CapitaLand Commercial Trust CCT - Phillip Securities 2016-05-16: The worst is yet to come

CapitaLand Commercial Trust CCT - Phillip Securities 2016-05-16: The worst is yet to come CAPITALAND COMMERCIAL TRUST C61U.SI 

CapitaLand Commercial Trust - The worst is yet to come


REIT SNAPSHOT

  • CapitaLand Commercial Trust (CCT) owns a portfolio of 10 prime commercial properties in Singapore, primarily office buildings in the downtown core area. 
  • Since listing in 2004, CCT has grown its property portfolio from S1.9b in FY2004 to S$7.7b in FY2015.



INVESTMENT THESIS – Historical high supply of office space coming at a time with multiple headwinds

  1. Sector demand supply dynamics - Worse than Global Financial Crisis (GFC) 2008-2009. Highest supply of office space in a single year historically is almost 4 times the average annual net demand over the last 5 years.
  2. Structural issues within Singapore worsen the situation. A gradual decentralisation theme adopted by the government to alleviate traffic and infrastructure congestion in the city centre means more suburban Grade A offices and business parks as alternatives for corporates in the tiny city state. Slowing local and foreign labour force growth amidst a close to full employment rate and aging population further restricts expansion plans of corporates and raises business costs.
  3. Share prices tend to lead rental rates at major economic turning points as shown in 2007-2009. We expect office rentals to remain in the doldrums for a further 2 years until 2018 at least. In such an environment, we do not see catalysts for major upsides in office REITs share prices.


INVESTMENT ACTIONS

  • CCT owns a portfolio of high quality prime commercial properties in downtown Singapore, handled by a proactive and competent management team. 
  • Nonetheless, the multiple headwinds surrounding the entire sector present heavy challenges for CCT and we have not seen the worst for the office sector. 
  • We initiate coverage on CCT with a “Reduce” call and DDM-derived target price of S$1.29.


COMPANY ANALYSIS


Strong occupancy over the years, bigger question is achievable rental rates

  • CCT has managed to keep overall portfolio occupancy at above 94% over the past decade, even throughout the GFC period. There is no question about the quality of the properties under CCT, and we think the proactive management and leasing team will continue to be able to protect occupancy decently well, given the staggered and well spread out lease expiries. 
  • What is a bigger worry is the achievable rents, especially when leases expire in 2017 and 2018. The average rents of leases expiring in 2017/2018 for Capital Tower, Six Battery Road, One George Street and Raffles City are already higher than current market rents, and we project market rents to fall further from here. These 4 buildings collectively make up c.74% of CCT’s portfolio by valuation.

Ample debt headroom, but historical trends suggest a more conservative management

  • As at 31 March 2016, CCT’s gearing stands at 30.1%. CCT expects aggregate leverage to range between 30% to 40% through property market cycles. Assuming a 40% aggregate leverage level, CCT will have a debt headroom of S$1.3b for further acquisitions. Nonetheless, CCT has maintained a near 30% gearing ratio post GFC, from 2010 until now.
  • In May 2009, after the acquisition of One George Street and progressive payments for Wilkie Edge (2008) which pushed its gearing up to 37.6%, CCT did a 1-1 rights issue and brought gearing down to 33.2% as at end FY09. This is despite low and falling interest rates during the time, and CCT’s allowable mandate to gear up to 60% with a corporate debt rating. Since then, CCT’s gearing level has stayed at close to the 30% mark. 
  • We think a gearing level close to 30% seems to be management’s preferred comfortable level. Thus, despite the high debt headroom, we do not expect management to carry out all-debt acquisitions which would lift gearing ratios significantly from this point.


RISKS TO OUR VIEW:

  1. Faster than expected take up of office spaces, leading to more resilient office rentals.
  2. Fed keeping interest rates low for longer than consensus expectations amidst subdued inflation, or more central banks adopting negative interest rate policies. A prolonged period of low interest rates, where growth is not strong enough for Fed to raise rates, but yet with conditions not drastic enough to cause any sort of market crash, present the most ideal environment for yield instruments to rally.




Dehong Tan Phillip Securities | http://www.poems.com.sg/ 2016-05-16
Phillip Securities SGX Stock Analyst Report REDUCE Initiate REDUCE 1.29 Same 1.29


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