UOB Kay Hian analyst Jonathan Koh has maintained his “overweight” rating on the Singapore REITs (S-REIT) sector, saying that a gradual easing of inflation rates are a “positive” for the sector.
In his note on Jan 9, Koh says that he expects the US Federal Funds Rate to peak at 5% by mid-2023 and remain elevated in the second half of 2023.
He elaborates that Fed chairman Jerome Powell has warned that the Fed has “some ways to go” in its efforts to tame inflation, and also cautioned that the peak of interest rates could be higher than previously anticipated.
Koh points out that the Fed raised the target for Fed Funds Rate by 50 basis points (bps) to 4.25% on Dec 14, 2022.
Based on the Fed’s dot plot, the median projection for Fed Funds Rate is 5.1% by end-2023, an increase of 50 bps compared to the previous survey conducted in September 2022.
As such, he expects the Fed to hike interest rates by 50 bps on Feb 1, and taper to a 25 bps hike on March 22.
Furthermore, he also points out that inflation has eased for two consecutive months in the US, with the consumer price index (CPI) falling 0.5 percentage points (ppts) and 0.6 ppts in October 2022 and November 2022 respectively.
The latest reading for CPI of 7.1% is much lower compared to the peak of 9.1% in June 2022. UOB KH attributes the slower inflation to the easing of supply chain disruptions as economies reopened after weathering the wave of Omicron variant infections in early 2022.
Moving forward, Koh expects inflation in the US to have already peaked in September 2022 and would continue easing gradually in the first half of 2023
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At home, Koh notes that Singapore government bond yields have receded, indicating that inflation and interest rates would eventually ease. In 4Q2022, yields for the 10-year Singapore government bond have eased by 40 bps to 3.08%.
Koh notes that based on the Fed’s dot plot, the Fed Funds Rate would be cut by 100 bps to 4.1% in 2024. What this means is that S-REITs have to weather higher interest rates in 2023 before the pressure eases in 2024.
But he still thinks that the sector provides an “attractive” distribution yield of 5.97%, which is 1.1 standard deviation (s.d.) above the long-term mean.
Meanwhile, the sector downside is limited to a correction of 8.4% if the distribution yield spikes to 2 s.d. above the mean at 6.52%.
To this end, Koh has raised target prices across the sector, but has cut distribution per unit (DPU) forecasts in response to higher forecasted interest rates. On average, Koh has reduced his DPU estimates for the FY2024 by 1.8%. On the other hand, he has upped target prices by 3.5% on average. Please refer to the chart below for a breakdown.
In light of this, his top picks are CapitaLand Ascendas REIT (CLAR), Capitaland Ascott Trust (CLAS), Frasers Logistics and Commercial Trust (FLCT), Mapletree Industrial Trust (MINT) and Mapletree Logistics Trust (MLT) with “buy” calls for all. Please refer to the chart below for a breakdown of ratings and target prices.
