- Property market is likely to face a tough year in 2019 but banks are looking to do better with growing net interest income.
- Market sentiment has driven financial valuations low, resulting in an opportune time to invest in the STI.
- Using a fair PE of 15, we have a potential total upside of 23% and annualised returns of about 17% by end of 2019.
In last week’s article, we forecasted a higher Singapore GDP growth of 3.5% - 3.8% in 2018. This article looks at the Straits Times Index (STI) and our price target for 2019. Trade tensions and the recent cooling measures were the hot topics in town, bringing about negative reactions in the stock market. The STI suffered a decline of 10.2% from its year-high of 3624 before the real estate cooling measures came about and subsequently, the STI fell another 2.02% on 5 July, when the cooling measures were announced. The market did well to recover in July, however, August has seen it suffer losses again, closing at 3209 as of 17 August. This has consequently brought down the market’s valuations, making it an attractive investment.
Property Market Outlook
Chart 1: Private Property Price Index
Quoting Mr Ravi Menon, Managing Director of the Monetary Authority of Singapore (MAS), “there is euphoria in the Singapore property market, and developers, banks and home buyers should be cautious.” This is apparent as shown in the chart above, where there is a 9% appreciation in private property prices in the past year, whereas prices declined by 13% from 2013 after the slew of cooling measures since 2011.
The en bloc fever did not help the situation with sales potentially numbering more than 38 and exceeding SGD 10.8 billion this year. Whereas 2017 saw 27 transactions totalling SGD 8.13 billion, 2018 could break 2007’s record sales volume of SGD 11.6 billion. The cooling measures then seem like a pre-emptive strike to deter the en bloc craze as developers now have to pay an additional non-remittable 5% ABSD (Additional Buyer’s Stamp Duty). It appears to be working as developers and residents express doubts over previous agreements.
We expect the property market to tide over the second half of 2018 due to demand from displaced owners and tenants from earlier en bloc sales. However, potential higher supply and lower demand next year may slow the pace of housing price appreciation.
At the end of June, 26,961 units with planning approvals remained unsold, up from 24,193 units in the previous quarter, suggests poorer prospects for 2019 and beyond from a higher supply pipeline. In addition, there is a potential supply of 19,500 units from Government Land Sales and en bloc sites that are still pending planning approval. URA noted that a large part of this new supply may be launch-ready in 2019, which exacerbates supply risk. (Read more on our views on the bonds of Oxley Holdings here.)
Furthermore, with the tightening of loan-to-value (LTV) limits and a highly-likely increase in SIBOR (Singapore Interbank Offered Rate), we could see demand falling due to higher mortgage payments and higher down payments. This double whammy would translate to lower profit margins for real estate companies. Likewise, MAS introduced the cooling measures to prevent a crash in housing prices in the future due to these two factors.
The MAS introduced the cooling measures to prevent a crash in housing prices if the prices were to appreciate too quickly due to euphoria. Instead, we should see prices flattening and picking up again in the future.
Although these measures would hit hard for the real estate developers, they have diverse operations, for example – hoteling, which is expected to perform better in the second half, and overseas assets that will help cushion the blow. Take City Developments Ltd, a constituent in the STI as an example, which we argued for its attractive bond in this article.
Outlook for Banks
For the banks, earning outlook looks bright. All three banks saw higher net interest income and margin in the second quarter which were driven by higher loan volumes. With the US looking to hike interest rates further, the banks are expected to increase their earnings through higher yields and higher loan growth both domestically and regionally. The banks also face higher profitability from lower provisions as the oil-and-gas sector recovers from their slump of oil prices in 2015 – 2016.
Chart 2: Net Interest Income for the 3 Local Banks
Asset quality for all three banks remain stable with non-performing loans (NPL) ratio below 1.7%. OCBC boasts healthier capital positions and UOB faces lower credit costs. The cooling measures will also help lower credit risk in the home mortgage business. With lower credit risk and optimistic earnings outlook, the banks are forecasted to do well for second half of 2018 and in 2019.
Market Sentiment
Financial markets started off well in January this year, however, trade tensions and negative geopolitical developments have turned the mood sour, turning investors bearish. However, this provides an opportunity to investors who are looking to enter the market as prices are low and equities are relatively undervalued.
Earnings are projected to increase in 2019 and 2020 and it is unlikely that we will return to a long protracted downtrend in earnings growth in 2015 and 2016. During that period, oil prices were falling to all-time lows and Singapore’s economy was affected with contraction in merchandise trade and disinflation amidst low GDP growth.
Chart 3: STI Estimated Earnings
With banks composing of more than 40% of the STI, we believe that their earning power can withstand the foreseen drop in earnings from real estate companies. The consensus estimates for earnings growth for FY2018 and FY2019 are 14.1% and 7.6% respectively.
Furthermore, the banks and most of STI’s constituents offer reasonable estimated dividend yields of about 4%. Subsequently, dividend yields for STI is projected to be at 4.19% next year.
Chart 4: Sector Breakdown of Straits Times Index (STI)
Our Valuations
We are reducing our fair Price-Earnings Ratio (PE Ratio) from 16.0X to 15.0X due to various reasons. Firstly, as the government tightens the foreign labour market, high economic growth driven by high foreign labour growth will become a past phenomenon. Economic growth will be derived from innovation and higher productivity as Singapore continues its efforts to restructure its economy. Going forward, Singapore’s economy will be structurally different and economic growth is unlikely to mirror what has been seen over the past few decades.
Secondly, we believe there should be a premium over STI’s historical adjusted positive PE Ratio and estimated PE ratio due to strong corporate governance and Singapore’s political stability relative to other countries in the Southeast Asia region.
Chart 5: Singapore’s Estimated PE Ratio
Thus, our price target is 4000 for 2019 which gives us a total upside of about 23% and annualised returns of about 17% as of 28 August 2018. Our Star Ratings remained unchanged at 4.0 stars.
Investors looking to enter the market can purchase our recommended fund Nikko AM Shenton Thrift Fund. Those looking for passive-management choices can look into the SPDR STI ETF.
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