Keppel REIT (KREIT SP) - UOB Kay Hian 2016-10-19: 3Q16 Portfolio De-risking Through Active Leasing

Keppel REIT (KREIT SP) - UOB Kay Hian 2016-10-19: 3Q16: Portfolio De-risking Through Active Leasing KEPPEL REIT K71U.SI

Keppel REIT (KREIT SP) - 3Q16: Portfolio De-risking Through Active Leasing

  • Results were in line with expectations. Proactive leasing efforts saw renewal of all leases due in 2016, leaving marginal leases due in 2017 and 2018. 
  • Nascent signs of office rental stabilisation and aggressive execution, coupled with flight to quality to its super prime offices, should tide KREIT through choppy waters when supply headwinds threaten in 2017. 
  • Maintain BUY with an unchanged target price of S$1.31.


RESULTS



Results in line. 

  • Keppel REIT (KREIT) reported 3Q16 DPU of 1.60 S cents/share (-5.9% yoy, -0.6% qoq). 
  • Property income and NPI saw respective declines of 6.3% yoy and 5.4% yoy, attributable to the loss of contribution from 77 King Street (divested early-Jan 16). The decline was slightly offset by JV and associate income from One Raffles Quay and Australia. 
  • The results are in line with expectations, with 9M16 DPU representing 73.6% of full-year estimates.


STOCK IMPACT


Enthusiastic forward renewals to minimise tenant flight risk. 

  • KREIT has completely renewed all expiring leases in 2016, leaving a mere 5.2% and 5.4% by NLA remaining in 2017 and 2018 respectively. This would minimise tenant flight risk during the next wave of commercial supply due in 2H16 to 2017, from the likes of Guoco Tower (0.9m sf in 2016), Marina One (1.9m sf in 1Q17) and Duo (0.6m sf in 4Q16). 
  • We understand from management that the bulk of expiring leases in 2017 and 2018 are in their first renewal cycles and are thus likely to be renewed. Retention remains high at 98%.

Positive rental reversion implied in 3Q16.

  • Positive rental reversion implied in 3Q16, with overall reversions (new, renewal and forward renewals) in 9M16 amounting to +3% (1H16: +2%). 
  • We understand that passing rents are low at S$9 psf pm for leases due in 2017-18, implying limited downside to current Grade-A rentals (S$9.30 psf pm). Management also noted that 75% of new tenants secured in 9M16 were new and flight-to-quality, supporting our thesis that Grade-B office space may continue to see tenant flight risk, especially as Grade-A rentals continue to slide.

Positive leasing newsflow, coupled with positive office absorption. 

  • Singapore’s largest office projects Marina One (1.9m sf) and Guoco Tower (0.89m sf) have been gaining momentum on the leasing front. Pre-leasing at Marina One stands at about 35.3% (including Julius Baer’s reported take-up of 100,000 sf), while Guoco Tower is now 80% committed (tenants: Agoda, Danone, Straits Trading). 
  • According to industry consultant CBRE, the healthy take-up led to positive islandwide take-up of 0.82m sf in office space for 3Q16, reversing four consecutive quarters of negative space absorption (average 0.23m sft).

Nascent signs of rental stabilisation. 

  • According to CBRE, Grade-A office rentals declined 2.1% qoq in 3Q16 to hit S$9.30 psf pm (18.4% decline from 1Q15’s peak of S$11.40 psf pm). However, we note that the Grade-A rental declines on a qoq basis have slowed in 3Q16. In previous quarters during 3Q15-2Q16, 
  • Grade-A rents witnessed qoq declines ranging from 3.5-4.8%. We note management had previously guided for flattish to marginally positive rental reversions going forward.

Expect pick-up after short-term pressure. 

  • We expect a potential recovery in 2018, post supply digestion next year, after around 20% correction in office rents from 1Q15’s peak. 
  • Beyond 2018, core CBD office supply remains meagre at below 0.9m sf (Frasers Tower as well as the redevelopment of International Factors Building and Robinson Towers).


EARNINGS REVISION/RISK

  • None.


VALUATION/RECOMMENDATION

  • Maintain BUY with an unchanged target of S$1.31, based on DDM (required rate of return: 6.7%, terminal growth: 1.7%).


SHARE PRICE CATALYST

  • Higher office rentals.
  • Positive newsflow on leasing activity, employment and economic growth.
  • Slower rise in interest rates.




Vikrant Pandey UOB Kay Hian | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2016-10-19
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.31 Same 1.310



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