CapitaLand Group is keeping dry powder for opportunistic acquisitions, say DBS Group Research analysts Derek Tan and Dale Lai. The analysts are bullish on CapitaLand’s stable of listed names, issuing “buy” on the CapitaLand Investment (CLI) and its four REITs.
Most CLI REITs have turned cautious and are keeping their debt headroom for more opportunistic purchases in 2023, given the spike in funding costs in 2022, while the weak share prices have caused overall cost of capital to increase, limiting accretion, write the analysts in a Nov 17 note.
“We believe that CLI and CLI REITs will deliver overall -2% to +18% growth in FY2022-2024 distribution per unit (DPU) and earnings per share (EPS), supported by steady real estate fundamentals,” say Tan and Lai.
Most CLI REITs are expected to see positive rental reversions heading into 2023 which will overcome rising interest costs, they add. “The diversified footprint CapitaLand Ascendas REIT (CLAR) and CapitaLand Integrated Commercial Trust (CICT) should be able to withstand the knock-on effects of an economic slowdown. That said, we see bright spots for the hospitality sector, riding a multi-year cyclical demand upturn.”
Tan and Lai see target prices of $4.30 for CLI, $3.40 for CLAS and $2.20 for CICT.
China will be a wildcard for the group, writes Tan and Lai, as the relaxation of the strict zero-Covid-19 rules domestically will lift consumer sentiment for overall retail sales (CLCT, CLI) and also re-ignite the asset recycling momentum to boost overall funds under management income growth.
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The analysts have a target price of $1.45 for CapitaLand China Trust.
CapitaLand India Trust (CLINT), however, remains “firmly on the growth trajectory”, given the high returns that the trust is able to generate from its forward fund contracts, while CapitaLand Malaysia Trust (CLMT) is ready to morph into one of Malaysia’s leading REITs with the planned acquisition of Queensbay Mall in Penang.
Tan and Lai see a target price of $1.50 for CLINT.
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“CLI and its REITs continue to put up ample defences against the onslaught of interest rate hikes. Fixed hedge ratios remain high at 70%-80%, while a termed-out debt expiry limited refinancing risks,” says Tan and Lai. “Gearing levels should remain stable, given expectations that asset values should remain resilient, supported by improving cash flows and stable cap rates, given the lack of transactions.”
Cap rate expansion
The group’s high level of hedge ratio defends against interest rate spikes, say Tan and Lai.
“The impact of higher interest rates will be manageable for the group with an average 10-20 basis point (bps) increase q-o-q. Meanwhile, interest costs are expected to continue to inch higher in 2023, as more loans are refinanced, depending on how base rates trend. In our estimates across the various companies, we have assumed a 60 bps and 80 bps increase in interest rates, assuming a 200 bp hike in refinancing rates,” they add.
Most managers are monitoring the current interest rate environment, say Tan and Lai. With inflation potentially peaking by 1Q2023, the manager will want to maintain a high hedge ratio of 70%-80% and may potentially see the hedge ratio head towards the lower end in order to prevent the REIT from locking in high interest rates.
They add: “We sense that most REITs are not expected to see a significant shift in capital values with cap rates remaining fairly stable; or rather a slight expansion, if any, especially for Singapore properties. Most managers are watching overseas properties and believe that there is some risk of cap rate expansion, impacting capital values.”
This is mainly for properties in Australia, Europe, and UK and any movement, in their view, subject to more transaction evidence showing otherwise. Based on DBS’s estimates, it will take an 8% to up to 20% decline in asset values before the CLI REITs will see gearing breach the 45% level — “a remote possibility for now”. “This is given recent evidence of valuations reported by peers that showed stable valuations with minimal changes in cap rates,” say Tan and Lai.
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Private capital deployments
On the other hand, CLI is preparing its suite of private fund products for launch to take advantage of the market dislocations, write the analysts.
While its listed REITs turn more cautious and are limited by their high cost of capital, CLI stands ready to deploy capital in the private equity space (real estate and alternative assets), where interest rate pressure raises acquisition opportunities for the group, say Tan and Lai. “The intent to grow is seen through the recent launch of two RMB-focused funds (with assets under management of$1 billion) and a joint-venture with APG to acquire a self-storage sector in Singapore.”
They add: “The higher cost of capital for the various managed REITs could make it tough for acquisitions to be accretive and capital values still remain high from third parties, the sponsor (CLI) remains a key source of acquisition opportunities. CLI is endowed with a strong pipeline of assets with close to $10 billion of assets on the balance sheet as opportunities for acquisition.”
As at 11.27am, shares in CLI are trading 5 cents lower, or 1.36% down, at $3.62.
