Rating: Sell (price target: S$2.21)
We expect the pace of Ascendas REIT’s (AREIT's) rental growth to slow in FY15, as the gap between expiring and market rents narrows. To offset this, AREIT could drive portfolio occupancies up from the current 90.1%, which was 3.5ppt lower QoQ, due to the recent completions of Nexus@one-north and A-REIT City@Jinqiao. We are cautious on net expansionary demand for industrial space, as leasing activity has slowed in the past quarters, although AREIT's portfolio suggests there may be pockets of new demand from sectors such as precision engineering and transport & storage.
On acquisitions, apart from its sponsor's pipeline of business and science parks in Singapore, AREIT is considering expanding to Iskandar Malaysia, although we think its nearer-term focus will remain on asset enhancement initiatives (AEIs) and development projects locally.
On the broader sector outlook, we expect lower value-added industries to suffer the most. Manufacturing should continue to be an important economic pillar of Singapore's growth but we believe the ongoing labour crunch and inflationary cost pressures will force industrialists to restructure and focus on higher productivity activities. The fallout should be manageable for higher value-added and essential industries such as biomedical/pharmaceuticals, petrochemicals, R&D, hi-tech manufacturing and logistics. Lower value industries, such as food manufacturing and printing & packaging, will bear the brunt of the government’s rigorous policy, and may be forced to relocate or cease operations.
We think the evolving mix in tenant composition towards high valued added sectors will result in increased demand for better quality assets with higher build specifications. This ‘flight to quality’ theme should benefit landlords with new assets. Conversely, landlords catering mostly to traditional manufacturing or small-medium sized tenants (SMEs) will face challenges in retaining tenants and growing rents.
In the medium term, we believe the threat of Iskandar as a lower cost alternative will intensify. However, there is unlikely to be a mass exodus of industrial tenants across the border as there are similar challenges in securing skilled labour there, according to our checks. Security is also an issue, and the absence of a supporting nucleus of suppliers and end-customers makes a shift neither cost nor time efficient. However with time, we believe these issues will be resolved, implying the headwinds for domestic landlords can only increase.
The softening of market rents would reduce the ability to drive positive rental reversions for the portfolio. Other negative catalysts include equity raising in the early months of the year to fund acquisitions and AEIs. Conversely, potential positive surprises include new acquisitions, a stronger take-up of completing AEIs and development projects.