Phillip Singapore Monthly January 2018: No bond rout February 12, 2018

Market:   STI started the year with 3.9% surge in January. As per our 2018 strategy, our STI target for 2018 is 3900. The macro highlight this month is the rise of 10-year US Treasury yields to 4-year highs. The last time we had such a substantial correlation (or sell-off) between bond and equity markets was during the US elections in late 2016. Worth noting that bond yields rose more aggressively during that period. Similarities between both episodes are the fiscal deficit and inflation fears.  A multitude of factors has prompted the recent pick-up in Treasury yields. In the foreground, nudging rates higher has been the improving global economy and the Fed unwinding of US$250bn Treasuries in 2018. We think several new pressure points emerged: (i) Trump tax cut had fortified growth and fiscal deficit expectations; (ii) strong commodity prices, weak USD and strong wage growth stoked inflationary concerns. The US 10 year break-even inflation expectations now at 4-year highs; (iii) political commentary from the US, such as Treasury Secretary endorsing a weak USD and the State of Union address for unfunded $1.5tr infrastructure spending, only added fuel to the bond market uneasiness. Eventually, bond yields spiked, triggering a surge in volatility and technical selling. The equity market is now adjusting to this environment, as all asset values are essentially anchored off interest rates.

Whilst we believe that we are in a new era of interest rates, as per our November 2017 report, a bond rout is not underway. A bear market, perhaps. If we use the Bank of England case study of bond routs, there have been three typical drivers. First, we have the fundamental triggers of 1965-70. The bond market suffered when inflation rose from 1% to a peak of 6.4%. Inflation was unleashed as the result of a rise in wage growth to 6%. Interestingly, the worsening of fiscal performance was not a significant factor in the bond sell-off. At present, we are not a major believer that massive inflation scare is on the horizon. The velocity of money from US and OECD money supply does not support a significant inflation thesis. Second, was the bond massacre of 1994. This plunge in bond prices was the result of poor communications by the Fed, which surprised the market with “pre-emptive” interest rate hikes (somewhat similar to 2013 “Taper Tantrum”). On communications, we think the Fed has well flagged three rate hikes in its dot plots. Third, was the bond rout in mid-2003. Fears of reversal in QE caused nervousness and volatility in Japanese government bonds (JGBs). The spike in bond price volatility stirred Japanese banks to sell even more of their JGB holdings to contain their maximum daily losses. Admittedly, the impact from the current bond price volatility on current holders of long duration bonds is less to clear us, in particular, how long dated or large are the bond holdings of mutual funds or insurance companies.  

Recommendation:   We maintain Overweight on banks, property, electronics and consumer. In January, we initiated coverage on China Sunsine (beneficiary of supply containment in China due to environmental concerns) and Y Ventures (growth propelled by monetizing of its data analytics through e-commerce).

PHILLIP SINGAPORE SECTOR UNIVERSE

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Best performing sectors in Jan18 were Shipping, Industrials and Transportation. The gains in Shipping came from SembCorp Marine (+36%) and PACC Offshore (+27.5%). Industrial positive returns were led by Y Ventures (+101.8%), AEM (+48.4%) and China Sunsine (+24.4%). The rise in transportation was broad based – SIA Engineering (+6.7%), SATs (6.3%) and Comfort DelGro (+6.1%).

Worst performing sectors in Jan18 were REIT-Office, Telecommunications and REIT-Retail. REIT-Office experienced declines from CCT (-3.1%) and Suntec REIT (-3.7%). Telecommunications was marginally down due to modest drop in SingTel (-0.8%). REIT-Retail was under pressure from a decline in Dasin Retail (-2.8%) and CMT (-1.4%).

SUMMARY OF SECTOR AND COMPANY VIEWS

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RESULTS COMMENTARY

FINANCE

Singapore Exchange Limited (Target px: S$9.00 / ACCUMULATE)

  • 2Q18 SDAV was 4% higher but poor SDAV performance in December was a drag.
  • Equity, FX and commodity derivatives volume was strong despite a weak trading environment globally.
  • Securities clearing fee spreads and Derivatives contract fee yields declined due to higher trading volumes by MMLPs and trading members respectively and changes in product mix.

INDUSTRIALS

Micro-Mechanics (Target px: S$2.50 / Downgrade to ACCUMULATE)

  • Despite a record quarter, 2Q18 revenue and PATMI were below expectation. We are reducing our earnings forecast by 7% for FY18e.
  • The weak USD partly hurt top-line momentum in the 2Q18.
  • As our target price is unchanged at S$2.50 and the share price is up 18% since our last report, we are downgrading our recommendation to ACCUMULATE.

REITs – INDUSTRIAL

Ascendas REIT (Target px: S$2.89 / ACCUMULATE)

  • Operationally stable with unchanged WALE, marginally lower occupancy and aggregate positive renewals.
  • Relatively low gearing of 35.2%, affords headroom of ~$800mn for acquisitions.
  • Contribution from recent acquisitions able to buffer the 5.1% of Singapore NLA that is up for renewal in 4Q FY17/18.

Cache Logistics Trust (Target px: S$0.92 / ACCUMULATE)

  • Lower rents contributed to year-end fair value loss of $31.8mn to investment properties.
  • Recapitalised balance sheet through a Rights Issue, gearing now 36.3%.
  • Concern now is the master lease expiry of CWT Commodity Hub in an environment of warehouse oversupply.

Keppel DC REIT (Target px: S$1.47 / NEUTRAL)

  • KDC DUB 2 (acquired in September 2017) and maincubes Data Centre (expected 2Q18) to contribute positively in 2018.
  • Manager is working towards achieving $2bn AUM target in 2018.
  • Valuation appears to be rich at an implied 1.45 times FY18e P/NAV multiple.

Mapletree Industrial Trust (Target px: S$2.15 / NEUTRAL)

  • JV of 14 data centres in the US started contributing, increasing income exposure to Hi-Tech Buildings.
  • Kallang AEI (12% pre-committed) and data centre build to suit (no occupancy risk) coming on stream in 2018.
  • Uncompelling valuation at an implied 1.48 times FY18e P/NAV multiple.

REITs – OFFICE

CapitaLand Commercial Trust (Target px: S$1.80 / Downgrade to NEUTRAL)

  • Portfolio occupancy stable as tenant retention rate improves.
  • Momentum in office rent recovery accelerates in 4Q17, but portfolio still experiencing negative reversions.
  • DPU outlook stable, with cumulative unutilized tax-exempt income of S$27mn, which could be used for future distributions.

REITs – RETAIL

First REIT (Target px: S$1.32 / NEUTRAL)

  • 2% YoY uplift in DPU driven by 3 new acquisitions since December 2016.
  • Outlook for organic growth for FY18 is positive after an uptick in Singapore CPI.
  • Maintain Neutral due to rich valuations vs post GFC average.

Frasers Centrepoint Trust (Target px: S$2.14 / NEUTRAL)

  • Portfolio tenant sales (excl. NPNW) stabilised and are up 0.2% YoY (vs 1-year trough of -6.9% YoY in 2Q17).
  • Slight improvement in portfolio occupancy to 92.6%, supported by the gradual resumption of occupancies at NPNW post-AEI.
  • Slowing rental reversions at 1% (FY17: 5.1%) primarily dragged down by Bedok Point.

CapitaLand Mall Trust (Target px: S$2.03 / NEUTRAL)

  • Gross revenue stable (excluding Funan) despite negative reversions.
  • Rental reversions came in at negative 1.7% for FY17, dragged down by Westgate, Bedok Mall and Tampines Mall.
  • Expect continued pressure for rental reversions for FY18 on the back of high occupancy costs.

CapitaLand Retail China Trust (Target px: S$1.66 / NEUTRAL)

  • Stable portfolio occupancy with rental reversion inching up from FY16.
  • S$3.7mn capital distribution from CapitaMall Anzhen’s divestment gains (out of total c.S$32mn).
  • Expect flat DPU growth for FY18e, with revenue contribution from Rock Square starting from Feb 2017, partially offset by a higher number of units from placement issue.

Phillip On The Ground – excerpts from our various conversations

Property: Johor, Malaysia

  1. The possibility of Shanghai Jiao Tong University setting up going into EduCity, Nusajaya. This University is known as the “eastern MIT” and one of the nine members of the elite C9 League (the Chinese equivalent of the Ivy League).
  2. Puteri Harbour-Singapore Harbourfront ferry service bilateral talks had begun and fine-tuning details such as security around key port operations in Singapore.
  3. Some high-end projects offer 5% rental guarantee and deferred payment scheme for foreigners (55% upfront and remaining 45% in Year 3). The lack of Airbnb restriction allows for flexibility in generating rental income.

REIT: Office

  1. New office supply entering this year have reported healthy pre-commitment levels.
  2. Strong growth in office demand from financial services funds, wealth mgmt, co-working space, energy and commodity sectors. Co-working space master tenant pay market rental and no direct impact to landlord on volatility in occupancy.
  3. Singapore Grade A office asset tightly held and highly sought after. It is very difficult to acquire.

REIT: Retail

  1. Still able to compress spreads despite the rising interest rate environment. Expect cost of debt to come down.
  2. Malls no longer after the best-paying mall tenants but to go for tenants who can bring in shoppers, willing to lower rents to attract such tenants. Paring down exposure to fashion who are higher paying. Some retailers offer promos more attractive than online competitors. In general, consumer mood better in 4Q17. Cinema, electronics and other consumer discretionary performing well.
  3. Supermarkets have been weak. Consumers are going overseas, last year 5mn trips to Malaysia, if 50% buy S$100 that will be 10% of the grocery market.

Healthcare

  1. O&G business: While birth rates are lower, average spend is higher because most families are having children later, which result in more challenging procedures. Hospitals look to tag other ancillary services such as confinement food service, paediatric dental service, etc. Key is to provide lifecycle care, not episodic care.
  2. Hospitals in Medini lack a local catchment area. Drive from Johor Bahru to Medini is 45 minutes. So need to depend on Singapore based patients.
  3. Recruiting doctors: All doctors want different arrangements. Physicians tend to be employed because their work is routine. Surgeons have some star status and want to be their own boss. Thus, more opt for joint venture arrangements and the hospital to handle the admin work.

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About the author

Profile photo of Paul Chew

Paul Chew
Head of Research
Phillip Securities Research Pte Ltd

Paul has almost 20 years of experience as a fund manager and sell-side analyst. During his time as fund manager, he has managed multiple funds and mandates including capital guaranteed, dividend income, renewable energy, single country and regionally focused funds.

He graduated from Monash University and had completed both his Chartered Financial Analyst and Australian CPA programme.

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