Frasers Commercial Trust - DBS Research 2018-01-19: A Dawn Of A New Era

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FRASERS COMMERCIAL TRUST ND8U.SI

Frasers Commercial Trust - A Dawn Of A New Era

• Frasers Commercial Trust (FCOT) enters into a 50:50 JV with its Sponsor to acquire Farnborough Business Park for GBP174.6m.
• DPU accretive acquisition with the property’s long WALE of 8.3 years mitigating Brexit risks.
• Acquisition kick-starts FCOT’s inorganic growth strategy following overhang from the HP leases.

Laggard office play. 

• We maintain our BUY call with a Target Price of S$1.71. 
• While the share price of Frasers Commercial Trust (FCOT) over the past 18 months has rallied, it has lagged the other office REITs such as CapitaLand Commercial Trust (CCT) and Keppel REIT (KREIT) given concerns over the impact of HP vacating Alexandra Technopark (ATP) and concerns over a lack of growth. As these issues in our view have been addressed, we believe FCOT’s share price should catch up, as the c.2% yield differential between FCOT and its large cap peers is higher than the historical average spread of c.0.8%.

Where we differ – Back on the growth path. 

• Consensus has a HOLD call due to concerns that FCOT is ex-growth. However, we believe the acquisition of the Farnborough Business Park (FBP) puts FCOT back on the growth path as the UK now provides a growth avenue.
• The UK offers attractive yields relative to the tighter yields for office assets in Singapore and Australia, FCOT’s original core markets. Moreover, with its sponsor expanding into the UK business park space, FCOT has increased its visible acquisition pipeline to over S$4bn. Thus, with resumption of growth, we believe FCOT should be accorded a premium as implied by our Target Price of S$1.71. 

Clarity over HP lease. 

• The news that HP Inc will stagger its exit from ATP finally removes the HP lease uncertainty as an overhang on FCOT. 
• In addition, we believe the market should react positively as the change in tenant mix at ATP  provides an opportunity raise rents post the completion of the AEI currently undertaken. 
• Both these factors should act as re-rating catalysts.

Valuation

• After incorporating the acquisition of FBP and S$79m equity raising, we raised our DCF-based Target Price to S$1.71 from S$1.55.

Key Risks to Our View

• A key risk to our view is the market ignoring FCOT’s ability to mitigate the loss of HP as a tenant and slower than expected recovery in office rents.
• To better reflect our positive view, potential redevelopment potential of FBP in the medium term (potential 30% increase in NLA) and prospects for stronger growth ahead, we raised our DCF-based Target Price to S$1.71 from S$1.55 after raising our terminal growth rate to 2% from 1.5% previously.
• Thus, with 13% capital upside and attractive 6.6% yield, we maintain our BUY call.

WHAT’S NEW - Maiden entry into the UK 

Acquires Farnborough Business Park with its Sponsor

• Frasers Commercial Trust (FCOT) announced it has entered into a 50:50 JV with its Sponsor, Frasers Centrepoint Limited (FCL) to acquire Farnborough Business Park (FBP) for GBP174.6m (c.S$314.8m) and estimated NPI yield of 6.3%. The acquisition price is slightly below the independent valuation of GBP175.05m. FCOT’s share of the acquisition cost is GBP87.3m.
• FBP is located in the Blackwater Valley micro-market in the Thames Valley which is in the west of London. Spread over 46.5 hectares, the freehold business park has 14 commercial buildings with a total net lettable area (NLA) of c.555,000 sqft.
• The property is close to key motorways with a nearby train station providing a direct service to Waterloo Station in London. In addition, the business park is adjacent to the TAG Farnborough Airport and Farnborough International Exhibition & Conference Centre.
• Occupancy for the property as at 30 September is high at 98.1%. The tenant retention rate is also healthy at 89%.
• FBP also provides strong cashflow visibility with a long WALE of 8.3 years. There are no leases up for renewal in FY18 with only 8.8% and 2.1% of leases expiring in FY19 and FY20 respectively.
• The property has a diversified tenant base of 36 tenants which includes established companies such as Fluor Limited, INC Research UK Ltd, Time Inc (UK) Ltd, Aetna Global Benefits (UK) Ltd and a unit of Regus.
• The top five tenants represent c.65% of total gross rental income with the largest tenant Fluor comprising 35.6% of total gross rental income.
• The acquisition is expected to be completed by end January 2018 and funded through a combination of debt and equity.

Stable Blackwater Valley micro-market

• Blackwater Valley is home to a large pool of highly skilled workers, and has attracted blue chip tenants including multinationals such as Fluor, AON, Samsung, Ericsson, GE, Audi, Sanofi, Novartis and 3M.
• This quality of the talent pool is also boosted by access to the universities in the South East UK which provides access to over 340k university students.
• Key industries in the area include manufacturing, financial & business services, Hi-tech, TMT and aerospace.
• On the back of a healthy economy, rents in the area have risen from GBP19.50 psf per annum in 2012 to GBP26.50 currently. Occupancy rates over the same period have risen from 77.9% to 88.3%.
• Nevertheless, going forward we understand the investment case for FBP is based on the Blackwater market remaining stable.

Edge from having Sponsor’s strong presence in the area

• While FCOT going into UK alone would have posed some risk given its lack of track record there, we believe one of the positive attributes of the acquisition is the fact FCOT is partnering with its Sponsor which has a strong presence in the Thames Valley market. Its sponsor currently has 4 other properties in the area.
• This ensures FCOT benefits from the clustering effect of multiple business parks in terms of access to prospective tenants and leasing agents but also overall information on the market.

Mitigating factors to Brexit risk

• In light of the Brexit vote, there is some uncertainty over the impact on the British economy and potential volatility of the GBPSGD FX rate which could negatively impact FCOT’s exposure to the UK business park sector.
• However, we believe some of this Brexit risk is mitigated by the property’s stable cashflows through a long WALE and having average passing rents of GBP21-22 psf per annum, which are below spot office rents of around GBP26.50.
• Furthermore, thus far, there has been limited impact on the UK economy since the Brexit vote with the UK economy still growing at a healthy rate, domestic profits rising, and there has been increased foreign direct investment in the UK.
• Furthermore, rents and occupancy in the Blackwater Valley have also been stable owing largely due to the industries in the area being non-financial.
• In terms of managing its FX risks, FCOT intends to enter into rolling 6-9 month hedges.
• Overall, we believe FCOT has taken a well calculated risk with its entry into the UK, with the earnings risks mitigated by having a property with stable long term cashflows and buying when there may be less competition for assets during a period of uncertainty.

DPU accretive transaction despite anticipated S$79m capital raising

• Assuming financial close for the FBP acquisition at end February combined with a S$79m raising (c.58m shares at S$1.37), we project a 1-2% accretion to our FY18- 19F DPU. This should result in FCOT in delivering 1-2% per annum growth in DPU versus our previous forecast for a flat DPU profile.
• Post acquisition, we also estimate gearing to increase to c.37% from c.35% at end September 2017. In addition, proforma NPI contribution from UK will be approximately 8.0% with contribution from Australia and Singapore dropping to 43.3% and 48.7% from 47.1% and 52.9% respectively.
• Based on asset value, UK will represent 7.1% of FCOT’s portfolio with Australia and Singapore making up 38.5% and 54.4% of the portfolio respectively. Australia and Singapore previously contributed 41.5% and 58.5% respectively.
• Finally, beyond the diversification of FCOT portfolio, the overall WALE will be extended to 3.8 years from 3.4 years.

Maintain BUY - Resumption of inorganic strategy to trigger rerating

• We believe the expansion into the UK is the start of FCOT kick-starting its inorganic growth strategy and should allay any concerns that the REIT is ex-growth given the previous difficulty to identify DPU accretive acquisitions in Singapore and Australia due to the tight yields.
• With a visible acquisition pipeline from its Sponsor which has now doubled, we believe this should give investors’ confidence that FCOT’s growth outlook is secured. This should trigger a re-rating and reduce the c.2% yield differential between the large cap office REITs and FCOT to closer to the average yield differential of around 0.8% yield.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2018-01-19

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.71 Up 1.550