• Stable DPU
• Cap rate compression
• Top picks: FCT, KDCREIT, FLT and OUEHT

2QCY17 DPU Growth Came in Flat

All the 24 S-REITs under our coverage reported 2QCY17 results which came in within our expectations. On average, DPU growth was flat on a YoY basis, which was a moderation from the 2.4% increase registered in 1QCY17 but similar to the flattish performance for 2016. From a subsector perspective, positive DPU growth was driven largely by the data centre, industrial and healthcare REITs, but offset by the hospitality, office and retail REITs. Individually, OUE Hospitality Trust recorded a stellar 31.5% YoY growth in its DPU, while Viva Industrial Trust (+6.3% YoY) and Frasers Logistics & Industrial Trust (DPU beat IPO prospectus’ projections by 6.7%) also had good showings.

Firm Cap Rate Compression Seen in Retail and Office Sub-sectors

We observed a few key trends during this earnings season.

Firstly, the office and retail space saw some cap rate compressions by about 10-40 basis points and 40-50 basis points, respectively, based on the valuation exercise conducted by independent valuers. This was driven by a number of robust transactions in the market carried out at firm cap rates.

Secondly, looking across the various sub-sectors, operating metrics have shown some positive signs. For example, office rents appear to be bottoming out. From the retail front, there has been some improvement in shopper traffic and tenant sales, while RevPAR for the hospitality players have shown a smaller decline in Singapore and there was actually positive growth in overseas markets such as China, Malaysia and Japan in local currency terms for most of the hospitality REITs.

Thirdly, REIT managers remain proactive in unlocking value for their unitholders, as illustrated by capital recycling activities undertaken.

Valuations Still Stretched; be Selective

Based on the Fed funds futures rate, the probability of a third rate hike by this year has dipped to just 32.3%, versus 51.6% at the end of Jun. This has been largely driven by the relatively cautious tone sounded by a number of Fed Committee members over the soft inflation data points as revealed in the latest FOMC minutes.

Moreover, during Federal Reserve Chairperson Janet Yellen’s testimony to Congress in Jul, she highlighted that the neutral level of the fed funds rate in the longer run is likely to remain below levels seen previously. This implies that the fed funds rate may not have to increase much further to reach the neutral policy stance.

Coupled with ample liquidity in the markets and continued tight bond yield spreads, we believe further compression in S-REIT yields remains a possibility in the near-term, but recommend investors to buy on dips as valuations remain stretched.

Maintain NEUTRAL on the S-REITs sector. Since we added CapitaLand Mall Trust (CMT) [BUY; FV: S$2.20] into our top picks list on 5 Jun this year on the premise that it was a potential laggard play, its share price has jumped 8.4%. Given this outperformance, we replace CMT with OUE Hospitality Trust [BUY; FV: S$0.82]. Our other top picks remain the same: Frasers Centrepoint Trust [BUY; FV: S$2.28], Keppel DC REIT [BUY; FV: S$1.39] and Frasers Logistics & Industrial Trust [BUY; FV: S$1.22].

Source: OCBC Research - 22 Aug 2017