Keppel REIT - DBS Research 2016-07-20: Rally not over

KEPPEL REIT K71U.SI

Keppel REIT - Rally not over

Drop in 2Q16 DPU to 1.61 Scts was expected due to disposal of 77 King Street in the prior quarter.
Limited earnings risk near term as only 0.6% of expiring leases due for renewal in 2H16.
Recent office transactions support KREIT’s property valuations.

KREIT’s share price has rallied over 25% since its lows in late January.
KREIT still remains attractive as it offers a decent 6.1-6.2% yield and cheap valuations on a per square foot (sqft) basis. In addition, through proactive lease renewals, KREIT has derisked its portfolio mitigating against downside risk to occupancies and rental rates.
Thus, we maintain our BUY call with a higher TP of S$1.26.

The impact on DPU from potential loss of key tenants or negative rental reversions in 2016 has reduced considerably. Post renewals in 1H16, only 0.6% of leases have yet to be renewed in 2H16.
In addition, risk of large negative rental reversions ahead is low as expiring rents over the next two years (mid S$8 range to low S$9) remain below recent signing rents of S$10.10 and core CBD Grade A rents of S$9.50.
Furthermore, with S$50-60m of disposal gains yet to be distributed, KREIT has the flexibility to stabilise its DPU going forward.

KREIT’s Singapore Grade A office portfolio is trading at implied value of c.S$2,400 psf compared to recent office market transactions including the sale of Asia Square Tower 1, 60% interest in CapitaGreen and Straits Trading Building at between S$2,700 (adjusted for 99 year leasehold for CapitaGreen) to S$3,500 psf.
With abundant liquidity as well as long term investors being positive on the Singapore office market and looking beyond short term supply headwinds, we believe capital values for office properties will remain resilient near term and KREIT’s discount to the physical market is unwarranted.

As we roll forward to FY17, we raise our DCF-based TP to S$1.26 from S$1.11.
Our TP implies a valuation of c.S$2,580 per sqft for KREIT’s Grade A offices in Singapore.

A key risk to our view is new offices supply causing spot rents to fall below S$7 psf, which will likely lead to lower asking rents, coming in below our expectations.

Mervin Song CFA DBS Vickers | Derek Tan DBS Vickers | http://www.dbsvickers.com/ 2016-07-20

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.26 Up 1.11