A MOTLEY FOOL SPECIAL REPORT

Investing Hot Spots to Kickstart 2017

Winter 2017 3 Investing Hot Spots to Kickstart 2017

Investors we’ve met are often at a loss as to where they What Attracts Us should be looking for opportunities. There are more than Shares of , StarHub, and haven’t done too well 700 companies listed in Singapore—so, where should the over the past two years. This could partly be due to general search begin? market malaise – after all, Singapore’s stock market, as repre- Since it’s the start of a new year, we thought it’d be a great sented by Index (SGX: ^STI), is down by idea to put together a brief on some groups of stocks that we’re 14% for the same period. Another possible factor at play is watching in 2017 as potential long-term investing opportunities. more industry-specific, which we will come to later. Before we dive in, it’s worth noting that none of the stocks Singtel has suffered the least with its share price down by mentioned in this report are meant to be taken as official rec- ‘only’ 7% over the past two years. StarHub and M1 have seen ommendations. We’re just pointing out some interesting areas their share prices fall by 33% and 47%, respectively. The in the market that we’re seeing, at the moment. telcos’ lower share prices have resulted in attractive valua- tions in relation to history. This report also contains what we believe are useful discus- sions on the businesses, opportunities, and risks associated You can see this in the two charts below. The first shows with the three different groups of stocks that would be covered. their price-to-earnings (PE) ratios over the past five years. And as you can see, StarHub and M1’s PE ratios are near With that, let’s get going! five-year lows, while Singtel’s PE ratio is in the middle of its Telecommunications historical range. Data as of 24 December 2016 unless otherwise stated Telecommunications services providers—or telcos, for short—are a group of stocks that we think are worth watching in 2017. The telcos are Singapore Telecommunications (SGX: Z74), StarHub (SGX: CC3), and M1 (SGX: B2F). They are likely to be household names for many of you reading this, given that their services—mobile plans, broadband plans, cable TV sub- scriptions, etc.—touch the lives of millions of Singaporeans. Singtel is the largest of the trio by market cap and it actually has a huge business presence outside of our shores, too. In its fiscal year ended 31 March 2016, 71% of Singtel’s profit came Source: S&P Global Market Intelligence from other countries. StarHub and M1 occupy the second and third spots, respectively, in terms of market cap and they The second chart illustrates their dividend yields for the generate their revenues predominantly from Singapore. same period. You can see how their yields are all currently near five-year highs. With that, here’s why the telcos are worth watching in 2017.

2 The Motley Fool Special Report fool.sg The Risks Involved Recently, Australian telco TPG Telecom emerged as Singapore’s fourth telco after being declared in December 2016 as the winner in the New Entrant Spectrum Auction (NESA) held by the Infocomm Development Authority of Singapore. Thing is, the Singapore authorities had already officially declared that they were keen to allow a new entrant as early as July 2015. The potential of a new competitive force entering the fray may have scared investors away from the incumbent telcos – this could have contributed to their poor stock market performances over the past two years. There could be good reasons for investors to worry. In 2016, Source: S&P Global Market Intelligence the management of Singtel and StarHub had both commented Singapore’s three telcos have a history of generating that a price war could erupt if a new player was to enter the stable profits, operating cash flows, and free cash flows. We scene. And even without the new telco, the incumbents had think this is a consequence of their business models. In our started engaging in a price war in March 2016. view, telecommunications services are more of a need than TPG Telecom thinks that it can capture 5% to 6% of the a want—and this results in steady demand from customers market within a short period of time, once it starts offering through both good times and bad. its services in Singapore in 2018. If it succeeds, it’s very likely that the Singapore-based business results of the trio of (All numbers in $$, millions) incumbents will be hurt. The impact, though, is not likely to Singtel FY2012 FY2013 FY2014 FY2015 FY2016 be spread evenly. Profit 3,989 3,508 3,652 3,782 3,871 M1 is perhaps looking most at risk here. It has a narrower Operating cash flow 5,710 5,818 5,350 5,787 4,648 geographic source of revenue compared to Singtel, and has a Free cash flow 3,452 3,759 3,248 3,549 2,718 thinner portfolio of services when compared to StarHub (for StaeHub 2011 2012 2013 2014 2015 instance, StarHub has a sizeable pay-TV business, unlike M1). Profit 315.5 359.3 379.5 370.5 372.3 But for now, those living in Singapore only have the ser- Operating cash flow 696.2 689.5 594.7 654.9 544.5 vices of Singtel, StarHub, and M1 to choose from. Free cash flow 449.7 416.8 291.9 333.3 215.7 M1 2011 2012 2013 2014 2015 The Bottom Line Profit 164.1 146.5 160.2 175.8 178.5 We think the low valuations and historic business stability Operating cash flow 285.6 274.9 302.0 272.9 239.1 of Singtel, StarHub, and M1 have made the telco space worthy of a deeper look. But, there are also significant risks to their Free cash flow 182.9 152.4 176.7 133.2 105.6 businesses to consider, as we’ve detailed above. Source: S&P Global Market Intelligence Over 2017 and beyond, we will be watching how the All three companies are also finding avenues to grow competitive landscape develops when TPG Telecom officially beyond consumer mobile. For instance, Singtel is trying to starts operating in Singapore. We will also be watching to see grow a cybersecurity business and has a relatively new busi- how the incumbent telcos’ growth plans develop. ness segment focussing on new digital technologies, such as digital marketing and advanced analytics. Meanwhile StarHub is looking at the enterprise space as a growth op- portunity. As for M1, it is tapping into areas such as data analytics and the Internet of Things. When companies with defensive businesses and avenues for growth have attractive valuations in relation to history, our interest is piqued. But the analysis doesn’t stop there. The risks have to be considered, too.

fool.sg Special Report The Motley Fool 3 Banks Data as of 26 December 2016 unless otherwise stated

We think banks are also worth keeping an eye on in 2017. Singapore is the financial hub of Southeast Asia and is home to some of the largest financial institutions in the region. Finance has also been an important part of Singapore’s economy. In 2015, the financial and insurance industry accounted for 12.6% of Singapore’s Gross Domestic Product. The banking sector is also by far the largest within the , with a 34% weighting (as of 30 November 2016); the Source: S&P Global Market Intelligence second largest is real estate investment & services, with a The local banks are not only trading at low valuations in weighting of just 13%. relation to their historical records—they are also at lower P/B Singapore’s three listed banks, namely DBS Group Holdings ratios when compared to their peers within Southeast Asia. (SGX: D05), Oversea-Chinese Banking Corporation (SGX: O39), and (SGX: U11), have footprints The Risks Involved in many countries and have been actively expanding their Globally, banks are adjusting to myriad new regulations presence outside of Singapore. They also provide a wide range that have been set after the Global Financial Crisis. Many of financial services such as investment banking, transactional banks have also been slapped with huge financial penalties financing, foreign exchanges services, private banking, digital for their role in the crisis, with fines running into the billions banking, and insurance services. of dollars. This has created huge uncertainty over the sector as a whole, making investors nervous about the future landscape What Attracts Us of the industry, as well as the future liabilities of some banks. There are also many triggers for trouble in the global and/ The long-term business prospects of financial institutions in or regional economy, such as a slowdown in China, territorial Singapore look good to us. Singapore recently surpassed Hong disputes in the South China Sea, unrest in the Middle East, Kong as the third-best financial centre in the world. Moreover, Brexit, and a new U.S. president. the ASEAN economy is expected to continue growing in the mid-single-digit percentage range over the long term, partly Closer to home, there are also specific issues for Singapore due to the ASEAN Economic Community initiative. banks to grapple with. The economic growth of Singapore has been slowing in recent years and there is even talk of a Given Singapore’s status as a global financial centre, a possible recession. If Singapore’s economy did indeed slump, stronger ASEAN economy could indirectly benefit the banks. the financial sector could face tougher times ahead. Singapore’s three banks have also shown that they are flex- There are bank-specific issues, too. Singapore’s banks have ible and adaptive to changes in their industry. For instance, they seen their non-performing loans increase in recent years. This have been actively encouraging the development of FinTech is partly due to weakness in the oil & gas sector. If the banks’ (Financial Technology) start-ups in the region. This improves exposures to the sector or other weakening sectors are not handled well, they might need to make more provisions for the chances of Singapore’s banks staying relevant in the future, bad debts in the coming years. regardless of how the banking industry may be transformed by technology in the years ahead. The Bottom Line The three lenders have also been able to grow their book The financial sector is closely linked to the economy of values and revenues over the past decade, without signifi- Singapore. As an important financial hub, it also means that cantly diluting shareholders’ interests. banks in Singapore could benefit from the growth within The valuation of the three banks in Singapore—as mea- Southeast Asia. But there are also important risks associated sured by the price-to-book (P/B) ratio—are near a 10-year with the banks, such as the struggle Singapore’s economy is low, as you can see in the chart below. All three banks are also having with growth. currently trading near their book values per share and offer That being said, the banks’ low valuations make them an dividend yields of more than 3%. attractive group of stocks to watch in 2017.

4 The Motley Fool Special Report fool.sg A popular reason could be the expected rise in interest rates, Real Estate Investment Trusts which could increase the cost of borrowing for REITs. Data as of 24 December 2016 unless otherwise stated Before we touch on interest rates, let’s talk a little about The third group of stocks we’re featuring here is Real Estate debt. Imagine that you are buying a property on your own. Investment Trusts. You would most likely use your own savings (equity) and get a loan from a bank (debt). The same applies to a REIT—when REITs are a favourite among Singapore investors. it is buying a property. It would either sell new units to unit- When you buy units in a REIT, you are buying a share in a holders (to get more equity), get a loan from a bank (to obtain collection of properties that is managed by a REIT’s manager. debt), or do both. These properties can range from shopping malls and offices to There are some differences. Your personal property loan hotels, industrial buildings, and more. The properties receive tenure would likely be around 20 to 25 years. The debt tenure rent from their tenants, which are then distributed to unit- for a REIT is typically much shorter, between two and five holders on a quarterly or semi-annual basis after deduction of years. Meanwhile, your monthly debt repayment will involve relevant expenses. paying the interest and paying down the principal on your There are a few advantages to owning a REIT, as opposed loan. A REIT, on the other hand, pays only the interest. In to owning a property on your own. The most attractive benefit other words, the loans from a REIT are never quite fully paid might be the current high distribution yields on offer. REITs off. They will have to be refinanced when they fall due. are required to distribute at least 90% of their taxable income Coming back to interest rates, the most important point is the to enjoy tax-exempt status. As of 23 December 2016, most of amount of loans taken. When you buy a property on your own, Singapore’s REITs are offering distribution yields of between you can borrow up to 90% of the property’s value. By contrast, 5% and over 9%. a REIT is only allowed to borrow up to 45% (this ratio is also Diversification is another benefit. For instance, when you called gearing). As of March 2016, most REITs have a gearing buy into a shopping mall owner such as Frasers Centrepoint ratio below 40%. The higher the gearing for a REIT, the greater Trust (SGX: J69U), you are buying a share in the six proper- the impact that interest rate increases will have. ties that the REIT owns. The six properties have more than An interest rate hike might not be as dire as imagined. But 650 tenants. These give the REIT’s unitholders a level of di- there are still risks involved with REITs. versification that is better than, say, owning one condominium with one tenant. The Risks Involved Units of REITs can also be bought and sold with just a few We have talked about debt. In our view, the ongoing risk is clicks on the mouse. This makes REITs a more liquid invest- whether a REIT is able to refinance its obligations in a timely ment than physical properties, which often require a long manner. As investors, we will want to check whether there is process to buy or sell. any high concentration of maturing debt in any one year. With that in mind, let’s move to why the REITs sector is If a REIT is unable to refinance its loans, it may have to offer worth examining. new units at a discounted price. This is known as a rights issue. Unitholders who are unable to come up with the additional What Attracts Us funds to subscribe to the rights might be left with a reduced If you want to gain an overview on the valuation of a REIT, distribution per unit in the future due to dilution. The REIT the price-to-book (P/B) ratio can be a good place to look. A value might also offer new units to new investors to raise capital to of less than 1 could mean that the market is valuing a REIT at pay off loans, thereby diluting all existing unitholders. less than the current value of its properties, less all liabilities. A REIT might not be worth buying even when it has a low There are 31 REITs in the Singapore stock market. P/B ratio. That’s because its underlying properties might be Consider the following statistics from the group (figures as of overpriced, leading to an artificially high book value. If the 23 December 2016): assets are repriced downwards, the book value will fall and the P/B ratio will correspondingly rise (assuming the share 1. Only seven REITs have a P/B ratio of more than 1. price is unchanged). 2. Only 11 REITs have a P/B ratio of more than 0.9. A high distribution yield is also not an invitation to buy. As 3. The average P/B ratio is less than 0.9. investors, we have to consider whether a REIT has the means to sustain its distribution in the future. This overview suggests that there might be a few bargains. But hang on to your horses. Let’s think through why REITs in And, not all REITs offer the same risk profile. Commercial Singapore might be trading at low P/B ratios. REITs, for instance, have traditionally been cyclical. Between

fool.sg Special Report The Motley Fool 5 2002 and 2015, rental rates for the Grade A office market have been as high as S$18.80 per square feet per month and as low as S$4.50. Factors such as demand and supply can also put a dampener on a REIT’s portfolio occupancy. In the case of industrial REITs, demand for space can fluctuate from year to year, depending on the health of the economy. Additionally, the supply of industrial space can also change from one year to the next. The outcome of this demand-supply dynamics is that factory occupancy rates have fluctuated be- tween 86% and 96% from 2006 to 2015. The same can be said for hospitality REITs, where the same dynamic between hotel supply and tourist arrivals can increase or decrease occupancy and rental rates. We could go on, but we do not have space to cover every REIT industry in detail. The key takeaway here is to under- stand that each property sector has its pros and cons. With the risks in mind, you would be in a better position to think about a suitable price tag for the REIT that you are considering. The Bottom Line We have talked about why the REIT sector is worth looking at, the benefits that REITs can bring to your portfolio, and the risks that you have to look out for. If we invest well, REITs can offer regular distribution payouts and capital appreciation. Conclusion We hope this report can help you deepen your understanding of telcos, banks, and REITs in Singapore’s stock market. With that, we’d like to reiterate that none of the stocks mentioned here should be seen as official recommendations. For our timeliest investing ideas, do keep an eye on your Stock Advisor Singapore monthly recommendations. Disclosure: Neither The Motley Fool Singapore nor its registered representatives owns shares in any of the compa- nies mentioned. Motley Fool Singapore has recommended United Overseas Bank. All information is provided exclu- sively by The Motley Fool Singapore Pte Ltd, a licensed investment advisory research provider (MAS Licence No. FA100056-1). Any information, commentary, recommenda- tions or statements of opinion provided here are for general information purposes only.

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