Keppel REIT (KREIT SP) - FY16 a slight miss on lack of capital distributions
Maintain BUY, but TP lowered 2% to SGD1.18
- FY16 was a marginal miss due to lower-than-expected capital distributions.
- We cut FY17-18 DPU by 2% each to reflect slightly higher vacancy and lower rents, as evidenced by the negative rental reversions reported. This led to a slight cut in our TP to SGD1.18 (from SGD1.21), based on a target yield of 5.25%.
- Nonetheless, reiterate BUY as elevated prices for office assets in the physical market will continue to support the sector’s valuation.
- Our target yield is close to its historical low to reflect strong capital value support and incorporates our relative preference amongst office REITs.
- Risks to our view include sharper-than-expected decline in office rents and overpaying for acquisitions.
Lower-than-expected capital distributions
- FY16 DPU was a marginal miss due to lower-than-expected capital distributions. No capital distributions were made in 4Q16 (4Q15: SGD5m).
- Operating trends were broadly in line with the exception of sustained vacancy at Bugis Junction Tower (BJT).
- KREIT has a total of SGD48m of other gains that has not been distributed, which can support DPU downside amid the market weakness.
- With the exception of BJT, where its property value was cut by SGD10m to SGD540m, valuations of its Singapore assets remain unchanged. Higher valuations of its Australia assets reflect a 40-50bps cut in cap rate.
9% negative rental reversions for FY16
- KREIT recently announced a downwards revision to its rental reversions for 1H16 and 9M16. For FY16, the group reported negative rental reversion of 9% for all leases, including forward renewals, signed in the year.
- The small amount of leases due for renewal near term (FY17/18: 3.9%/7.1%) suggests a low risk of a sharp pick up in vacancy. However, we expect income weakness as negative rental reversions reported for FY16 includes forward renewals.
Cheap vs private market
- KREIT offers the best exposure to Singapore’s prime office market with assets in this sector accounting for 89% of its assets.
- The stock’s implied capital value of SGD2,200 psf and 4.2% cap rate remains attractive when compared to the replacement cost of a new office building (SGD2,800 psf) and the recent transaction of Asia Square Tower 1 (SGD2,704 psf).
- Appreciation in capital value of its properties.
- Divestments of fringe assets to reduce leverage.
- Earlier-than-expected rebound in office rents.
- Sharper-than-expected declines in office rents or occupancy.
- Overpaying for acquisitions.
- Higher financial leverage implies bigger exposure to interest-rate spikes than peers.