• Even though banks are approaching peak net interest margins and are currently experiencing slowing loan growth, non-interest income recovery and higher wealth management fees with the influx of new money and family offices are tailwinds for the sector.
• Current estimates for the REITs sector remain overly optimistic as some of these companies have yet to refinance their loans, and would likely have to do in a higher interest rate environment. Property valuations also have further room to fall, making it important to remain selective within this space.
• There are signs of a bottoming in chip demand, and the increase in adoption of artificial intelligence would benefit the semiconductor sector going forward.
• On top of macro and sector tailwinds, income seeking investors would also appreciate the projected 5% dividend yield across the next two years. We have maintained our 3.5 Stars “Attractive” rating for the Singapore equity market. At today’s price levels, the estimated upside potential is 23.8% by the end of 2025.
Peaking net interest margins and slowing loan growth offset by non-interest income recovery and higher wealth management fees
Making up nearly 50% of the STI, the performance of the local banks is of paramount importance to Singapore’s equity markets. After peaking in February, shares prices of local banks have been trending down, as investors are worried that peak net interest margins and slowing loan growth may affect their bottom line earnings.
In the second quarter of 2023, all three banks saw their net interest margin expanding on a year-over-year (YoY) basis, with net incomes for DBS and UOB at a record high (Figure 1).
Figure 1: Net income has generally been trending higher in the past few quarters
However, despite reporting strong results, it is likely that net interest margins are approaching their peaks, and these sentiments have also been echoed by the bank’s management during their earnings call (Figure 2). Despite this, projections for net interest margins remain upbeat for this year, as local banks are guiding for upside bias from current levels.
Figure 2: Net interest margins have surged in the past few quarters and projected to remain elevated for the year
As we are nearing the end of the rate tightening cycle, we are unlikely to witness another surge in net interest margins as seen in 2022, when the Fed increased interest rates at the fastest pace seen in decades.
Furthermore, loan growth has started to stagnate or even decline, as high borrowing costs have hurt the demand for loans by consumers and corporates. If net interest margins decrease in tandem with slowing or declining loan growth, it could negatively affect the net interest income earned by the banks.
Fortunately, local banks should still benefit from the elevated net interest margins for 2023, and shareholders could be rewarded with dividend yields between 5-6%, particularly at OCBC, where management has guided to maintain a dividend payout ratio at 50% as per their new dividend policy. Meanwhile, UOB has been committed to a dividend payout ratio of 50%, subject to a minimum Common Equity Tier 1 Capital Adequacy Ratio (CET1) of 13.5%. As for DBS, it does not target a specific dividend payout ratio, but has stated that it aims to pay sustainable dividends that grow progressively with earnings.
Additionally, asset quality at the banks remains benign (Figure 3), despite harsher operating conditions, the percentage of non-performing loans remain low. While it is possible that we may see an uptick heading into the second half of 2023 as customers adjust to a recessionary environment and become negatively affected by the higher borrowing costs, the local banks have set aside a sufficient amount for non-performing loans. Coupled with their strong balance sheets and diverse revenue streams, the local banks should remain resilient even in periods of economic slowdown.
Figure 3: Asset quality remains benign
Next, on the prospect of non-interest income, while fee incomes have fallen year-over-year for all the three banks due to weaker market sentiments which have affected wealth management and transaction service fees, the declines have started to moderate, with fee incomes growing on a quarter-over-quarter basis.
Looking ahead, the local banks should continue to benefit from regional and global new money inflows. This is due to the Singapore’s political stability, low crime rates and relatively lower tax rates for high-net-worth (HNW) individuals, which has attracted a large number of corporate entities and ultra-wealthy families to set up camp here for their family offices (Figure 4).
Figure 4: Number of family offices has grown significantly in recent years
Remain selective within the S-REITs space
The S-REIT’s index performance has been underwhelming year-to-date, returning +2.90% (as of 10 August 2023). Under the current higher interest rate environment, REITs are likely to incur higher financing costs, and would be negatively impacted.
Looking back at the DPU growth in FY22 (Figure 5), given that REITs are still in the midst of their earnings season for 1H23, we note that performance varied across the sub-sectors within the REITs space. The huge rebound in growth from the hospitality sub-sector due to the reopening of international borders has largely masked the challenges faced by the overall sector.
Meanwhile, other sub-sectors delivered median DPU growth ranged from merely 1.6% to -7.8%, which has trailed behind Singapore’s core inflation which averaged 4.1% in 2022. Among the various sub-sectors, we note that the retail and office REITs were the worst performers, suffering due to rental rebates, higher interest expenses and one-off refinancing expenses.
Figure 5: Median DPU growth across sub-sectors shows stark differences
The slowdown in commercial leasing activity is likely to put downward pressure on rental rates, and consequently the potential for DPU deterioration going forward. On aggregate, consensus estimates indicate that DPU growth of the S-REIT sector will only come in at a modest 1.6% in FY23. Excluding the still-recovering hospitality sub-sector, the growth remains only marginally positive at 0.3%.
We believe that interest rates are likely to remain higher for longer, making this current environment challenging for REITs. The Fed is unlikely to cut rates by the end of this year due to elevated and sticky inflation. Hence, although the majority of the REIT’s existing debt is on fixed rates, they will eventually be forced to refinance their expiring loans at higher rates, resulting in a higher average cost of debt.
Moreover, in the last two global recessions (Covid-19 and the global financial crisis), the S-REIT sector recorded double-digit negative growth (Figure 6). Thus, we believe that S-REITs are vulnerable to negative price reactions from earnings disappointment as the macro backdrop weakens.
Figure 6: DPU growth during past recessions presents a gloomy outlook
Lastly, despite, the yields of S-REIT rising to north of 6%, we continue to remain bearish on the sector. With the rapid rise in bond yields, there are plenty of opportunities for investors to earn higher yields without taking on equity risk. In fact, the yield spread between the S-REITs sector and the Singapore 10-year government bond continues to trade well below its 5-year historical average, meaning that investors are currently under-compensated by investing in S-REITs as compared to Singapore government bonds (Figure 7).
Figure 7: Yield spread remains narrow compared to historical standards
In such challenging and uncertain times, it is crucial for investors to be selective. There are certain pockets of opportunity to be found, particularly in the hospitality space, which should continue to ride on the reopening tailwinds.
Additionally, data centre REITs can continue on its path of secular growth from the increase in digitalisation and 5G/Artificial intelligence investments while logistics REITs benefit from an increase in e-commerce penetration and supply chain diversification.
Signs of demand bottoming within semiconductor space
Although local electronic companies like Venture Corp have reported weaker results in the first half of the year, a positive sign is that key customers appear to be signalling a bottoming in demand and a recovery in the second half of 2023. Moreover, as technology nodes continue to improve, the top foundry makers in the world are forecasting a rebound in chip demand in 2H23, as they ramp up new process nodes.
Looking ahead, the excitement and rapid rise in adoption of Generative Artificial Intelligence (AI) is fuelling demand for AI-focused semiconductor devices, particularly for these solutions to be delivered to the mass public at affordable prices, serving as tailwinds for chip companies.
All in all, there are signs of a bottoming in demand for chips (Figure 8). As global trade recovers, Singapore’s exports, which forms up a large part of the economy, would also receive a boost. This is coupled with tailwinds such as the increase in adoption of AI and the surge in demand of chips as technology advances, which is why we are turning increasingly positive on the semiconductor sector.
Figure 8: The semiconductor industry will eventually recover from the down cycle
Valuations for Singapore equities remain attractive
As per our last article on Singapore, with Singapore’s economy bottoming and a recovery in the manufacturing sector and exports, positive investor sentiments should result in an inflow of money into the country’s equity market, sparking a re-rating and driving valuations higher.
Related article: Singapore’s economy is set to bottom, here’s how you can play the rebound
Beyond which, we also expect earnings amongst the various sectors to continue growing in the years to come. Local banks will be supported by a recovery in non-interest income and higher wealth management fees, and we see selective opportunities within the REITs space, particularly in the hospitality, data centres, and logistics space.
With the STI currently trading at 11.3X 2025E earnings, we see further upside ahead. Based on our fair PE multiple of 14X, we arrive at a target price of 4,070 by the end of 2025. This translates to an upside potential of approximately 23.8%, with an average dividend yield of around 5% for the next two years.
In view of Singapore’s growth prospects and it being one of our Asian Tigers, we continue to maintain our star rating of 3.5 Stars “Attractive”. Investors who are keen can consider the Nikko AM Singapore Dividend Equity SGD or the SPDR Straits Times Index ETF (SGX:ES3).
Related article: The Shifting Geopolitics and The New Asian Tigers
Table 1: STI Index Valuation Table
|
2022 |
2023E |
2024E |
2025E |
|
|
PE Ratio (X) |
13.2 |
12.7 |
11.8 |
11.3 |
|
Earnings Growth (YoY %) |
36.6% |
4.0% |
7.8% |
4.2% |
|
Projected Earnings Per Share (EPS) |
248.8 |
258.7 |
278.9 |
290.6 |
|
Target Price (Based on 14X fair PE Ratio) |
- |
- |
- |
4,070 |
|
Potential Upside (%) |
- |
- |
- |
23.8% |
|
Dividend Yield (%) |
4.41% |
4.97% |
5.31% |
5.62% |
|
Source: Bloomberg Finance L.P., iFAST Estimates |
||||
Table 2: Recommend products for Singapore equities
|
Equity Market |
Unit Trust |
ETF |
|
Singapore |
Figure 9: STI Index Price vs EPS
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