REITs: Gradual Easing Of Inflation Positive For S-REITs

Excerpts from UOB KH report

Analyst: Jonathan Koh, CFA

REITs – Singapore
Gradual Easing Of Inflation Positive For S-REITs

We expect the Fed Funds Rate to peak at 5.0% by mid-23 and remain at elevated levels in 2H23. Singapore government bond yields have receded, indicating that inflation and interest rates would eventually ease. We focus on SREITs with resilient balance sheets to weather a protracted period of elevated interest rates. BUY CLAS (CapLand Ascott, Target: S$1.37), CLAR (CapLand Ascendas, Target: S$3.27), FLT (Frasers L&C Trust, Target: S$1.56), MINT (Mapletree Ind Trust, Target: S$3.30) and MLT (Mapletree Log Trust, Target: S$1.99). Maintain OVERWEIGHT.

WHAT’S NEW
• Higher terminal Fed Funds Rate. Fed chairman Jerome Powell has warned that the Fed has “some ways to go” in its efforts to tame inflation. He cautioned that the terminal level (peak) of interest rates could be higher than previously anticipated.

The Fed raised the target for Fed Funds Rate by 50bp to 4.25% on 14 Dec 22. Based on the Fed’s dot plot, the median projection for Fed Funds Rate is 5.1% by end-23, an increase of 50bp compared to the previous survey conducted in Sep 22.

We expect the Fed to hike 50bp on 1 Feb 23 and taper to a 25bp hike on 22 Mar 23. The Fed Funds Rate should reach a peak of 5.0% by mid-23 (previous: 4.5%) and remain at elevated levels in 2H23.

• Inflation has eased for two consecutive months. US CPI has eased for two consecutive months by 0.5ppt in Oct 22 and 0.6ppt in Nov 22. The latest reading for CPI of 7.1% is much lower compared to the peak of 9.1% in Jun 22.

The sequential mom momentum has also moderated to 0.1% in Nov 22 compared to 0.4% in Oct 22. The biggest contributor to the slowdown was energy, which declined 1.6% mom (gasoline: -2.0% mom, electricity: - 0.2% mom and piped gas: -3.5% mom). Used cars and medical care also dropped 2.9% and 0.7% mom respectively.

• Lower government bond yield. We attribute the slower inflation to easing of supply chain disruptions as economies reopened after weathering the wave of Omicron variant infections in early-22. We expect inflation in the US to have already peaked in Sep 22 and would continue easing gradually in 1H23. In response to the lower inflation, 10-year Singapore government bond yield has eased 40bp to 3.08% in 4Q22.

ACTION
• Maintain OVERWEIGHT. The Fed expects core PCE inflation to recede gradually to 3.5% in 2023 and 2.5% in 2024. Based on the Fed’s dot plot, the Fed Funds Rate would be cut by 100bp to 4.1% in 2024.

Thus, S-REITs have to weather higher interest rates in 2023 before the pressure eases in 2024. The sector provides attractive distribution yield of 5.97%, which
is 1.1SD above long-term mean. Downside is limited to a correction of 8.4% if distribution yield spikes to 2SD above mean at 6.52%.

• S-REITs weathering headwinds from higher interest rates. We have revised our DPU forecasts and target prices due to:

a) Higher peak interest rates based on revised forecasts by UOB Global Economics &
Markets Research:
o 3M SIBOR: 4.55% (previous: 3.85%)
o 3M Compounded SORA: 4.31% (previous: 3.86%)
o USD Fed Funds Rate: 5.00% (previous: 4.75%)
o EUR Refinancing Rate: 2.75% (previous: 1.75%)
o GBP Repo Rate: 4.00% (previous: 5.25%)
o AUD Official Cash Rate: 3.10% (previous: 3.10%)
o JPY Policy Rate: -0.10% (previous: -0.10%)

b) We lowered our risk-free rate from 3.25% to 3.00%.
c) We adjusted terminal growth for hospitality REIT slightly higher from 2.6% to 2.8% due to China reopening its international borders.

• On average, we have cut FY24 DPU by 1.8% but raised target prices by 3.5%.

ASSUMPTION CHANGES
• As stated in the above table.

RISKS
• Escalation of the Russia-Ukraine war beyond Ukraine.

Full report here.