Keppel REIT (KREIT SP) - UOB Kay Hian 2017-07-19: 2Q17 Lower-than-expected Results Tempered By Sector Potential

Keppel REIT (KREIT SP) - UOB Kay Hian 2017-07-19: 2Q17 Lower-than-expected Results Tempered By Sector Potential KEPPEL REIT K71U.SI

Keppel REIT (KREIT SP) - 2Q17 Lower-than-expected Results Tempered By Sector Potential

  • Results were slightly below expectations on fewer one-off distributions and weaker contribution from Bugis Junction Towers. However, pressure on rental reversions has eased following a nascent recovery in the office sector. 
  • Positive reversions in the second quarter offset negative rent reversions in the first quarter. 
  • Maintain BUY and target price of S$1.30.



RESULTS


Results slightly below expectations. 

  • Keppel REIT (KREIT) reported 2Q17 DPU of 1.42 S cents/share (-11.8% yoy, -4.4% qoq). 
  • Both property income and NPI declined 1.7% yoy each, attributed to the absence of income from 77 King Street (which was divested) and lower one-off distribution from pre-termination compensation. 
  • The drop in 2Q17 DPU was also partially due to further dilution from the distribution reinvestment plan with 9.7m units issued in 2Q17. 
  • Results are slightly below expectations, with 1H17 DPU representing 46.1% of our full-year estimate.


STOCK IMPACT


Efforts to minimise lease risk. 

  • Through a tenant-centric approach to minimise leasing risks, KREIT has completed all review leases such that only 2% of the NLA of leases are due for renewal in 2017. We understand that the majority of the expiries are for Singapore with potential negative reversions for some tenants as rents in the range of S$8.50-13psf pm are set to expire. 
  • In comparison, FY18 expiring rents are in the range of S$9.50- 12.50psf pm.

No net change in rent reversion in 1H17. 

  • As rent reversions were negative in 1Q17 and positive in 2Q17, there was zero change in rent reversions for 1H17. This is consistent with management’s belief that the Singapore office market is on track for recovery

DPU-accretive acquisition of 311 Spencer Street in Melbourne. 

  • KREIT acquired a 50% stake in a Grade-A premium office tower for S$362.4m that is to be constructed in 4Q19. The development consists of a net lettable area of 717,000sf over 42 storeys and will by fully leased to the Assistant Treasurer for the State of Victoria for 30 years. 
  • The lease stipulates annual rental escalation throughout the lease term with a rental review after 16 years and includes options to renew the lease for additional 5-year terms. 
  • An average annual yield of 6.4% is to be expected during the first 15 years of the lease. This would extend KREIT’s portfolio WALE to nine years from six years.

Gearing could rise to 40%

  • Gearing could rise to 40%, assuming that the full acquisition of 311 Spencer Street is to be funded by debt. Management noted that although it has no formal policy, it would place a self-imposed gearing limit of 41-42%.

S$48m of undistributed funds. 

  • After the 311 Spencer Street acquisition, management noted that S$48m remains undistributed. Management has expressed that the remaining funds could be used for further acquisitions or be distributed to unitholders over many quarters.

Rental income support balance for MBFC Tower 3 until 2019. 

  • Management reported that about S$3m was distributed as rental income support for MBFC Tower 3 this quarter.
  • As S$17m remains, management believes it will be able to disburse rental income support for MBFC Tower 3 until 2019.

Acquisition pipeline. 

  • Management expressed interest in acquiring assets in emerging markets such as China, Vietnam and Jakarta, from its sponsor, Keppel Land. However, it also noted the difficulty of finding assets in such markets that can produce stable incomes.

Grade-A CBD core office space remains stable

  • Grade-A CBD core office space remains stable despite downsizing in key banking and energy sectors. According to CBRE, largely owing to the completions for Marina One and UIC Building, the net absorption was 924,000sf in 2Q17, an improvement over the negative net absorption of 47,000sf in 1Q17. 
  • CBRE expects certain niche sectors such as info-communications, fintech and co-working will contribute to see demand.

Early indications of stabilising Grade-A CBD core office rentals. 

  • According to CBRE, Grade-A CBD core rents have stabilised with no qoq change and remained unchanged from 1Q17’s S$8.95psf. This, however, follows the slowing qoq declines from 3Q16.
  • Jones Lang Lasalle reported a bottoming-out and a modest increase in CBD rents of 0.6% in 2Q17. This may suggest that the wider Grade-A CBD core office rentals are at an inflexion point.

Significant potential upside following office yield compression. 

  • Given that the current yield spread in the office sector is 3.2%, close to its long-term spread of 3.9%, and despite a harsher operating landscape from the previous years, an economic resurgence could present significant upside. 
  • We opine that with a resurgence in the economy, there could be further compression in the office yield spread to its upcycle average spread of 2.3%, reflecting a 19% upside potential.


EARNINGS REVISION/RISK

  • We reduce our 2017F DPU by 3%, mainly factoring in lower rent reversions for Singapore properties, and raise 2019F DPU by 3.5%, factoring in contribution from 311 Spencer Street.


VALUATION/RECOMMENDATION

  • Maintain BUY and target price of S$1.30, based on DDM (required rate of return: 6.7%, terminal growth: 1.7%). 
  • The impact from the reduced contribution from Singapore is mitigated by the increased contribution from the 311 Spencer Street acquisition in Australia.


SHARE PRICE CATALYST

  • Higher office rentals.
  • Positive newsflow on leasing activity, employment and economic growth.
  • Slower rise in interest rates




Vikrant Pandey UOB Kay Hian | http://research.uobkayhian.com/ 2017-07-19
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.300 Same 1.300



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