equity: Given that our existing DDM uses 3% risk-free rate and (mostly) 6% risk-premium assumptions, we estimate that our DDM would be impacted 11-16% should the risk-free rate rise by 100 bp.
2) DPU impact if interest rates rise: After the sub-prime crisis, S-REITs have stronger balance sheets with longer debt expiry profiles and higher percentage of fixed debts, which should mitigate the
DPU impact in the near term if interest rates rise. CMT has one of the strongest balance sheets, with average debt duration of around four years and 99% of debt is fixed.
3) Leverage impact if cap rates expand: REITs with the highest leverage—MCT and KREIT—are most at risk if capital values fall as their existing leverage is relatively close to their target leverage (KREIT even more so with the recent Melbourne office acquisition, which should lift leverage to >45%, its internal target).
Return to fundamentals
With increased market volatility, investors will likely focus more on bottom-up fundamentals, as pre-correction, S-REITs were running largely on liquidity, in our view. We believe S-REITs are still an attractive asset class in the medium term, but investors should be more selective on the exposure given the different underlying sector fundamentals. Retail and logistics continue to have the most resilient fundamentals, given where valuations are at, after the recent sell-down.
Opportunity to buy quality at cheaper valuations
We believe S-REITs share prices have sufficiently corrected to factor in a higher cost of equity now—Figure 1 shows the REITs share prices are implying at least a +100 bp in cost of equity assumptions (except for office REITs). Meanwhile, the results of our stress-test suggest that there is some value in the sector, and conclude that the sector has been oversold. However, we believe in picking quality.
Prefer defensive REITs: Valuations have also become more attractive with the recent sell-offs. Of the REITs, our preferred picks are the defensive names—CMT, MCT and MLT. We also believe the risk-reward is beginning to look attractive for CDLHT and MINT, which we recently upgraded from Neutral to an OUTEPERFORM (click here for the note).
Near-term headwinds for office REITs. We continue to be neutral to negative on office, due to slow pre-commitment levels and meaningful supply pipeline, which we believe could impact the office landlords’ ability to raise rents. While we expect relatively flattish rental growth for mainly Grade A space, we believe the market is expecting growth, as is evident from the historically low cap rates used in valuing some office REITs, despite a fairly benign outlook. We have an UNDER-PERFORM on Suntec (and NEUTRAL ratings on KREIT and CCT, as we are slightly less bearish on the Grade A office space, for now).
Source/Extract/Excerpts/来源/转贴/摘录: Credit Suisse
Publish date: 11/07/13