Path to prosperity

Ascott Residence Trust (Ascott) owns 88 hospitality properties across 15 countries globally with a range of offerings like serviced residences, hotels and rental housing. Post-merger with Ascendas Hospitality Trust in 2019, it is currently the largest hospitality trust in Asia Pacific and has a market capitalization of S$3bn and S$7.4bn of assets under management. We think that its share price has been beaten down badly by the Covid-19-induced market turmoil and offers investors good value due to:

Highly geared to domestic travel rebound

As economies gradually reopen, governments are encouraging domestic travel to revive their fallen hospitality sectors as borders remain tightly controlled. Given Singapore’s small size and population, domestic travel has a far smaller role in reviving our hospitality sector, in our opinion. We therefore think that more globally diversified hospitality stocks like Ascott, which has exposure across 15 countries, could be more geared to the recovery in domestic travel.

For example, in Japan, which contributes 12% to Ascott’s FY19 gross profit, the government has announced a campaign to stimulate domestic travel by offering subsidies of up to 20,000 Yen per day through discounts and vouchers for hotels and attractions for residents taking domestic trips.

Ascott Residence Trust income diversity (Source: Ascott)

Strong balance sheet positioning it for growth

Ascott has a strong balance sheet due to its 35.4% gearing which implies a S$2.1bn debt headroom before reaching the 50% regulatory limit. It has ~S$300m cash on hand and will be receiving an additional S$163m cash proceeds from the divestment of Somerset Liang Court in 2H20. This strength could allow it to make opportunistic acquisitions, from either third-parties or its sponsor, without an equity fund raising at a time when property valuations could be taking a hit due to the lower cashflow projections from valuers.

Apart from inorganic growth, Ascott’s strong balance sheet allows it to undertake development and asset enhancement projects without putting too much strain on its financials. Examples include the development of lyf@one-north, and the redevelopment of Somerset Liang Court. 

Somerset Liang Court (Source: Ascott)

EPRA NAREIT Index inclusion

One of the benefits highlighted by Ascott for the merger with Ascendas Hospitality was the potential for inclusion into the EPRA NAREIT Developed Index which could lead to a wider investor base (higher visibility) and higher trading liquidity. Despite the decline in Ascott’s share price, its market cap of $3bn allowed it to qualify for index inclusion in Jun20. We think that the inclusion could be a further boost to Ascott’s share price due to inflows from institutional funds, like what FLT and KDCREIT experienced when they were included in 2019.

Key risks to be aware of

As only 11% of its FY19 gross profit is derived in S$, Ascott is exposed to FX risks if the S$ significantly appreciates against the basket of foreign currencies Ascott has exposure to. Additionally, like most other businesses, Ascott would also be negatively impacted if the downturn from Covid-19 is longer than expected or if a second wave of infections materializes. 

FTSE Russell released the changes to the STI Index following its quarterly review earlier today. Similar to the predictions of the MSCI Index changes, we were spot on again with Mapletree Industrial Trust being added and SPH being deleted. In addition to the index rebalancing, the new reserve list, by market cap, is as follows, FLCT replaces MNACT:

MSCI Singapore Small-Cap Changes (Source: MSCI)

MSCI Singapore Changes (Source: MSCI)

Top Value Traded for 29 May 2020 (Source: SGX)

Changes in price from announcement to cut-off date

MSCI Review Dates (Source: MSCI)

Fortitude Budget measures

Cash grant to be distributed to landlords who will then pass this on to their SME tenants. Retail tenants to get ~0.8 months of rent in addition to the property tax rebate passed on to them previously. This will amount to ~2months of rental support in total. Industrial and Office tenants to get ~0.64 months of rent; total of ~1 month of rental support from the government.

New Bill to mandate landlords to grant rental waivers to SME tenants that experienced a significant drop in revenue due to Covid-19. This mandated rental waiver will be shared between the government and landlords. Retail landlords would have to bear 2 months of rental while industrial/office landlords would have to bear 1-month rent.

Fortitude Budget Measures for Real Estate (Source: Singapore Government)

Impact of Fortitude Budget measures on REITs

Could be a slight negative for REITs as the new measures potentially quantify a fixed amount of rental support required whereas it was previously up to the landlords to decide on how much support to give (apart from passing on the property tax rebate).

Worryingly, the measures could potentially be supporting zombie SMEs and not be the best use of scarce resources. In the light of Covid-19 and the expected new norm of social distancing, a number of business owners would have assessed that it could make more sense to close down their business rather than suffer losses post-Covid. However, with a total of 4 months of rental support from landlords and the government, tenants could decide that instead of closing now, they would be better off taking the 4 months of support and close shop at a later date once the support runs out.

Using the Capitaland Mall Trust (CMT) as a bell-weather for Singapore malls, the average occupancy cost of ~18% implies significant savings for tenants struggling to make ends meet. 

Capitaland Mall Trust Occupancy Cost (Source: CMT)

Apart from the direct real estate measures introduced, the other additional support measures like the extension of the Jobs Support Scheme also indirectly benefit REITs as they promote the survival of REIT tenants. 

Other healthcare stocks performance (Source: Yahoo Finance)

Confluence of tailwinds
1. Soaring demand
Due to healthcare requirements, the demand for natural and synthetic rubber gloves is expected to soar. According to the Malaysian Rubber Gloves Manufacturers Association (MARGMA), they expect demand to be 345bn pieces in 2020 vs 298bn pieces in 2019 (+16% yoy).  The stronger demand has given glove makers the opportunity to raise average selling prices (ASP). It was reported that Top Glove has raised ASP by 3-5% in Feb/Mar and will be going to raise it 5% monthly from Jun-Aug and then 10% from Sep onwards.

2. Supply shortage
The soaring demand has also led to a supply shortage as utilization at glove makers are already very high (~95% for Riverstone vs ~88% pre-Covid) and order backlog 9mths (Riverstone) and 10-11mths (Top Glove). This compares favourably to the typical 1-2month timeframe to meet orders and ~3-4month timeframe during the previous H1N1 and SARS outbreaks. Although most glove makers have embarked on capacity expansion plans, these won't materialize fast enough to keep up with the spike in orders as new factories take time to build and equip. These limitations of capacity expansion have also contributed to increasing ASPs. The supply shortage is also compounded by lockdowns which disrupt supply chains and labour.

The price impact of higher demand and lower supply

3. FX impact
Interestingly, revenue contracts of glove makers are priced in USD due to the global nature of their customers while costs are in MYR as their factories are largely in Malaysia. Malaysia is the world's largest producer of rubber gloves, accounting for ~63% of global supply. Therefore, the recent appreciation of USD due to its position as the world's reserve currency has led to margin expansion of glove makers.

USD/MYR exchange rate (Source: CGS-CIMB)

4. A decline in raw material prices
Despite soaring demand for gloves, its raw material prices have been kept low as a result of the oil price crash in late April. Historically, the price of rubber and crude oil have been positively correlated as the substitute of rubber is synthetic rubber, which is made from crude oil derivatives. Declining raw material prices could help to improve profit margins, ceteris paribus. For longer-term operations, glove makers could possibly look at locking in these low prices via the use of financial derivatives.

Glove raw material prices (Source: Maybank KE)

Why you shouldn't throw your life-savings into Glove stocks
1. Peak-ish valuations
As a result of the run-up in the stock prices of glove makers over the past few weeks, most of them are trading at all-time high prices and peak valuations. While the higher forward trading P/E reflects the earnings growth expectations from the market, this could also imply that upside would be limited without any further increase in earnings forecasts. Additionally, as many existing investors have enjoyed much of the upside in the past few weeks, it is likely that glove makers would be amongst the first stocks investors look to take profits from in the event of a pullback.

Riverstone historical P/E chart (Source: CGS-CIMB)

2. Raw material price increases
While oil price crashed to below 0 in April due to the supply shock from OPEC and decline in demand from the pandemic, prices have shown signs of recovery and it has been consistently trading at above $30 for the past week. Additionally, as more economies come out from lockdowns and production resumes, demand for crude oil will inevitably improve. This will have a knock-on impact on the cost of raw materials used in glove production as explained in the earlier paragraph and could lead to margin compression.

3. Potential cure/vaccine for Covid-19
Unfortunately, this is probably one of the stocks that have such a risk factor. The longer the pandemic drags on, the longer the world has a virus-induced demand for protective equipment like gloves. Any potential recovery will be underpinned by a cure or vaccine, which many large pharmaceutical companies are working on. The more well-known ones have been Gilead, Moderna and the University of Oxford; all of which have produced encouraging early results.

4. Current expansion plans could cause oversupply post-pandemic
To keep up with peak demand, glove makers have been undertaking expansion plans to boost production capacity. Riverstone has commissioned 2 new expansion phases that will be completed in 4Q20 and 1Q21 which will increase their capacity by more than 10%. According to a report by Maybank Kim Eng, Top Glove intends to add 150 new production lines over the next 2 years that could boost capacity by almost 25%.

Top Glove Expansion Plans (Source: Maybank KE)

This expansion of production capacity increases the risk of an oversupply after the pandemic is over. Post-pandemic, we can reasonably expect demand to gradually taper off as the world returns to a pre-pandemic normal.

Performance of hospital stocks (Source: Yahoo Finance)

Expected resilience of hospital/clinic stocks
Hospital or clinic related stocks are stocks that operate/own hospitals and typically benefit from a higher patient load or utilisation of their healthcare services. Demand for healthcare services tends to be inelastic and relatively recession-proof as the need to cure illness is usually not something patients can or would stinge on.

Falling short of expectations because...
1. Fewer people falling sick
As the world goes into lockdown (and Singapore into Circuit Breaker) and the majority of people stay home, the chances of catching an illness also go down. This is the intended effect of such a measure but it also has the side effect of lowering demand for healthcare services as people don't fall sick as often.

2. Self-medication
A message that is constantly being pushed onto people is the need for better hygiene and to be more health-conscious during this period. This leads to people staying away from clinics/hospitals unless absolutely necessary. For minor ailments, most would typically be able to self-medicate at home. With many workplaces closed, the need for an MC (and hence a visit to the doctors) is also greatly reduced.

3. Deferral of less urgent services
On 6 April, the Ministry of Health in Singapore issued guidance that all non-essential medical services should be deferred in line with the Circuit Breaker in Singapore. Additionally, services suitable for teleconsultation should be delivered remotely. This was aimed at focusing healthcare resources towards combating the spread of Covid-19.

4. The dearth of medical tourists
Similarly, in end Mar, the MOH sent out a memo to practitioners to immediately stop of defer accepting foreign patients who do not reside in Singapore. Current foreign patients were also advised to continue seeking medical treatment in their home countries. This move greatly cut off medical tourism, which forms a sizable portion of private hospital revenues.

On the flip side, non-hospital/clinic-related healthcare stocks have done well. In particular glove makers like Riverstone and UG Healthcare have almost doubled since a year ago. This is because of a confluence of factors that I would be addressing in my next post so stay tuned!

Performance of other healthcare stocks (Source: Yahoo Finance)