Cache Logistics Trust - UOB Kay Hian 2016-09-07: Breaking Down The Rental Dispute

CACHE LOGISTICS TRUST K2LU.SI

Cache Logistics Trust (CACHE SP) - Breaking Down The Rental Dispute

The latest development in Cache Logistics’ rental dispute saw the REIT manager planning to file claims against C&P on its failure to return vacant possession of Schenker Megahub. This follows the earlier wrangle around rental rates which were agreed upon without Cache’s knowledge.
Our burndown scenario of potentially protracted legal proceedings still implies a healthy 8.7% yield.

Master tenant C&P has allowed its tenancy with Cache Logistics Trust (Cache) to lapse with effect from 31 Aug 16. Accordingly, Cache intends to claim from C&P double the rental amount for the duration of the holding over period (1 Sep onwards) or damages resulting, as the underlying end-user DB Schenker Logistics (Schenker) has not vacated the property.

On 30 May 16, Schenker issued a legal summons to Cache, calling upon the REIT manager to uphold Schenker’s agreement with master tenant C&P. The agreement included an option for Schenker to renew its anchor lease (expired 31 Aug 16) at a rental rate agreed upon by itself and C&P.
Cache then announced that it would seek legal advice over the terms of the agreement, which it asserted was wholly between C&P and DB Schenker, and beyond its own masterlease agreement with C&P.

When C&P sub-leased the building to Schenker, it also entered into an option to renew the lease at a pre-determined rate on 31 Aug 16 on commercial terms, unbeknownst to Cache.
Thus, Cache is contesting the legality of the option extended to Schenker by C&P, asserting that it was previously informed by C&P that Schenker’s option to renew is not valid.

While the exact agreed upon rent has not been disclosed, 1Q16 pro-forma DPU would decline 7.3% to 1.89 S cents (previously 2.039 S cents) should the REIT manager have accepted the new rate. As Schenker Megahub contributed about 8.8% of 2015 gross revenue, the shortfall in rental implies substantial lower rates under the option agreement extended to Schenker by C&P.

While resolution of the legal dispute is ongoing, we opine that Cache Logistics Trust could enter into a holding arrangement, likely at the pre-determined rental rates (under protest or without prejudice).
We have assumed that the legal wrangle could potentially be protracted, stretching over the next two years in our burn-down scenario. Thus, we lowered rental income contribution from Schenker Megahub by extrapolating from the company’s announced pro-forma decline in 1Q16 DPU.
Divestment gains from Kim Heng warehouse potentially used to shore up distributions. Cache sold its Kim Heng warehouse for a gain of S$9.7m in June last year.
After distributing a collective S$6.7m in divestment gains since then, we opine that the S$3m remaining proceeds could likely be utilised to shore up the shortfall in distributions.
We have accordingly factored about S$2m in gains to be paid out for 2H16, with the remainder divvied out in 2017.

As a result of failing to deliver vacant possession of the Schenker Megahub asset (still occupied by the end user), C&P could be liable to pay Cache double the rental rates, or damages arising from Schenker remaining in 51 ALPS, over the duration of the holding over period (from 1 Sep 16 onwards), under the terms of its master lease agreement. We have not factored this uplift in our earnings estimates due to the opacity in length of legal proceedings.
Terms of legal summons by Schenker:
1. A declaration that the Anchor Lease Agreement (ALA) between itself and C&P is binding upon the REIT Manager and the Trustee.
2. That the REIT manager and Trustee (HSBC Institutional Trust) seek consent from JTC for the ALA renewal.
3. Alternatively, that C&P, the Trustee, and the REIT manager jointly seek consent from JTC for the ALA renewal.

We reduce our 2016, 2017 and 2018 DPU estimates by 2.1%, 7.7% and 8.3% respectively with the conservative assumption of a drawn-out legal process over the next two years.

Maintain BUY with a lowered target price of S$1.12 (previously S$1.21) based on DDM (required rate of return: 6.6%, terminal growth: 1.3%). Cache continues to trade a healthy forward DPU yield of 8.7%, above its 5-year mean of 7.93%.

Vikrant Pandey UOB Kay Hian | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2016-09-07

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.12 Down 1.210