• 1QCY18 DPU fell
• Rising bond yields
• Top picks: FLT, FCT and MGCCT

1QCY18 Results Roundup

Looking at the recently concluded 1QCY18 results season, 19 out of the 23 S-REITs under our coverage reported results which met our expectations, while four missed. The average DPU growth came in at -2.6% on a YoY basis.

Notwithstanding this decline, we believe the operational outlook appears more positive, especially for the office sub-sector, whereby signing rents have improved firmly in tandem with the robust recovery in market rents.

Looking ahead, we are projecting stable DPU growth (market-cap weighted) of 1.9% for the current financial year and 1.6% for the next financial year.

Grass Is Also Green on Overseas Pastures

One of the key trends which emerged since late last year was the penetration of S-REITs into new geographical markets.

Following Mapletree Industrial Trust’s and Frasers Commercial Trust’s decisions to penetrate the U.S. and U.K. data centre and business park industries in Dec 2017 and Jan 2018, respectively, other REITs have recently followed suit in marking their maiden acquisitions in a new geographical market. This includes Mapletree Greater China Commercial Trust in Japan, Frasers Logistics & Industrial Trust in Europe (Germany and The Netherlands) and CapitaLand Commercial Trust in Frankfurt, Germany.

Similar attractive traits underpinning these moves include freehold land, high occupancy rates with long WALEs and lower cost of funding in local currency terms.

Another key sector event was the agreement reached between the REIT managers of ESR-REIT and Viva Industrial Trust on their proposed merger. Should approvals from both sets of unitholders be obtained, this could potentially create the fourth largest industrial REIT in Singapore and set the stage for further consolidation in the industry in the future.

Valuations Still Stretched Given Spike in Bond Yields

The S-REITs sector, using the FTSE Straits Times REIT Index (FSTREI) as a benchmark, is down 6.0% YTD (as of the close of 22 May).

Including dividends, the sector has posted total returns of -3.4% YTD. We believe this decline has been driven by concerns over a rising interest rate environment, as government bond yields have also seen a spike since the start of the year.

This is despite the more positive operational outlook amid firmer underlying industry fundamentals. The Singapore government 10-year bond yield is currently at 2.67%, a relatively significant increase versus the 2.00% level seen as at the end of 2017.

Given that the FSTREI is trading at a forward distribution yield of 6.0%, this implies that the yield spread against the Singapore government 10-year bond yield is 334 basis points (bps). Despite the share price correction YTD, valuations are still stretched, in our view, as this yield spread represents two standard deviations below the 5-year average (410 bps).

Maintain NEUTRAL on the S-REITs sector, with a selective stock picking approach remaining key at this juncture. Our preferred picks are Frasers Logistics & Industrial Trust [BUY; FV: S$1.21]; Frasers Centrepoint Trust [BUY; FV: S$2.49]; and Mapletree Greater China Commercial Trust [BUY; FV: S$1.42].

Source: OCBC Research - 23 May 2018