Keppel REIT - UOB Kay Hian 2016-04-15: 1Q16 Enthusiastic Leasing Despite Sector Headwinds

Keppel REIT - UOB Kay Hian 2016-04-15: 1Q16 Enthusiastic Leasing Despite Sector Headwinds KEPPEL REIT K71U.SI 

Keppel REIT (KREIT SP) 1Q16: Enthusiastic Leasing Despite Sector Headwinds 

  • Results were in line with expectations. 
  • Proactive leasing efforts saw forward renewal of the bulk of expiring leases due in 2016 and 2017 at decent 7% rent reversions, leaving an inconsequential 2.6% and 4.0% of leases remaining respectively. This execution ability, coupled with the flight to quality to its super prime offices, will tide KREIT through choppy waters when supply headwinds threaten in 2H16. 
  • Maintain BUY with an unchanged target price of S$1.22. 


RESULTS 


• Results in line. 

  • Keppel REIT (KREIT) reported 1Q16 DPU of 1.68 S cents/share (-2.9% yoy, 0% qoq). Excluding distribution of divestment gains from Prudential Tower, core DPU came in at 23.5% of full-year estimates. 
  • Distributable income growth was mainly due to higher contributions from JVs in Australia. 1Q16 DPU saw a 1.2% dip yoy from the dilutive effects of the payment of management fee in units, attributable to share price decline from last year. 

• Leasing activity driven by financial and legal sectors this quarter. 

  • KREIT achieved an admirable retention rate of 99% (4Q15: 90%) and a 7% positive rent reversion for its Singapore portfolio for the quarter. 
  • Surprisingly, leasing activity this quarter was driven by the financial sector as well as legal firms. 
  • We note that RHB, which was rumoured to be contemplating returning space mere weeks ago, also contributed to this quarter’s vigorous leasing activity. 
  • Singapore occupancy stayed high at 99.3%, which coupled with Australia’s occupancy rate of 99.5%, resulted in an overall occupancy rate of 99.4%. 

• Increase in fixed rate borrowings to further dampen interest rate volatility, 

  • ...with 75% of total borrowings now on fixed rates an increase of 5 ppt qoq. 
  • We also note that gearing was reduced by 30bp to reach 39% in the quarter. 
  • Overall financing costs inched up 8bp qoq to reach 2.58% in the quarter. 



STOCK IMPACT 


• Enthusiastic forward renewals and healthy rental reversions... 

  • KREIT’s leasing team went into overdrive this quarter, forward renewing the bulk of expiring leases due in 2016 and 2017, with an inconsequential 2.6% and 4.0% of leases remaining respectively (4Q15: 13.6% and 11.0% by NLA). 
  • Despite the aggression, it was still able to command a respectable rental reversion of 7% for the quarter. This puts the REIT manager in an enviable position for the next wave of supply due in 2H16, from the likes of Marina One (1.9m sf) Guoco Tower (0.9m sf), and Duo (0.6m sf). 

• ...despite continued easing in the office segment. 

  • Office rents saw continued easing in 1Q16. According to CBRE, Grade-A office rentals declined a further 4.9% qoq in 1Q15 to hit S$9.90 psf pm (4Q15: S$10.40). This represents a 13.2% decline in rentals from 1Q15’s peak of S$11.40 psf pm. 
  • With this being the third consecutive quarter of negative office space absorption, landlords are likely to have compromised on rental to retain new tenants or attract new ones. 
  • We are thus heartened by KREIT’s ability to retain 99% of its tenants, while achieving healthy rental reversions to boot. 

• Expect further softness before pick-up. 

  • We expect a 15-20% correction in office rents from 1Q15’s peak before the next leg up. We understand that KREIT’s portfolio average passing rents range from S$8.50-9.50 for leases due from 2016-18, implying 15-20% headroom till current Grade-A rentals. Beyond 2018, commercial supply remains meagre at below 0.65m sf (Frasers Tower). We also note that Guoco Tower recently saw some leasing activity from new tenants like AccorHotels and K Line, which brought total pre- commitment of office space to 18%. 

• Amenable to subletting of occupied space. 

  • Current leasing structures subject tenants like Barclays to penalties should they decide to end their contract pre-maturely. However management had previously expressed its comfort with permitting tenants to sublet contracted space should the need arise. 


EARNINGS REVISION/RISK 

  • We tweak our estimates, slightly lowering our 2016 and 2017 DPU by 0.9% and 0.6% respectively, to account for slightly higher DPU dilution from units issued. 

VALUATION/RECOMMENDATION 

  • Maintain BUY with an unchanged target of S$1.22, based on DDM (required rate of return: 7.1%, terminal growth: 1.7%). 

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 | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2015-04-15
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.22 Same 1.22


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