Inflation — more specifically, the fight with inflation — has hogged headlines for the better part of last year. From the perspective of the research team at Phillip Securities, this economic phenomenon will continue to be in the limelight as investors nurse their wounds from a best-forgotten 2022, where most asset classes were hurt. “Inflation will be the most important determinant of the direction of all asset classes,” says head of research Paul Chew at a recent webinar, with the theme “positioning for a disinflation.”
Due to surging energy and food prices on one hand and capped supply amid recovering demand from the pandemic, inflation shot up to multi-decade highs last year and remained there stubbornly, goading central banks to jack up interest rates in response, hurting investment gains in the process.
To the relief of investors, the inflation and related numbers are trending down. For example, US markets rallied recently on news that wage growth has slowed. “Goods, rents, money supply are all starting to drop,” says Chew, adding that while markets are already at a matured stage of the cycle and growth, if any, will slow, 2023 will still be a much better year for the various asset classes.
Singapore stood out last year, turning in what Chew calls an “exceptional” performance relative to other major markets and asset classes. Bank stocks and energy and commodities plays, in particular, did well. Now, the most prominent black mark, of course, was the REITs sector, whose defensive reputation took a beating as investors worried about higher funding costs because of the higher interest rates.
This year, Chew has distilled several global and local key themes that will sway the Singapore market. First, inflation, likely to be peaking soon, will then start to fall. Chew calls this long-awaited indicator the most critical theme swaying the direction of the markets. Judging from the most recent data, inflation is coming down, led by the cost of housing, otherwise known as “shelter”. Logistics costs — which shot up because of the post-pandemic demand squeeze — have also returned to pre-pandemic levels.
Chew believes that interest rates, while likely to follow suit, will merely “come off” but not “collapse” as the Fed wants to maintain a “real” interest rate above inflation levels. For all the worries over another US recession, Chew says that if one does happen, it will be a relatively “soft” one. Manufacturing activity has dropped, but new jobs are still being added at levels above before the pandemic, which supports consumption. “Nominal GDP growth is still robust. We are still in an inflationary period.”
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Singapore’s economy, Chew adds, is still “very robust”. One such indicator is that retail sales, with the October numbers released last month indicating an expansion at a rate nine times — faster than the pre-pandemic growth of barely 1% a year. “This reflects the strong domestic economy here in Singapore,” says Chew.
He adds that the labour market is still tight, with more than two openings for each job seeker, wage growth is still “robust”, and — last but not least — household wealth is getting an across-the-board lift from rising property prices.
Meanwhile, Singapore’s stature as an international finance and wealth hub continues to gain strength, with foreign direct investment continuing to pour in even though borders have yet to be fully opened. “Imagine if borders are all open,” says Chew.
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Tourism, a vital driver of the economy, has recovered strongly too. Hotels can charge average rates of $240 per night — higher than before the pandemic- before tourists from China return. And when they do so, the room rates are likely to hit record levels, says Chew.
This leads to another theme: China’s re-opening, which Chew calls “very critical” for many Singapore companies spanning multiple sectors. He says that three of every four index stocks have some exposure to China or China’s re-opening. For example, two local banks, DBS Group Holdings and Oversea Chinese Banking Corp have significant loan books in China. Wilmar International and DFI Retail Group Holdings are directly plugged into an improvement in consumption.
Chew says that even the telcos Singapore Telecommunications and StarHub are set to ride on this theme because Chinese tourists in the pre-pandemic years were one of the leading sources of arrivals. Their return will help lift roaming revenue for the telcos, giving them a stream of almost pure-profit earnings. “This is just going to be a Christmas present for a lot of companies if China’s economy rebounds,” says Chew, as his team presents the firm’s quarterly model portfolio of 10 absolute stock picks.
Casa advantage
Two local banks, DBS Group Holdings and Oversea-Chinese Banking Corp have been kept on the list of 10 stocks of Phillip Securities’ absolute picks for their earnings growth and relatively generous dividend yields. Analyst Glenn Thum has given DBS and OCBC target prices of $41.60 and $14.22, respectively. United Overseas Bank, meanwhile, had outperformed both DBS and OCBC in 2022, but that was probably because of its most minor loan exposure to China (including Hong Kong) relative to its two peers. For 1HFY2022 ended June, DBS’s total exposure to this market was 14% of its total loan book. OCBC, on the other hand, had a corresponding exposure of 13% for 3QFY2022. UOB had just 5% as of 3QFY2022 ended Sept 30 last year.
“With China re-opening, DBS and OCBC’s higher exposure to China might pay off and add more to their growth going forwards,” says Thum. On the other hand, the banks’ exposure to China’s real estate is minimal, reducing the strain given how the property market is still in the doldrums.
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That aside, the two banks picked by Thum have their respective positive attributes. OCBC is trading at a level close to its book value, offering a higher dividend of 4.4% while giving a yield of 3.5%. DBS enjoys better margins because of its relatively larger and cheaper deposit base, which will come in handy as interest rates continue to trend up, thereby boosting its interest income. As a percentage of total deposits, the DBS’s Casa (current accounts and savings accounts) ratio is around 60.3%, versus 56.1% for OCBC and 49.8% for UOB.
OCBC has the highest CET1 ratio among the three local banks and might have the potential to increase its dividends / Photo: Samuel Isaac Chua
In yet another positive attribute, OCBC, among the three banks, has the highest Common Equity Tier 1 ratio — a measure of a bank’s capital strength — of 14.4%, slightly ahead of DBS’ 13.8% and UOB’s 12.8%, respectively. Thum sees this higher equity ratio can potentially translate into higher dividends from OCBC if it chooses not to be so conservative.
Throughout 2022, banks enjoyed higher net interest income because rates shot up at a record pace as central banks tried to dampen inflation, which caused the local benchmark rates — Sora and Sibor, — to move in tandem.
For this current year, Thum sees rates in the US exceeding 5%, giving more room for the banks to further grow their net interest margin throughout 2023. For now, the banks have guided for the entire year FY2022 ending December net interest margin of 1.75%.
However, for this current FY2023, better margins will offset slower loan growth as economies slow. Of the various sectors, demand for loans from homeowners, having enjoyed a 4.4% growth in 2021, is seen to moderate. The sector with the most significant loan growth potential is the finance sector, specifically REITs. Meanwhile, banks will likely enjoy lower fee income as their clients remain cautious in investing, trading and deal-making.
Another pick by Thum was Singapore Exchange (SGX) Group, the bourse operator. Due to subdued market sentiment over the past year, securities trading volume has decreased. On the other hand, derivatives volume has increased as investors traded more of these instruments to protect their positions. “As market volatility continues to rise, derivatives volume can go up for the rest of 2023,” says Thum. In addition, treasury income, which lags behind the US Fed rates, can be expected to rebound by at least 8%, pushing this other earnings stream back to pre-pandemic levels and thereby SGX’s overall revenue growth and bottom line, he estimates.
Ascott and Prime
There are two REITs within the 10 stocks picked. The first, CapitaLand Ascott Trust, is a clear winner from the resumption of travel demand. The REIT, part of the CapitaLand stable, owns a portfolio of 95 properties with more than 17,000 units in 44 cities across 15 countries worldwide. As at June 30 this year, this portfolio is valued at $7.6 billion and is considered the largest lodging trust in the Asia Pacific. From the low of $70 seen in 3QFY2021, ended Sept 2021, CLAS’s RevPAR has almost doubled to $132 come 3QFY2022, says analyst Darren Chan.
With China poised to reopen in a big way, further gains can be seen. Over the last two years, amid the pandemic, CLAS has been tweaking its portfolio to include a more significant proportion of so-called longer stay properties compared to short-term accommodation such as hotels. By doing so, CLAS can have better revenue visibility. CLAS has indicated a target of between 25 and 30% of its assets as the so-called long-stay types such as student accommodation and rental housing.
On the other hand, short-term stay properties can offer an upside. As of 3QFY2022, CLAS generates 56% of its gross profit from so-called “stable income”, such as the long-term master leases, and 44% from so-called “growth income”, which refers to management contracts of serviced residences and hotels that have more significant variations. “The macro environment may not be favourable this year, but Ascott offers stable income,” says Chan.
Just like the other SGX-traded REITs with US assets, Prime US REIT has been hurt in recent months because of the slowdown in the US economy, thereby hurting leasing demand, plus the rising rates, raising financing costs. Prime US REIT, for example, was down by more than half over 2022. That, to Chan, is a good reason why this REIT should be included in the 10 stocks, replacing Singtel along the way.
On Dec 30, another US-based REIT, Manulife US REIT, reported that it got to devalue its portfolio by 10.9%, or some 13 US cents off its net asset value, to take into account higher discount rates and capitalisation rates because of weaker portfolio performance.
Out of the dozen properties held by Manulife US REIT, its property at Los Angeles got to take the biggest hit with a 33.1% plunge in valuation to US$211 million ($278 million) from US$315.2 million. The news, announced just before the market opened, sending Manulife US REIT shares down by around a tenth in reaction. The likes of Prime US REIT dropped in sympathy, too, although to a smaller extent. “It is inevitable because of rising interest rates, which means the discount rate used got higher,” says Chan.
However, Chan sees Prime US REIT’s devaluation at a smaller magnitude (relative to Manulife US REIT), down by mid-single digits. Even with the lower value, Prime is still a “value play”, given how Prime US REIT’s trading at just 0.45 times book, giving a dividend yield of 17.5%, thereby justifying the 88 US cents target price by Chan. At current levels, he adds that all the interest rate hikes and uncertainties have already been priced.
The analyst adds that Prime US REIT has enjoyed positive rental reversions for the 10 previous quarters. Up to three-quarters of its tenants are companies in so-called established sectors such as finance and leasing, which has remained “quite strong”. Occupancy, which was below 90%, has been improved too.
Keppel Corp and BRC
Asia Keppel Corp has been kept as a re-rating play within the research firm’s 10-stock pick. Senior analyst Terence Chua says that Keppel Corp has recently gotten the go-ahead from its shareholders to divest its offshore and marine unit to Sembcorp Marine. The ball is now in the latter’s court for Sembcorp Marine’s shareholders to vote on this deal.
Assuming completion of the deal, Keppel Corp will be transformed into a leaner entity with a stronger focus on fund management, urban and infrastructure systems and renewable energy. By doing so, it will likely receive a round of re-rating by the market.
In a worst-case scenario where Sembcorp Marine shareholders shoot down the deal, Keppel Corp can still go ahead with the gradual divestment of its legacy rigs, as it was already doing so over the past few months. On the other hand, Keppel Corp has received a steady stream of new orders, lifting the order book to some $11.8 billion — its highest in years.
A KFELS B class family of rigs — a few units of which are being steadily divested by Keppel Corp ahead of the proposed merger of its offshore and marine unit with Sembcorp Marine / Photo: Keppel Corp
Chua’s other pick in the 10 is that of BRC Asia. The leading supplier of reinforced steel, with a market share of around two-thirds, can be seen as a “cheap” proxy for the recovery of the construction industry, which is likely to see construction demand worth between $29 billion and $32 billion in 2022, revised upwards from an earlier estimate of between $27 billion and $32 billion, which is also what has been projected by the government annually up to 2025.
The stock trades at just forward FY2023 earnings of five times while generating a yield of more than 9%. Also, the spike in steel prices, which dented profitability last year, has since been reversed, and BRC Asia is set to enjoy better margins. “This is not a difficult call. The low P/E and the dividend yield also supports our decision to hold the counter,” he says.
Unfortunately, some factors are holding back the recovery of this sector. The number of fatal accidents hit 57 last year, forcing the authorities to impose safety breaks at work sites. Additionally, the pace of new contracts has slowed somewhat, down 9.5% y-o-y for the amount awarded in the first 10 months of last year. “We remain cautious until 1Q 2023, but overall construction demand for 2023 to 2025 will remain very healthy,” says Chua.
There are nagging worries about further cooling measures, but the overall market is still attractive from an investment perspective because of the lack of supply. HDB prices, now at record levels, have also helped generate a big leg up for those that want to upgrade to private property. Phillip Securities has an “overweight” call on this sector. Within the sector, the top pick is City Developments (CDL). It has more than 1,800 units in the pipeline, yet to be launched. And when they hit the market, they are likely to generate yet another strong income stream for the developer. In addition, precisely because of this significant number of units still being launched, CDL can afford to be more selective in replenishing its land bank and not be rushed into bidding for plots at higher prices than necessary, says Chua.
Meanwhile, CDL, which owns a portfolio of more than 140 hotels across 80 locations worldwide, is plugged directly into travel recovery from the pandemic. The average room per night has doubled between 1HFY2021 and 1HFY2022. As Chua says: “Hospitality’s driving profit growth now.”
One of the repeat picks within the 10 that did not do well is Del Monte Pacific, which dropped by nearly a fifth last year. Still, Chew is sticking to his guns and is betting that the foodstuffs and juice maker — which has a commanding share in the home market in the Philippines, plus a significant presence in the US — can have a more bountiful harvest soon. The company has been undertaking a long-drawn restructuring and turnaround process in the US, but the results are starting to manifest.
Chew acknowledges that the share price suffers from some overhang because of its debt load. However, that was because the company was building up inventory before raw materials prices increased further. He adds that margins are now at a record level, and with inflation lifting prices, consumers are more likely to eat at home and foodstuffs makers such as Del Monte will benefit.
A significant potential catalyst for this stock is the separate listing of its US unit, which will help reduce debt, even though the stock is already trading at just four times earnings and giving a yield of 8%. “We see a meaningful turnaround in FY2023 and FY2024,” says Chew.
HRnetGroup, a regional recruitment agency, is another stock to remain in the list of 10. The company, with its established presence, operates two main businesses. The first is relatively highend head hunting, where companies hire HRnetGroup to fill specialised positions. The other segment is flexible staffing, which refers to short-term or part-time demand for workers.
With the company’s well-established presence, Chew says it can command high entry barriers. The largely debt-free company sits on a cash hoard of $300 million, which, if excluded from the balance sheet, means the company is generating a return on equity of around 200%. If not, the company generates an ROE of 16%.
To further support its share price, HRnetGroup has in place a share buyback programme to the tune of some $30 million. With some 40% of its business from markets such as China and Taiwan, the re-opening will likely bring about more revenue, says Chew.
At the webinar, Chew candidly acknowledges that one of his regular picks, ComfortDelGro — , which rounds up the 10 stock — is not a popular choice. For several quarters, Chew had flagged this stock as his “preferred” recovery stock poised to ride on the re-opening of economies and to normalise daily activities, including commuting. However, a significant re-rating of the stock did not take place. “We’ve already chilled the champagne in 3Q,” adds Chew, referring to the earnings period that ended Sept 30 last year.
One of the critical reasons why ComfortDelGro’s earnings did not improve as expected was the continued doldrums in the non-Singapore markets of China, the UK and Australia. In the UK, for example, costs shot up in line with multi-decade-high inflation. Yet, the repricing of the contracts, which gives ComfortDelGro the revenue, is done once a year, and therefore there is a lag.
In contrast, Singapore’s commuting traffic has improved. However, investors are still hostile towards ComfortDelGro’s taxi business here. The taxi fleet, according to Chew, is shrinking at a rate of 5% to 6% per year. Even so, the company has been pushing for wide usage of its ride-booking app. “There’s a change in the model. It is now more commission-based; more business (for the taxis) will come through app bookings,” says Chew, adding that other ride-hailing platforms charge a quarter of that levy commission charged by ComfortDelGro. “Growth coming from ride-hailing; this is a perfect transition for them,” he adds. Another reason Chew picks ComfortDelGro is the prospect of higher dividends, supported by the cash accumulated by the company through the pandemic.
