LHN - Recent Acquisitions To Bear Fruit
- LHN will see strong contributions streaming in from its recent acquisitions, with the Ang Mo Kio property alone potentially generating steady state annual revenue of $6m.
- It is in a niche market of providing bite-sized spaces and is unaffected by tighter JTC subletting rules, unlike industrial REITs. Their margins are relatively defensive in the soft industrial market.
- Maintain BUY with a reduced target price of S$0.28 (from S$0.32).
- We attended LHN’s site visit/analyst briefing post its FY16 results release. Following this, we have revised our estimates and price target to reflect recent acquisitions and the softer industrial leasing market.
- FY16 results were also in line with our previous estimates, with FY16 core net profit of S$6.3m (S$8.8m in revaluation gains) accounting for 97% of our FY16 estimates.
Recent acquisitions expected to bear fruit in the coming year.
- 38 Ang Mo Kio will see contributions streaming in post refurbishment in 1Q17.
- The S$30m acquisition was completed in May 16, with 30% sub-let and the remaining 70% leased to its “Work+Store” subsidiary that provides space optimisation solutions to e-commerce players. On a steady-state basis, this asset has a potential of generating S$6m revenue annually and it alone accounted for S$6.7m in net revaluation gains (LHN’s 50% effective stake).
- Golden Mile car park, which was acquired in Sep 16, could also see some upside next year, as management intends to raise car park fees by 20% (potentially in 1Q17). This is in line with URA and HDB’s announced 20% hike in car park rates (effective 1 Dec 16).
- LHN’s latest acquisition (Four Star building in Kallang) is also expected to see its asset enhancement complete in 3Q17.
Unaffected by tighter JTC subletting rules, unlike industrial REITs.
- JTC has raised the requirement for anchor tenants to occupy 70% of the available space for a broad spectrum of JTC properties, including those under direct allocation, sale and leaseback and build-to-suit schemes.
- LHN’s properties are not affected by the ruling and could see a surge in interest from smaller-space tenants who do not get their existing sub-tenancies renewed by landlords subject to JTC’s requirements.
Margin defensive business in the face of challenging leasing climate...
- LHN leases most of its managed assets, and profits from the spread between the rents it charges to its tenants and its rental costs are paid to the respective landlords. Thus, while the leasing outlook in Singapore remains challenging, the impact from lower rental income can potentially be mitigated by lower rents paid to either government bodies or private owners for the assets that LHN enhances and sublets.
…as the domestic industrial outlook looks poised to remain soft.
- CBRE estimates that 2017 will see an additional 6.1m sf of warehouse supply (historical 10-year average: 3.4m sf). We note that 3Q16 warehouse ground-upper floor rents have seen a ytd decline of 3.5-4.5%, while 3Q16 factory ground-upper floor rents have softened 2.9-3.6% ytd.
Niche market by providing bite-sized spaces.
- In our opinion, the risk of tenants bypassing LHN and renting the properties directly is very small, because the spaces are often very huge and will need to be carved up into smaller units to be leased to SMEs.
- In addition, we note that property conversion may run into power supply and flooding problems and will require the involvement of an experienced specialist like LHN.
- Management alluded to the expansion of its Indonesian footprint beyond its current two serviced offices (which accounted for 1.1% of FY16 revenue).
- While keeping tabs on the current political unrest in Jakarta, management nevertheless still favours the long-term fundamentals of the Indonesian economy and continues to be on the lookout for acquisition opportunities (its local team is already in place).
- We have retooled our model to factor in the softer industrial market, reducing rents by 2- 4% in FY17 and factoring recent acquisitions.
- Maintain BUY with slightly lower target price of S$0.28 (from S$0.32) as we incorporate our updated estimates and introduce FY18-19 numbers, based on our SOTP/DCF model (WACC : 7.5%, terminal growth: 0%).
SHARE PRICE CATALYST
- Rental growth in industrial space.
- Inorganic growth from further accretive acquisitions, both in local and overseas markets.