OUE Commercial REIT - DBS Research 2017-05-08: Awaiting Acquisitions

OUE COMMERCIAL REIT TS0U.SI

OUE Commercial REIT - Awaiting Acquisitions

1Q17 DPU down 7% y-o-y due to impact from recent equity placement.
Potential near term pressure on occupancy and rents from headwinds in Singapore and Shanghai.
Awaiting potential acquisition to mitigate recent dilution.

We maintain our HOLD call on OUE Commercial REIT (OUECT) with a revised TP of S$0.67.
While we see long-term value in OUECT as it trades at c.20% discount to its book value, we believe the stock will be range-bound in the near term, given the potential operational weakness ahead of new office supply in 2017, dilution from the recent equity placement, and uncertainty over the timing of any acquisition.

OUE will be renewing close to 20% of its income in 2017, where market rents are still expected to slide given the excess supply situation.
We note that there are approximately 12.7% of leases by gross income at OUE Bayfront and 26% at One Raffles Place (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, most likely at a higher base than current market rates.
However, we note that the untapped portion of income support at OUE Bayfront allows the Manager to be more discerning in choosing the right tenant mix till it expires at the end of 2018. Therefore, downside from OUE Bayfront is limited.

OUECT recently conducted an equity placement, raising c.S$150m. However, it has yet to deploy the proceeds for any acquisition, but has paid down its debt.
Potential acquisitions would provide upside risk to our DPU estimates and TP.

1Q17 DPU fell 7% y-o-y to 1.23 Scts largely on account of the recent S$150m equity placement and impact from adjustment for the amount set aside for the transfer of China-sourced profits from Lippo Plaza to the statutory reserve.
Despite the disappointment over a fall in DPU, OUECT reported a 4% up lift in top line and net property income (NPI) which was a credible result considering the macro headwinds. The improvement in revenue and NPI was mainly due to an increase in occupancies across its three properties.
Overall portfolio occupancy was up at 95.8% from 94.5% in 1Q16.
On an individual property basis, OUE Bayfront’s occupancy rose 2.3pts to 100%, One Raffles Place was up 0.8pts to 93% and Lippo Plaza’s occupancy jumped 1.3pts to 95.8%.

Over the quarter, OUECT was able to achieve higher than market rents for new and renewal leases.
However, due to the downturn in the Singapore office market, on average, it reported negative rental reversions. For OUE Bayfront, it achieved committed rents of between S$10.00-11.70 psf/month, compared to average expiring rents of S$11.41 psf/mth. For One Raffles Place, committed rents over the quarter were between S$8.00-10.20 psf/mth, lower than average expiring rents of S$11.38 psf/mth.
As a consequence of negative rental reversions and weakness in prior quarters, average passing rents at OUE Bayfront and One Raffles Place fell from S$11.82 and S$10.27 psf per month in 1Q16 to S$11.67 and S$10.21 respectively.
In contrast, Lippo Plaza continued to enjoy positive rental reversions with committed rents of RMB8.00- 11.30 per square metres per day (psm/day) reported over the quarter compared to average expiring rents of RMB9.17 psm/day. This led to average passing rents increasing 3.5% y-o-y to RMB9.88 psm/day.
Post the renewals over the quarter (7.3% of leases by net lettable area (NLA)), another 11.8% of leases are up for renewal for the remainder of FY17 with another 27% in FY18.

Following the repayment of debt post the recent rights issue, gearing fell to 36.2% from 39.8% at the end of December 2016.
Post the refinancing of SGD loans due in 2017 and 2019, with a 5-year facility maturing in 2022, the average cost of debt dipped to 3.4% from 3.6% from the prior quarter. In addition, the proportion of fixed debt rose to 81.2% from 79.3% and weighted average debt maturity was extended to 3.3 years from 1.5 years.

After incorporating the increase in the number of shares from the recent equity placement, we cut our FY17-18F DPU by 10-12%.
We also reduced our DPU estimates, to account for potential downside risk to rentals and occupancy at Lippo Plaza. This is largely due to the increase in supply in Shanghai which in 1Q17 had caused Grade A office rents to fall 0.8% q-o-q and occupancy to drop 2.2pts q-o-q to 87.6%.
We likewise also lowered out DCF-based TP to $0.67 from S$0.74 on the back of our lower earnings estimates

After incorporating the recent equity placement, we lowered our DCF-based TP to S$0.67 from S$0.74 previously.

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).

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | Singapore Research Team DBS Vickers | http://www.dbsvickers.com/ 2017-05-08

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 0.67 Down 0.740