OUE Commercial REIT - DBS Research 2016-08-03: Tops expectations, but incoming office supply is a concern

OUE COMMERCIAL REIT TS0U.SI

OUE Commercial REIT - Tops expectations, but incoming office supply is a concern

We maintain our HOLD call for OUE Commercial REIT (OUECT) with a revised TP of S$0.73.
We remain cautious despite attractive valuation of close to 30% discount to its book value, due to fears over falling office rents ahead of the impending 4.5m sqft of new office space over 2016-2017.
Combined with OUECT’s above-average gearing (around 40%), in our view, its share price is likely to remain range bound in the near term.

With an income support arrangement providing income stability to OUE Bayfront, contributing a third of net property income (NPI) till 2018, earnings upside would come from driving better performance at ORP (c.50% of NPI).
With initial yield estimated at 3.4%, the Manager is actively seeking to push occupancy rates closer to c.95% from c.91% currently.

As OUECT’s proactive forward renewals have reduced the number of leases expiring in FY16, the greatest earnings risk for OUECT is in FY17. There are approximately 20% of leases by net lettable area (NLA) at OUE Bayfront and 26% at ORP up for renewal in FY17.
The risk of negative rental reversions arises as rents for these leases were signed during the better times in FY14/15. The potential magnitude of falling rents is still uncertain as it is unclear how aggressive the management of the new office buildings will be in discounting rental rates.

Given the better-than-expected 2Q16 results, we raised our FY16-17F DPU by 1-2% and increased our DCF-based TP to S$0.73 from S$0.70 previously.

The key risk to our view is a greater-than-expected fall in spot Grade A office rents to below S$7 psf/mth. Our current assumption is for rents to bottom out at S$8-9 psf/mth.

Mervin Song CFA DBS Vickers | Derek Tan DBS Vickers | http://www.dbsvickers.com/ 2016-08-03

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 0.73 Up 0.70