SINGAPORE ( March 31): Office rents have been depressed in recent years owing to a glut of supply and downsizing by some tenants. But the sector could be on a rebound, according to industry watchers and property experts. Our cover story last week (Issue 722, “Trough times”) highlighted that leasing activity is improving and new supply is being snatched up this year. At the same time, the supply of office spaces is tapering off. Alan Cheong, senior director of Savills’ research and consultancy unit, expects gross rental for CBD-grade offices to fall 10% in 2017, before rising 0.6% in 2018 and surging another 6.2% in 2019.

Against this backdrop, we are adding local property developer and landlord UOL Group to our Singapore Market Portfolio. The company has a clutch of commercial properties, and a reputation of being a conservative developer. It has lagged its peers in the recent property stocks rally. City Developments is up more than 23%, while CapitaLand is up 21% this year. UOL has gained just 14%.

We think there is more upside to this stock as the commercial property market improves. Meanwhile, UOL is undervalued relative to its holdings. The company has direct stakes in Novena Square, United Square, Faber House, Odeon Tower and One Upper Pickering. These properties were valued at S$3.1 billion in its latest annual report for FY2016 ended last December.

UOL also owns 45% of United Industrial Corp, an investment holding company that owns seven office buildings valued at S$4.4 billion. Based on UIC’s share price of S$3.07, UOL’s stake is worth almost S$2 billion. UOL has a market cap of S$5.6 billion, which means investors are paying just S$500 million for the company’s other operations.

According to Maybank Kim Eng Research, UOL has the highest share of recurring income among the developers it covers. It generates over S$300 million of recurring cash flow a year. “We think this cushions it against more cyclical property development earnings,” says Maybank KE analyst Derrick Heng.

Even when office rents were going downhill last year, UOL had positive rental reversions of 3%. This is because its properties are on the fringe of the CBD and face less competition than those in the heart of the city. Heng puts UOL’s revalued net asset value at S$9.93 a share. He has a price target of S$7.93, a 20% discount to his RNAV.

Taking profits on Fischer Tech
At the same time, we are selling our shares in components maker Fischer Tech. At S$2.02 a share, our 6,900 shares will give us S$13,938. That is a profit of S$3,933 over our purchase price.

We added the electronics maker to our portfolio owing to its exposure to the fast-growing automotive industry. The company makes info tainment and other control panels for cars. Major automakers are increasingly using common platforms for car models and Fischer Tech has been a beneficiary of this strategy. Its efficiency has improved because of the use of common standards and it has been able to sell more units. The company also did well on the back of strong car sales growth in China. Fischer Tech’s customers in the automotive sector include BHTC, TRW and Panasonic.

Shares in Fischer Tech have gained 40% since we added the stock to our portfolio, making it our second-best performer, after egg producer Chew’s Group. We think the time has come to take profit on the counter. Although Fischer remains cheaply priced, at just 8.9 times earnings, there is growing risk that the company’s earnings may disappoint in the months ahead.

Auto sales in China were down in January and February owing to purchase tax cuts. And in the US, auto sales fell 1.1% in February. “Over the coming months, demand from China should remain soft as car sales are unlikely to pick up. There are no signs of improving momentum in the US, the world’s second-largest market. Sales have been stagnating for more than a year while dealer incentives have started to increase against the backdrop of rising inventories,” says Carsten Menke, commodities research analyst at Julius Baer.

CapitaLand making some moves
Meanwhile, it has been a pretty busy week for CapitaLand. The company’s subsidiary, CapitaLand Mall Asia, has signed a third-party mall management contract with Singapore Post for the upcoming SingPost Centre. This would be CMA’s third mall-management contract in the last six months.

CapitaLand will be in charge of the preopening and retail management of the fivestorey mall, which has a net lettable area of about 175,000 sq ft. With this contract, Capita Land will have 20 shopping malls under management with a combined gross floor area of 14.2 million sq ft.

In a separate filing, CapitaLand says it plans to acquire more sites in Vietnam for residential development. These sites are expected to yield 2,000 to 2,500 units this year. It is also looking for investment opportunities in offices, serviced residences and integrated developments there. CapitaLand says it is considering “Ho Chi Minh City as a potential home for a Raffles City”. The developer currently has S$2.1 billion worth of gross assets under management in Vietnam.

Also, CapitaLand is reportedly in negotiations with BlackRock to acquire Asia Square Tower 2. According to a March 27 report by RHB Research Institute Singapore, the pricing is expected to be between S$2.1 billion and S$2.3 billion. This works out to between S$2,700 and S$2,900 psf. “The deal, if concluded, would strengthen its recurring income base and position it ahead of a potential rebound in the office sector,” says RHB analyst Vijay Natarajan in a note. He has a “neutral” position on the stock, with a price target of S$3.84.

Natarajan adds that CapitaLand’s residential sales in China are likely to slow down amid new rounds of policy measures to ease property prices, including raising down payments for second home purchases. The group has about 8,430 units to be launched in China this year.

Shares in CapitaLand gained just 1% between March 21 and 28, ranking the stock among the weaker performers in the portfolio this past week. It still outperformed the Straits Times Index, which lost 0.75 point. But other counters saw more significant gains. Notably, Chew’s Group was up 12.9%. AP Oil International, which distributes lubricants, gained 3.8%, while logistics player Cogent Holdings rose 3.9%.

Our total returns since we started on Jan 4 stands at S$14,277.97, or 7.1%. The STI has gained 8% over the same period.

This article appears in Issue 773 (April 3) of The Edge Singapore.