“Stress-testing” Singapore Inc

“What if” analysis should growth slow more than expected
Although our economics team maintains the fundamental view that Singapore’s growth can withstand a USA slowdown and will continue to grow at above 6% for 2008-09, we have done a bottom-up stress-test to assess the earnings risks and valuation contraction for the top-25 stocks listed in Singapore should global growth slow.

Bear case scenario: 13% downside to 2008 profit forecasts
If one assumes that the Singapore economy slows to 2-3% similar to the level experienced in 2002-03, we forecast that in aggregate there could be a 13% downside to the current 2008 earnings forecasts under the bear-case scenario.


De-rating possibilities? Looking through past experiences
Meanwhile, we have also provided a comparative valuation looking at the trough multiples that these stocks have traded in past bear markets (ie. 1998 Asian crisis, 2002/3 SARS, Sept 11) to assess the de-rating risks of the respective stocks.

Conclusion: Identifying risks sectors and safe havens
In conclusion, we note that the financials, airlines, shipbuilding and petrochemical sectors are most exposed to a global and Singapore growth slowdown.
Meanwhile, the telecoms and the REITs sectors are the most defensive with respectable dividend yields.

Singapore big cap stocks with the greatest earnings risks (>15%)
SGX -30% Less frenetic stock trading activities
SPC -30% Lower oil demand impacting refining margins
Noble -26% Lower tonnage traded and easing in freight rates
Cosco Corp -26% Lower shipyard revenue due to possible order delays
SIA -23% Revenue-led decline in operating margins
DBS -20% Falling loans growth and SIBOR decline
Keppel Land -20% Lower office rental and residential selling prices
ST Eng -20% High exposure to USA and European aerospace
UOB -15% Falling loans growth and SIBOR decline
OCBC -15% Falling loans growth

DBS
Earnings for DBS in geographic terms come from Singapore and HK. DBS's profits are sensitive to (1) slower loan growth from regional corporates, and (2) fall in SIBOR, caused by a drop in US interest rates, depressing its margins. Provisions are of lesser concern, in our view.

UOB
Earnings are mainly from Singapore, Malaysia and Thailand in that order of importance. Bear-scenario would mean slower loan growth from its bread-and-butter mortgage and SME
customers as well as fewer fees earned from sale of wealth management products. Less negative impact on margins from fall in SIBOR compared to DBS. Provisions are of lesser concern, in our view.

OCBC
Earnings are from Singapore, Malaysia and Indonesia in that order of importance. Bear-scenario would mean slower loan growth and much lower investment returns earned at its 87%-held insurer Great Eastern Hldgs. Less impact than DBS as a falling SIBOR helps OCBC's margins. Provisions are of lesser concern, in our view.

SGX
About 20% of turnover activity comes from overseas companies listed on SGX, mostly from China, Indonesia, Thailand and India. A general fall in trading activity would have an outsized impact on profits due to the significant operational leverage of the exchange model.

CapitaMall Trust
Limited downside to 2008 estimates. 22% of the portfolio expires in 2008. If we assume expires are transacted at S$8psf (vs current assumption of S$10.50psf) our earnings would fall by less than 2%.

Ascendas
Limited downside to 2008 estimates. 11% of the portfolio is exposed to lease expiry during 2008. If we assume flat rental growth for this portion of the portfolio then our 2008 NPAT would fall by less than 1%.

CapitalCommercial Trust
Limited downside to 2008 estimates. 30% of the portfolio is expiring in 2008. If we assume expires are transacted at S$7psf (vs current assumption of S$10psf) our earnings would fall by less than 3%.

SPC
Downside to earnings due to 1) lower oil demand growth in US and Asia thus affecting oil price and refining margins; 2) new refinery coming onstream in India, thus potential oversupply of refined product in 2H08; 3) lower levels of maintenance shutdown by refineries in 2Q; 4) higher than normal levels of exports from Europe, especially fuel oil.

Economic decoupling?
Singapore: Benefiting from Diversification
􀂄 We think Singapore is well positioned to cope with a slowdown in the US economy and we are therefore unlikely to see a repeat of the simultaneous recessions experienced back in 2001-02.
􀂄 Our optimism firstly stems from the fact that the emergence of emerging markets and the commodities boom has led to a more diversified global economy. This has reduced the importance of the US as a final destination of goods.
􀂄 Secondly, an on-going structural transformation means that Singapore has a more diversified set of growth drivers (eg, pharmaceuticals, financial services, tourism, education, etc…) that it can rely on to offset slower US/tech demand.
􀂄 Thirdly, domestic demand is the middle of a robust expansion on account: (a) a tight labor market (which is underpinning consumer spending) and (b) the need to upgrade/expand the physical infrastructure and housing supply (which is underpinning construction).
􀂄 As a consequence, we expect Singapore’s economy to be only mildly effected by the US downturn. We are forecasting GDP growth to average 6.3% in 2008- 09, compared to an estimate of 7.8% in 2007.

US economic slowdown hard to ignore
As one of Asia’s most trade-intensive economies, it is difficult for Singapore to ignore the impact of a US slowdown, nevertheless a recession. Measured as a proportion of GDP, exports to the US stood at 12.4% in 2006, which is the second highest in the region after Malaysia.

Repeat of simultaneous recessions in 2001-02 unlikely
We, however, think that the Singapore economy will not follow the US downwards like it did back in 2001-02, which was the last time both countries jointly fell into recession in the wake of NASDAQ/Internet/ICT meltdown. This is because: (1) the global economy is more diversified now and (2) Singapore’s domestic economy is in the midst of ongoing structural shift/upturn – where the electronics sector is being gradually replaced by new drivers of growth.

A more diversified global economy
Evidence that the world economy has become more diversified and/or the importance of the US has diminished can be shown two ways. Firstly, chart 2 shows that Singapore’s exports to the US are on the decline, accounting for 8.8% of total exports in 2007, compared to 15.4% in 2001. Secondly, chart 3 shows that despite a 2.8% contraction in exports to the US last year, total exports still grew 10.1% in 2007.
A large part of this diversification can be credited to a combination of a pick up in globalization in recent years (eg, China joining WTO), large emerging markets joining the global economy (eg, India and Eastern Europe) and the global commodities boom (eg, Russia, Brazil and Middle East). This combination has led to sharp shift in global spending power away from the US.

Structural transformation continues
Not only has the global economic landscape changed, there are significant shifts taking place in Singapore’s domestic economic landscape. In an effort to diversify its economic base and, more specifically, reduce its dependence on the volatile electronics sector, the following initiatives have been taken:
1. Manufacturing shifts away from electronics: The Economic Development Board has focused its efforts on attracting foreign multi-nationals involved in nonelectronics products such as chemicals, pharmaceuticals and higher value-added equipment, where pricing power is stronger and less volatile.
2. Boosting the services sector: In order to take advantage of the region’s economic revival, which is being powered by Asia’s giants China and India, the government continues to reposition itself into a key regional/global hub.

Key areas of focus include:
􀂄 Financial services – The rise in the region’s wealth, particularly in China and India, has made Singapore an attractive place to expand wealth management operations. Hedge funds have also set up shop in Singapore.
􀂄 Tourism – The decision to allow the building casinos shows that the government is keen to diversify its export base.
􀂄 Business services – A number of other business services are thriving including include legal, accounting, logistics medical and back office services. Thanks to a strong education system and on the ground campuses of leading international business schools, Singapore continues to attract more foreign students.

Domestic demand is back
It should come as little surprise that Singapore’s ongoing diversification has not only resulted in a significant tightening in the job market but has also led to a huge influx of foreigner workers. Note the seasonally adjusted unemployment rate fell to 1.6% in 4Q07 (vs 1.7% in 3Q07).
In response, domestic demand (both consumption and investment) has been rapidly expanding. Nearly 80% of the rise in Singapore’s headline GDP growth can be directly attributed to domestic demand. More importantly, Singapore appears to be in the early stages of a long-run investment upturn. Chart 5 shows that construction activity has surged in response to a combination of increased demand for housing, an upgrading of the physical infrastructure by the government and on-going construction of the new integrated resorts and casino projects.

Well positioned to cope with a US slowdown this time
To be clear, we are not saying that a US slowdown doesn’t matter, it is a negative development as trade activity will be affected. However, it is unlikely to have the same impact on the Singapore economy as it did back in 2001-02, which was the last time the city-state experience a recession.
We think that the combination of new economic drivers coupled with the upturn in domestic demand should help Singapore offset weaker US demand. As a consequence, are forecasting GDP growth to average 6.3% over the 2008-09 period, compared to an estimate of 7.8% in 2007.

If anything, we think that Singapore’s authorities (behind close doors) may be actually glad to see external demand take a breather as inflation has been rekindled on the back of a tighter labor market.