• NetLink Trust (SGX:CJLU)’s outperformance is likely to continue due to the regulated nature of its business.
• In case of a severe market-meltdown, NetLink Trust could decline to S$0.76, implying 10% downside risk.
• NetLink Trust’s 5.8% yield is attractive compared to 6.2% average yield offered by large-cap industrial S-REITs.

Netlink’s Outperformance Is Likely to Continue

• NetLink Trust is trading at 5.8% yield, vs. an average yield of 6.2 % offered by large-cap industrial S-REITs.
• We argue that NetLink Trust should trade at a lower yield of 80-100bps than large-cap Industrial S-REITs’ yield due to three reasons:
  1. NetLink Trust Share Price has dropped 4% year-to-date (YTD) vs. 25% decline for Strait Times Index (STI). NetLink Trust’s distributions are largely independent of the economic cycle due to the regulated nature of its business. Almost 93% of the business is regulated in nature, another 5% of the business is unregulated but contractual in nature. Only ~2% of the business from diversion income and others is less predictable in nature.
  2. NetLink Trust’s asset life is longer than S-REITS as it incurs annual capex to replenish its depreciated asset base. NetLink Trust incurs an annual capex of S$55-60m or more to replenish its depreciated asset base, making its asset life quite long. Industrial S-REITs, on the other hand, have much shorter asset life of 40-50 years.
  3. NetLink Trust’s gearing is less than half of S-REITs’ with ample debt headroom to fund future growth. NetLink Trust’s net debt to EBITDA of less than 2x implies ample room for raising cheap debt if needed. If we look at regional utilities and infrastructure players with RAB model, most of them have net debt to EBITDA above 5x. Clearly, NetLink Trust can easily raise up to S$500m in additional debt if required. NetLink Trust’s net debt to equity of 16% is less than half the gearing of S-REITs at 35-40%. We think that NetLink Trust’s gearing has been kept low to have enough flexibility to raise capex in the future as NetLink Trust provides the backbone of broadband infrastructure in Singapore.

Maintain BUY, Lower Target Price of S$0.95

• Our DCF valuation assumes 6.0% WACC and 1.2% terminal growth based on long-term household formation rates. Our change in Target Price is largely on the back of higher WACC (5.4% previously) to factor in a higher market risk premium and beta in the face of higher market volatility.
• We have raised market risk premium from 7% to 7.5%, and beta from 0.5 to 0.6 to reflect the higher volatility brought about by the COVID-19 crisis. The Federal Reserve Board of US announced another rate cut on 15 March, and hence we have cut the risk-free rate from 2.5% previously to 2%.

According to our bear-case scenario analysis, NetLink Trust could drop to S$0.76 per share.

• In the case of continued market dislocation due to COVID-19, industrial S-REITs could decline to -2SD valuation in the worst-case scenario. This would imply industrial S-REITs’ average yield dropping to 7.7% from 6.2% currently (pls see the table in attached PDF report) implying almost a drop of 20% in the share price of industrial S-REITS.
• Given higher earnings resilience, lower gearing and longer asset life of NetLink Trust, we project NetLink Trust to trade at 90bps of 6.8% under our bear case scenario. Based on current FY21F distribution per share of 5.2Scts, it translates into a bear-case price of S$0.76 per share. Overall, that implies a downside risk of 10% including 5.8% yield.

Source: DBS Research - 23 Mar 2020