Banks and Property Developers Boost Singapore Dividends

Banks and property developers boost Singapore dividends

Thursday, March 15th 2018

Companies in the FTSE Straits Times Index are expected to return SGD 20.9bn in dividends to shareholders this year.

• Our average forecast yield for the index is 3.8%, the highest among other key benchmark indices in the region.

• Dividends from the index are anchored by the banking, real estate and telecommunication sectors.

• Increase in dividends is mostly attributed to higher payouts projected for banks and property developers. Aggregate dividends in Singapore are set to hit multi-year high in 2018. We are forecasting companies in the FTSE Straits Times Index (STI) to return SGD 20.9bn in dividends to shareholders this year, up 29% from SGD 16.2bn in 2017. Dividend growth had been lackluster in recent years due to the collapse in oil prices, as oil and gas companies reduce payouts and banks become conservative with dividends, as a result of the decrease in their bottom line figures. However, dividends announced since the beginning of this year, suggests a turnaround in payouts from the benchmark index. The index now boasts an average forward dividend yield of 3.8% based on our forecasts, the highest compared with other benchmark indices in the region. Dividends from STI are anchored by the banking, telecommunication and real estate sectors. On aggregate, dividends from these sectors are estimated to grow by 30% year-on-year to SGD 13.5bn, which represents nearly two-thirds of the projected aggregate dividends in 2018. This report provides an in-depth look at these key sectors to explain our predicted dividend trajectory of the index. Aggregate dividends from FTSE Straits Times Index (SGD bn)

22 20 18 16 14 12 10 2014 2015 2016 2017 2018E

Source: IHS Markit, Factset

Average forward yield of constituents

4.0%

3.0%

2.0%

1.0%

0.0% FTSE Straits S&P ASX 200 Hang Seng FTSE Bursa Nikkei 225 KOSPI 200 Times Index Index Malaysia KLCI

Source: IHS Markit

Banks – strong fundamentals to underpin dividend growth The banking sector comprises of DBS Group Holdings (DBS), United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC), and we are forecasting these three banks to announce SGD 7.7bn in dividends in 2018, translating to an uplift of around 80% from the amount registered a year ago. We highlight the following factors as strong support for our optimism on this sector’s dividend growth. Aggregate dividends from Singapore banks (SGD bn)

10.0 8.0 6.0 4.0 2.0 0.0 2014 2015 2016 2017 2018E

DBS Group Holdings Ltd Oversea-Chinese Banking Corp Ltd United Overseas Bank Ltd

Source: IHS Markit, Factset

Firstly, although the price outlook of oil remains dull due to oversupply concerns, the banks had cleaned up their balance sheet in recent quarters and have recorded the necessary impairments. Management teams asserted that risks from the struggling oil and gas sector are well contained, and this implies that there should not be any unexpected bad debt expenses over the short term, which could cause a drag on its bottom line growth. Secondly, there is no imminent need for banks to increase capital, and this is reflected from the generous special dividends paid from DBS and UOB. The Monetary Authority of Singapore mandates banks to have a minimum Common Equity Tier 1 (CET1) ratio of at least 9% by 1 January 2019 and as per latest filing, all three banking giants have exceeded the requirement. Fully loaded CET1 ratios for DBS, UOB and OCBC stood at 13.9% 14.7% and 13.1%, indicating that there is no need

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for these banks to reduce their payout ratios to build their capital in the near term. Unlike the big four Australian banks, which are barely meeting the capital requirement from their domestic regulator and had therefore shown no clear dividend growth in recent years, Singapore banks are deploying these excess capitals to grow their businesses to drive earnings higher. For instance, UOB is expanding into Vietnam while OCBC is deploying capital into its growth pillars which are capital intensive, such as insurance. Lastly, the banks have - to various degrees - provided some form of dividend guidance for the current year. This highlights the confidence they have in their performance over the short term. DBS is guiding SGD 1.2 per share for FY18 and has reiterated its policy of growing dividends at its earnings growth rate. UOB is expecting FY18 core dividend to be at SGD 0.8 per share and has stated its intention to grow dividends on a progressive basis; it are aiming to return 40% to 60% of their earnings to shareholders as dividends. While OCBC grew its final dividend modestly by 5.6% despite a 19% jump in earnings, this emphasized its commitment to pay dividends on a predictable and sustainable basis. Indeed, Singapore banks are poised to generate higher profits as global interest rates are set to rise this year. The positive outlook is consistent with consensus earnings estimates as street analysts are projecting earnings to be on an upward trajectory. These factors suggest that there is more upside to the dividends from the banking sector in Singapore. Real Estate – Contrasting dividend outlook for developers and REITs We are expecting dividends from the real estate companies to come in at SGD 2.6bn, which represents an uplift of around 7.1% from the dividends declared in 2017. Property developers account for around 55% of aggregate dividends from the sector, and Real Estate Investment Trusts (REITs) account for the remaining 45%. Property developers, that is Capitaland Limited (Capitaland), City Developments Limited (City Developments), Hongkong Land Holdings (HK Land) and UOL Group Limited (UOL), have consistently paid out flat or higher dividends in recent years, and we expect this conservative practice to continue going forward. This phenomenon is supported by their aim to derive a significant component of their earnings from their investment properties, which are recurring in nature and provide some visibility to bottom line figures. Apart from UOL, recurring income from investment properties contribute more than half to operating profits for the rest of the property developers. Specifically, recurring income represents 71.2% of Capitaland’s EBIT in 2016, 56% of City Developments’ EBITDA in 2017 and 64.7% of HK Land’s operating profits. We expect the amount received from these stable income streams to grow further for some of these developers as The Ascott Limited, Capitaland’s subsidiary looks to expand its network to 160,000 units over the next five years, and as City Developments strives to increase the proportion of recurring income to 65% of EBITDA over the short to medium term.

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Dividends per share from property developers

0.25

0.2

0.15

0.1

0.05 FY14 FY15 FY16 FY17 FY18E

Capitaland Ltd City Developments Ltd

Hongkong Land Holdings UOL Group

Source: Company announcements *figures based on declared currency.

In addition, the increase in dividends by all four developers for FY17 signalled their confidence in their short term outlook. The key factors we deem will underpin earnings growth this year for each company are: Capitaland’s significant amount of unrecognised revenue; City Development’s healthy pipeline of apartments for sale in Singapore; positive rental reversion on HK Land’s portfolio; and UOL’s strong exposure to Singapore’s residential market. We also expect their relatively strong financial position to provide the management teams with financial flexibility to pursue any growth opportunities, such as growing their land banks. With growing recurring income contribution and a positive earnings outlook, these factors are likely to continue to provide support for predictable and sustainable dividend growth going forward. Dividend outlook is however, mixed for the REITs in Singapore, and we are expecting aggregate distributions from Capitaland Mall Trust (CMT), Capitaland Commercial Trust (CCT) and Ascendas Real Estate Investment Trust (A-REIT) to grow by 2.6% and 1.8% in 2018 and 2019 respectively. Distributions are expected to be weighed on by downbeat rental reversion outlook for CMT and A- REIT, offset by the optimism in CCT’s distribution outlook stemming from the recovery in commercial rental rates. Projected growth in aggregate distributions from REITs

6.0%

4.0%

2.0%

0.0% A-REIT CCT CMT

2018E 2019E

Source: IHS Markit, Factset

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We are expecting the poor retail outlook in Singapore to keep a lid on CMT’s distribution growth. Notwithstanding the closure of Funan for redevelopment, aggregate distribution for 2017 grew at its slowest rate in recent years to SGD 394.9m. Negative rental reversion for leases committed in 2017 is consistent with downtrend in retail rental rates in recent quarters, and while these rates are showing signs of stabilizing, any rents renewed on the back of the expiring leases in 2018 is likely to lower than those committed a few years ago. On expectation that online shopping will continue to prise away shoppers from brick and mortar stores, we are forecasting muted growth in distribution over the short term. It is worth mentioning that more than half of the existing leases will be expiring in 2018 and 2019, and therefore, any further decline in rental reversions is likely to pose a significant risk to future distributions. We are monitoring this trend and will revise our forecasts when needed. In the same vein, A-REIT has around 60% of its leases expiring between now till March 2021, and given that rental rates are projected to have limited upside due to new supply of industrial properties over the short term, we expect leases renewed over this period to weigh on distributable income. However, there is a lack of concentration risk in the REIT’s portfolio, and as occupancy rate stood at 91.1%, this implies that there is potential growth for higher distributions. We conservatively forecast an average growth of 2.1% per year in A-REIT’s distribution over the short term, with a view that vacancy rate will reduce once redevelopments and asset enhancement initiatives are completed. Rental index of office space in central region in Singapore

180 175 170 165 160 155 150 145 Q116 Q216 Q316 Q416 Q117 Q217 Q317 Q417

Rental Index

Source: Urban Redevelopment Authority

Conversely we are upbeat on CCT’s distributions in the forthcoming years. We are expecting aggregate distributions to grow by 5.4% in 2018 and 4.6% in 2019. The management expressed optimism on the expected recovery in rental rates, which is set to benefit the REIT in two ways. Firstly, it cushions the adverse impact of the negative rental reversion registered in 2017, as new leases committed will be based on rising rates. The occupancy rates for the newly acquired Asia Square Tower 2 and Twenty Anson are still below the market level and we believe newly committed rents for these two properties will help to support distribution growth over the short term. Secondly, around 40% of the existing leases are expiring over the next two years, and CCT can fully benefit from the upturn in rental rates when tenants renew their leases. We noted that the management is closely monitoring the trend in office rents, and may conduct forward lease extensions when appropriate.

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Telecommunications – Intense competition to drag sector dividends Aggregate dividends from the telecommunication sector are expected to fall in 2018 due to the absence of the one-off special dividend from Singapore Telecommunications Limited (Singtel) in 2017. Payouts are projected to be relatively flat in short term, weighed on by intense intra-industry competition. Competition is harsh in the Singapore telecommunications sector. Notably, the decrease in revenue experienced over the past year from the mobile services segment suggests that companies have been undercutting prices to retain and attract customers. In the same vein, the postpaid segment, which makes up the bulk of the mobile market and is the most lucrative part of the industry, also saw its average revenue per user (APRU) trended downwards in recent years. The impact of competition and need for investments to remain competitive on shareholder returns is clearly demonstrated by Telstra Limited in Australia, which cut its dividends last month - the first time in recent years as the company grapples with intense competition and other pressing issues. In addition, the challenging operating environment is set to be aggravated by the entry of various Mobile Virtual Network Operators (MVNO) and TPG Limited in 2018. TPG Limited indicated that it is aiming to grab around 5% of the market share in Singapore within a short period of time, and this is likely to put additional pressure on the dividends outlook of Singtel and Starhub Limited (Starhub). Payout ratios of Singtel and Starhub

120.0% 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% 2013 2014 2015 2016 2017 2018E

Singtel Starhub

Source: Company announcements

Despite growing concerns over these issues, we believe that Singtel is better positioned to meet these challenges. At least 40% of its profit before tax is derived from its interests in associates in other geographical regions, which helps to mitigate the impact of the increased competition in Australia and Singapore due to TPG Limited’s entry. Singtel also has a more conservative dividend policy, and this gives Singtel sufficient funds for future investments to ensure that it remains competitive. While Singtel is on track to record lower profit this year, EBITDA margins have remained relatively stable amid the management’s efforts to focus on costs. More importantly, dividends paid in recent years (except FY16) are fully covered by free cash flow generated. The confluence of these factors signaled that while operating environment remains competitive, we see little downside risk to dividends in the short term.

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Starhub dividends paid vs. free cash flow generated (SGD per share)

0.25

0.2

0.15

0.1

0.05

0 2013 2014 2015 2016 2017

Dividend per share FCF per share

Source: Company announcements

Conversely, we deem Starhub’s dividends as unsustainable, and are expecting dividends to fall further to SGD 0.14 per share in FY19. Amid intense competition, the decrease in top line figures showed no signs of slowing down as mobile revenue fell for the third consecutive year in 2017. Still, costs continues to balloon, causing EBITDA margins to fall its recent peak of 33.7% in 2014 to 27.9% in 2017, and earnings per share to slump by 34.4% over the same period. Payout ratios exceeded 100% in the preceding two years, which is a clear indication that existing dividends are unsustainable. From a cash flow’s perspective, there has been a shortfall between the amount of dividends paid and the amount of free cash flow generated. Due to competing needs for funds for other purposes, cash for dividends were sourced from other avenues such as cash on balance sheet or borrowings, which resulted in the jump in Net Debt to EBITDA of 0.57 in 2014 to 1.03 in 2017. Clearly these compelling factors indicate that it is impossible for Starhub to continue to pay dividends at its existing level without losing its competitiveness further. It is worth mentioning that with a forward dividend yield of 6.6%, Starhub is the second- highest yielding stock in the index.

Chong Jun Wong +65 6922 4257 [email protected]

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All dividend data is provided by IHS Markit. All supplementary data, such as number of shares, is provided by FactSet. All data is correct as of March 9th 2018.

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