Keppel DC REIT - Can KDCREIT be top in class again in 2017?
- Organic portfolio weakness, a less visible acquisition pipeline (12-month timeframe) and a strong S$ are reasons for pessimism on KDCREIT, in our view.
- In contrast to 2016, when the manager provided explicit guidance on the acquisition of SGP 3, the acquisition pipeline for 2017 is less visible.
- We foresee negative rental reversion for the Singapore and Basis Bay leases, which are up for renewal in 2017. It is also taking longer than expected to backfill Dublin 1.
- While there are minimal lease expiries in FY18-20F, the flip side is that the trust may not enjoy positive rental reversions if 2018 becomes a landlord’s market.
- Reiterate Hold with lower DDM-based target price.
Can KDCREIT be top in class again in 2017?
- We downgraded KDCREIT from Add to Hold in “Navigating Singapore–Rocky is the new status quo” in 5 Dec 16. While its elevated valuation is an easy “bear” argument to sell the stock – the stock is trading at 1.28x FY16F P/BV and 5.7% FY17F dividend yield – we also flag the following as reasons that could cap its share price performance:
- organic portfolio weakness,
- a less visible acquisition pipeline (12-month timeframe), and
- a stronger S$ vs. currencies in which its foreign-sourced income is denominated.
Less visible acquisition pipeline in 2017
- A big part of the KDCREIT story is powered by acquisitions. The manager has targeted to expand the REIT’s AUM by S$2bn by 2018 (currently S$1.4bn). However, unlike 2016 when it guided for the acquisition of SGP 3, the acquisition pipeline for 2017 is less visible.
- We think the two assets in the right of first refusal (ROFR) pipeline (Almere 2 and SGP 4) will not be ready for acquisition by 2017. This also means that the manager has to rely on smaller, overseas third-party deals that may not excite the market.
Pencilling in more conservative assumptions
- Around 25.7% of KDCREIT’s rental income or 17% of its net lettable area (NLA) is up for renewal in 2017. For its Singapore lease expiry, we now assume -10% rental reversion, in line with our estimated weighted average negative reversion for its Singapore leases in FY16. As for Basis Bay, we factor in -5% reversion to the prevailing rent at expiry.
- Lastly, it has taken longer than expected to backfill the vacant Dublin 1 space. We now expect it to take two years (or by FY18F) to raise Dublin 1's occupancy back to c.75%.
Stronger S$; Minimal expiries post-FY17 good or bad?
- We update our FX assumptions as the REIT’s foreign-sourced income (especially RM and £) has depreciated sharply against the S$. Altogether, we reduce our FY16-18F DPU by 1.5-4.1%. While there are minimal lease expiries in FY18-20F, which spells higher income certainty, the flip side of the coin is that the trust may not enjoy positive rental reversions if 2018 becomes a landlord’s market.
Reiterate Hold with lower DDM-based target price
- While the above factors should not cause the stock to de-rate (as reflected by our moderate DPU cuts), they could collectively cap KDCREIT’s share price performance in 2017. Hence, we reiterate our Hold rating, with a lower target price as we roll over our DDM valuation (S$1.18).
- Upside/downside risks hinge upon acquisition momentum, leasing terms and tax transparency for SGP 3.