OUE Commercial REIT - Concerns to weigh on share price
Impediments to re-rating.
- We maintain our HOLD call for OUE Commercial REIT (OUECT) and a TP of S$0.74.
- While we see long term value in OUECT as it trades at over 20% discount to its book value and offers > 7% yield, we believe the stock will be range bound near term, due to its above-average gearing (around 41%), relatively small capitalisation and fears over falling office rents ahead of new office supply in 2017.
Uplift from One Raffles Place (ORP).
- With an income support arrangement providing income stability to OUE Bayfront, contributing a third of net property income (NPI) till 2018, earnings upside would come from driving a better performance at ORP.
- With initial yield estimated at 3.4%, the Manager is actively seeking to push occupancy rates closer to c.95% from c.91% currently.
Earnings risk possible in FY17.
- As OUECT’s proactive forward renewals have reduced the number of leases expiring in FY16, the greatest earnings risk for OUECT is in FY17. There are approximately 16% of leases by net lettable area (NLA) at OUE Bayfront and 26% at ORP that are up for renewal in FY17.
- The risk of negative rental reversions arises as rents for these leases were signed during the better times in FY14/15.
- The potential magnitude of falling rents is still uncertain as it is unclear how aggressive the management of the new office buildings will be in discounting rental rates.
- We maintain our DCF-based TP of S$0.74.
Key Risks to Our View
- The key risk to our view is a greater-than-expected fall in spot Grade A office rents to below S$7 per square foot per month (psf/mth).