Keppel REIT (KREIT SP) - Small Negative Rental Reversion
Maintain BUY on attractive valuations
- 1Q17 DPU was a slight miss. Nonetheless, our forecasts remain largely unchanged as we believe management can mitigate any income weakness through capital distributions.
- The small negative rental reversion of just 1% for KREIT’s portfolio and the slower pace of rent decline in the market reinforce our view of a bottoming market.
- While we continue to forecast falling DPUs, KREIT’s undemanding valuation of 0.7x P/BV and 6% yield more than compensate for this.
- We continue to see strong stock support from elevated office prices in the physical market. Maintain BUY with unchanged TP of SGD1.18 based on a target yield of 5.25%.
- Risks to our view include sharp retreats in office rents and overpaying for acquisitions.
1Q17 a slight miss; No capital distributions
- 1Q17 DPU of 1.45 SGD cts (-14% YoY, -2% QoQ) was a slight miss at just 23% of our FY17E estimates.
- The dip in DPU was due to a lack of contribution from 77 King Street (divested in 1Q16), lower income at Bugis Junction Tower (BJT),and alack of capital distributions in the quarter (1Q16: SGD3m). However, the weaker performance was offset by higher distributions from ORQ and MBFC.
- Despite softer contribution at BJT, committed occupancy at the building improved by 2.2ppt to 95.9%.
- Our forecasts are largely unchanged as we believe management can mitigate any income weakness with capital distributions. Furthermore, income from BJT should pick up as occupancy improves in the coming quarters.
Small negative rental reversion an improvement
- It is interesting to note that KREIT’s portfolio experienced a negative rental reversion of just 1% in the quarter. This is a significant improvement from the negative reversion of 9% for FY2016 and we view this as a sign of rents bottoming. This, along with a slower pace of rent decline in the market, reinforces our view of a bottoming office market.
Attractive valuations compensates falling DPU
- Even though DPU could continue to fall, we believe KREIT’s attractive valuation with an implied capital value of SGD2,200 psf and cap rate of 4.1% more than compensates for prospects of weaker distributions. BUY.
- 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.