REIT - CIMB Research 2016-08-15: Valuations not overly stretched

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KEPPEL DC REIT AJBU.SI  KEPPEL REIT K71U.SI  MAPLETREE COMMERCIAL TRUST N2IU.SI  MAPLETREE INDUSTRIAL TRUST ME8U.SI 

REIT - Valuations not overly stretched

• Despite the rally, valuations are not over-stretched. S-REITs are trading at mean. In terms of yield spread, it is also one of the cheapest vs. other key REIT markets.
• Industrials replace office as our most preferred sub-sector.
• 2QCY16: Industrials and retail were the most resilient. With the exception of SUN, the retail REITs continued to push through positive rental reversions.
• Office starting to feel negative retail reversions. RevPAR declines for hotels re- accelerated.
• Maintain Overweight. Preferred picks are now KDCREIT, MCT and MINT.

2QCY16 RESULTS SUMMARY

Results largely in line; acquisitions mask organic weakness

• As with 1Q, 2QCY16 results were largely in line but did not excite us. Sub- sector wise, industrials posted the best showing. Stock-wise, beats came from MINT (purely driven by organic growth, which was impressive) and LMRT (boosted by acquisitions and positive rental reversions). Misses came wholly from the hospitality sub-sector as the hoteliers continued to grapple with weak corporate demand and supply pressures.
• Organic performance continued to soften, with reported DPU averaging a decrease of 0.6% yoy (1Q16: +1.2% yoy). Nevertheless, overall portfolio performance was masked by full-year contributions from acquisitions made over the past 12 months. Additionally, several REITs, such as FCT, FCOT, KREIT and SUN, used capital top-ups to pad their distributions.
• Outside of Singapore and the four key segments, the healthcare REITs continued to deliver. Notably, RHT is expected to deliver a one-time special distribution of 24.4 Scts back to unitholders, following the approval of its disposal of a 51% economic interest in Fortis Hospotel Ltd (holds the Gurgaon and Shalimar Bagh assets). Meanwhile, MAGIC remained underpinned by Festival Walk and Sandhill Plaza.
• 2Q16 was also distinguished by several landmark acquisitions, especially in the commercial segment. CCT exercised its call in its remaining 60% interest in CapitaGreen (which valued the entire property at S$1.6bn). Meanwhile, Asia Square Tower 1 was transacted at S$3.4bn to Qatar Investment Authority (from BlackRock), marking the transaction as the largest in Asia Pacific to date. Straits Trading Building was also transacted at S$560m to Indonesian tycoon Tahir, setting a new per sq ft record price (c.S$3,250 psf). MCT also recently announced the proposed acquisition of Mapletree Business City Phase 1 (MBC P1) for S$1.78bn. These transactions are in line with recent revaluations done by the office REITs and should provide a strong data point for asset values.

2QCY16 KEY TRENDS

Office: negative rental reversions starting to be felt

• Excluding outlier OUECT, office REITs recorded an average 1.1% yoy decrease in 2QCY16 DPU. We observed that the office REITs started to feel the supply pressures, which is expected to hit the hardest in 2H16-1H17, following which Marina One (1.88m sq ft), Duo (570k sq ft) and Guoco Tower (890k sq ft) are expected to be completed. YTD, Grade A office market rents have declined 8.7% to S$9.50psf.
• Driven by both organic and inorganic growth (One Raffles Place), OUECT continued to outperform. Excluding ORP, organic growth in the NPI of the portfolio was still a strong 15.9% yoy. That said, 2Q16 rental reversion was slightly negative, with OUE Bayfront (OUEB) recording a negative 0.9% rental reversion. However, average passing rents continued to increase as a result of 1H16 positive rental reversions (OUEB: S$11.84psf, ORP:S$10.33psf). Occupancy for OUEB was maintained at 98.2% while occupancy at ORP inched up 1.2% pts to 91.8%.
• CCT’s performance was flattish as lower occupancy at Capital Tower and One George Street was offset by higher associates’ contributions (Raffles City and CapitaGreen). Accordingly, portfolio occupancy slid 0.9% pts qoq to 97.2%. The trust signed c.277k sq ft of leases in the quarter. There was a slight positive reversion, which increased average portfolio rent to S$8.98psf (1Q: S$8.96psf).
• Meanwhile, capital distributions helped to prop up softer underlying performance by FCOT and KREIT. FCOT’s DPU included a capital distribution of 0.38Scts (c.16% of DPU), which was used to compensate for lower occupancies at China Square Central (certain units affected by construction works). On the flip side, the trust signed 214k sq ft of new/renewed leases in the quarter, with positive rental reversions ranging from 5.5% to 10.3%. Of note, Microsoft (occupies 7.4% of the property) extended its lease at Alexandra Technopark by another five years to FY22. The office tower of China Square Central continued to enjoy full occupancy while occupancies at 55 Market Street and Alexandra Technopark remained stable at 95.8% and 94.8%, respectively.
• KREIT’s DPU included a capital distribution of 0.15 Scts (c.9.5% of DPU), which was due to divestment gains from 77 Kings Street. The trust signed c.547k sq ft of leases in the quarter but we estimated that rental reversions were negative. Signing rents averaged S$10.10psf in 2Q16 vs. S$10.30psf in 1Q16. The positive was KREIT’s successful tenant retention strategy. Portfolio occupancy stayed at a high of 99.7%.
• For the balance of 2016, we expect office rents to register a similar or even accelerated pace of decline vs. 1H16. With relatively low pre-commitments in Marina One (c.30%), Duo (c.35%) and Guoco Tower (c.20%), we expect the supply overhang to extend into 2017. Meanwhile, CBD vacancy rate was stable at 5% in 2Q16. However, we expect the vacancy rate to rise sharply to slightly over 10% in the next 6-9 months with the completion of the new developments.
• With negative rental reversions starting to be felt, we project the office REITs (excluding OUEHT) to register flat yoy DPU for FY16. In terms of lease expiries, KREIT has a minimal 0.6% of leases due for renewal in 2H16. The expiring rents average between mid-S$8psf and low-S$9psf vs. spot rent of S$9.50psf.
• FOCT has 1.5% of leases for renewal in FY16. The expiring rents average between S$6.80psf and S$7.20psf vs. Grade B spot rent of S$7.25psf. In addition, OUECT has renewed all expiring offices lease for OUEB and 5.4% of ORP’s income is up for renewal in 2H16. The average expiring rent for the property is S$10+psf. Lastly, CCT has 4% of income to be re-contracted in 2H16 and 11%/17% in 2017/18. Average expiring rents range from S$9.40psf to S$10.77psf, which implies that negative rental reversion will kick in over the next two years. However, we expect the income drag to be more than offset by contributions from the additional 60% stake in CapitaGreen.

Retail: still resilient; income vacuum from AEIs

• Retail REITs remained resilient, recording an average of 0.4% yoy growth in 2QCY16 DPU.
• Retail sales (excluding motor vehicles) contracted by 3% yoy for Apr and 3.3% yoy for May. The fashion trade sector was beaten down further, with British apparel brand New Look and French menswear Celio announcing their exits from the island-state. Meanwhile, the retail landlords are propping up occupancies with short-term leasing to pop-up stores. In all, suburban malls integrated with major transport nodes have been more resilient vs. the Orchard Road shopping belt and the secondary shopping area. Prime rents for Orchard Road declined by 1.1% qoq while that for suburban markets declined by 0.7% qoq.
• Despite the challenging environment, the retail REITs (with the exception of SUN) continued to push through positive rental reversions for their lease expiries. CT achieved a 1.7% rental reversion growth for the 533k sq ft of NLA it re-contracted in 1H16, with shopper traffic and tenant sales rising 3.6% and 2.3% yoy, respectively. Portfolio occupancy was sustained at a high of 97.9%.
• Meanwhile, FCT renewed 4.6% of portfolio NLA with an average 8.3% uplift from previous quarters. Due to ongoing AEI at Northpoint, shopper traffic and tenant sales dipped 0.4% yoy and 1.8% yoy, respectively. Portfolio occupancy also fell 1.2% pts qoq to 90.8%. With the release of S$2.1m of cash retained from previous quarters and a higher proportion of management fees in units, the manager succeeded in keeping DPU flat yoy.
• MCT achieved a 12% rental reversion for Vivocity. The mall’s tenant sales inched up 0.3% yoy but shopper traffic came down 3.6% yoy. Completion of its second AEI is on track for end-Jul 16, which should raise contributions. The committed occupancy for Vivovity is 99.9%.
• SPHREIT enjoyed a 4.9% rental hike for its expiring leases, with both Paragon and Clementi Mall 100%-filled. This was despite Paragon experiencing a dip in shopper footfall.
• Amid ongoing tenant remixing at SGREIT’s Wisma Atria, tenant sales fell 2.5% yoy despite shopper traffic rising by 2.3% yoy. Wisma Atria’s retail occupancy improved 0.9% pts to 97.7%. Meanwhile, Ngee Ann City’s performance improved on the back of a 5.5% upward adjustment in the Toshin master lease in Jun.
• Higher capital distribution of S$8m helped to maintain SUN’s DPU. SUN re- contracted 165k sq ft of retail space, with average rents slipping 3.5% qoq to S$11.85psf. Occupancy decreased 1.2% pts to 97.5%. The negative reversion stemmed from the renewal of leases in phase one of Suntec City Mall, which was re-contracted at the peak of the market three years ago. As more and more leases are re-pegged to market levels, we believe retail rents could stabilise towards end-16.
• For 2H16, the impact of AEIs will be more keenly felt, with occupancy being adversely affected by ongoing renovation works. As such, we project retail S- REITs (excluding SGREIT) to post an average 0.7% yoy improvement in DPU for FY16/17.
• The drag mainly comes largely from CT as its Funan IT Digital Mall will be closed for three years starting Jun 16. The property will be doubled in size to 611k sq ft of NLA into an integrated lifestyle mall/office/serviced residence property when completed in 4Q19. The redevelopment exercise will cost S$560m and will be internally funded.
• FCT’s Northpoint is likely to see occupancy dip to 76% over the next six months due to renovation works ahead of the property’s integration with new Northpoint City (currently under development).

Industrial: Adept performance from the bigger caps; logistics experienced sharp negative rental reversions

• Excluding the smaller caps (CACHE and CREIT), the mid-big caps’ performance was adept, posting an average of 2.9% yoy improvement in 2QCY16 DPU. Additionally, despite the seemingly high headline declines, we note that CACHE would have registered a 1.7% yoy increase in 2Q16 DPU if we were to exclude the capital distribution from 2Q15 DPU. Similarly, CREIT’s DPU would have been flat if we were to exclude management fees paid in units and one-off capital distribution in 2Q15.
• On the physical side, rents continued to erode in 2Q16, by 0.8% qoq for business parks and 1.2% qoq for logistics. The city fringe business parks continued to hold up and we are more positive on this asset given the supply outlook post 2016.
• In spite of the headwinds, MINT recorded a stellar set of results, which was driven by higher rental rates achieved across all segments and higher occupancies at hi-tech buildings and business parks. AREIT also made an emphatic start to its FY17. Performance was mainly driven by new acquisitions (Australian portfolio and ONE@Changi City) as well as improvement in Singapore occupancy (+0.4% pts qoq to 88.3%) and rates (+4.1% rental reversion).
• On the other hand, the logistics trusts experienced sharp negative rental reversions in the quarter as STBs (single-tenanted buildings) were converted into MTBs (multi-tenanted buildings), with the preceding net rates being marked to market. MLT recorded a 6% negative rental reversion for its portfolio as its Pyeongtaek Port experienced a c.20% negative rental reversion with the extension of its lease till end-16. CREIT also recorded a c.16% negative rental reversion as its 4/6 Clementi Loop warehouse was converted from master lease to MTB. Lastly, we think that it is most likely that CACHE’s Hi-Speed Logistics Centre will register a like-for-like negative rental reversion. The master lease expires in Oct 16 and the facility will be converted into an MTB then.
• Going forward, we project the mid-big caps to remain resilient and post an average 1.1% yoy improvement in DPU for FY17. New contributions from acquisitions will underpin AREIT (recently announced the proposed acquisition of two properties in Australia plus AEI of a high-specs Singapore asset), KDCREIT (intends to acquire Keppel DC Singapore 3) and MLT (proposed acquisition of a portfolio of four properties in Australia and a logistics facility in Malaysia).
• Further out, contributions from the build-to-suit facility (BTS) for Hewett- Packard (HP) could bump up MINT’s FY18 DPU. Backed by its organic developments, we project a 3-year DPU CAGR of 5% (FY17-19F) for MINT, which is one of the highest under our coverage.
• We remain cautious on CACHE and CREIT as a structural change in their lease mix to a higher proportion of MTBs could herald declining NPI margins.

Hospitality: still bad, if not worse

• Hospitality REITs recorded an average 12.9% yoy decline for 2QCY16 DPU. In light of shortening length of stays and poorer corporate demand, we reiterate that the rebound in visitor arrivals (+13.3% yoy for 5M16) will not benefit the hospitality REITs. In fact, RevPAR declines re-accelerated, with the REITs reporting an average of 7.8% yoy decline in RevPARs in 2Q16 (1Q16: -2%, 1H16: -5%). Comparatively, the industry recorded a 0.8% yoy decline in RevPAR for 5M16.
• Apart from supply pressures and poor corporate demand, the common culprits in 2Q16 were renovations and an exceptionally poor June. CDREIT’s M Hotel, Grand Copthrone Waterfront and FEHT’s Orchard Parade were affected by renovations in the quarter. Meanwhile, the absence of SEA Games (held in June 15) and the shift in Ramadan this year to 6 Jun-5 Jul (vs. 18 Jun-17 Jul last year) could be some of the reasons behind the awful June.
• For ART, its performance was boosted by one-off divestment gains from Fortune Garden Apartments, excluding which 2Q16 DPU decreased 8.6% yoy (instead of +1.9%). Otherwise, its results underscored our sluggish growth outlook for the trust. In addition, we highlight that OUEHT’s large drop in DPU was mainly due to the rights issue in Apr 16.
• For the remainder of the year, we now forecast hospitality REITs to post an average DPU decline of 10.3% yoy for 2016. Barring another bad month, we expect 2H16 to be slightly better than 1H16.
• Overall, we remain cautious on all the hospitality REITs (except OUEHT) as we only envision a recovery by end-2017. Propelled by inorganic contribution from Crowne Plaza Changi Airport Extension and the completion of retail fit-outs, we project 16% yoy growth for OUEHT’s FY17 DPU. This is also the strongest DPU growth while its 2017 dividend yield of 7.9% is the highest among the hospitality REITs.

VALUATION & RECOMMENDATION

YTD share price performance

• Post Brexit, S-REITs have rallied, boosted by the hunt for yield and flight to safety. In fact, the fall-out from Brexit has resulted in a firmer ‘lower-for-longer’ rate outlook. The REIT index is up 8.6% YTD while the FSSTI is down marginally at 0.5%. The developer index (FSTREH) is down 3.7%.
• For stocks, the top three outperformers are MCT (+18.8%), MAGIC (+17.5%) and KDCREIT (+17.5%). The top three underperformers are FEHT (-9%), OUEHT (-5.8%) and CREIT (-4.4%).

From a yield spread perspective, S-REITs still cheap

• In terms of valuations, the sector is trading at its mean of 6.3% dividend yield and 1x P/BV. Weighing the top-down hunt for yield against bottom-up lacklustre fundamentals, we believe that current valuations are not excessive. We could turn to a more price-taking mode if the sector trades 0.5 s.d. above its mean.
• Furthermore, S-REITs are still trading at a 450bp spread vs. the 10-year bond yield, c.75bp higher than the average 370bp. Compared to the other key REIT markets, S-REITs is also one of the cheapest.

Industrials now our preferred sub-sector

• We maintain Overweight on S-REITs. The key change in this note is in our sub-sector positioning. Industrials replace office as our most preferred sub-sector. We project industrial to record an average 1.1% yoy increase in 12-month DPU, followed by +0.7% yoy for retail, -0.1% yoy for office and -10.1% yoy for hospitality.
• Overall, the mid-big industrial caps offered the best showing for 2QCY16. Looking ahead, we believe that the sector is best poised to navigate past the headwinds. 
• Firstly, the likes of AREIT and MINT have been diversifying away from traditional manufacturing activities and towards higher value-added businesses. About 10% of AREIT’s NLA are occupied by tenants engaged in manufacturing activities while 37% of MINT’s rental income stem from manufacturing activities. 
• Secondly, mid-bigger industrial caps are well- diversified in terms of tenants and trade sectors. Their well-staggered lease expiry profiles also help to manage rental erosions.
• Thirdly, we see upside risks from an acquisition angle. Specifically, AREIT will look to enhance its Australian portfolio. In the longer term, overseas properties could form 20-30% of the trust’s AUM. In addition, KDCREIT aims to double its AUM to S$2bn by 2018. 
• Meanwhile, MINT will benefit from the completion of development projects (BTS for HP will contribute in FY18 and Kallang Basin 4 Cluster in FY19). Its ROFR pipeline also includes an industrial facility inside the Paya Lebar iPark and it is directly connected to the nearby Tai Seng MRT. Lastly, MLT will be able to capitalise on its sponsor’s extensive ROFR pipeline - 3.2m sq m of logistics development in Asia.
• Our second order of preference is retail as we think that the sub-sector will remain resilient, as proven by its track record. In the interim, however, the likes of CT and FCT will have to cope with income slippage from AEIs.
• The office REITs have performed admirably in the face of severe supply shock (4.8m sq ft of supply will be coming online in 2016-17 vs. past 10-year annual average of 0.8m sq ft) and have been successful in their pro-active tenant retention strategy. However, we believe that office REITs will inexorably be engulfed by the supply flood in 2H16-1H17 and will feel the most from negative rental reversions.
• Lastly, we do not foresee the competitive hotel landscape to ease anytime soon. Our base-case scenario is for the sector to bottom in 2017 and recover from 2018 and onwards.

Preferred picks are now KDCREIT, MCT & MINT

• MCT and MINT replace KREIT and MAGIC as our preferred picks. While the latter two have done well, the stock picks now also jive with our sub-sector rejig.
• What the three have in common is their visible growth paths. KDCREIT will be powered by acquisitions. Meanwhile, MCT will benefit from the strategic addition of MBC P1. Together with VivoCity, both properties will contribute a substantial portion of MCT’s NPI. Last, MINT will benefit from completion of development projects. Hence, we believe that the valuation bias for all three stocks will remain.

Maintain Add on KDCREIT with target price of S$1.29

• Despite some supply pressures, we remain confident that healthy demand should quickly mop up supply. 
• Acquisitions and potential revaluation gains lead us to remain positive on the stock. The manager has an ambitious target to double the REIT’s AUM to S$2bn by 2018. 
• Also, a larger AUM could attract more institutional following and increase the stock’s liquidity. 
• We forecast a total return of 15% over the next 12 months.

Maintain Add on MCT with target price of S$1.62

• We believe that the acquisition of MBC P1 will strategically enhance MCT’s size and stability. Post the purchase, MCT’s AUM and market cap will grow to c.S$6.2bn and >c.S$4bn, respectively, making it one of the top 6 largest listed S-REITs. 
• We also see earnings upside at the property as expiring leases are below spot rents. 
• Meanwhile, completion of AEI at Vivocity in Jul 16 should continue to drive bottomline while minimal office renewals should provide a stable outlook. 
• We forecast a total return of 12% over the next 12 months.

Maintain Add on MINT with target price of S$1.90

• We like MINT for its resilient portfolio, strong balance sheet and 3-year DPU CAGR of 5% (FY16-19F), one of the highest under our coverage. Although MINT trades in excess of one s.d. above historical mean, its growth means that investors will enjoy normalised yields by FY19F. 
• In the interim, the possible relocation of Johnson & Johnson (MINT’s third-largest tenant, contributing 2% of GRI) is not likely to derail MINT’s visible growth trajectory. The J&J lease expires in 2018. 
• We forecast a total return of 14% over the next 12 months.

SREITs Peer Comparison 

YEO Zhi Bin CIMB Securities | LOCK Mun Yee CIMB Securities | http://research.itradecimb.com/ 2016-08-15

CIMB Securities SGX Stock Analyst Report ADD Maintain ADD 1.29 Same 1.29

ADD Maintain ADD 1.62 Same 1.62

ADD Maintain ADD 1.90 Same 1.90