Keppel REIT - DBS Research 2017-04-20: Undervalued Office Portfolio

KEPPEL REIT K71U.SI

Keppel REIT - Undervalued office portfolio

1Q17 DPU of 1.45 Scts (-14% y-o-y) in line with expectations.
DPU rebasing due to well flagged lack of capital distributions and weak office market.
Attractive valuations too good to ignore.

Keppel REIT (KREIT)’s share price has rallied over 25% since late January 2016 but took a breather in recent months on the back of sudden changes in CEOs and clarification over its past rental reversions.
We believe the rally will resume as KREIT is attractive on a per square foot (psf) basis and as investors position themselves for a potential recovery in the office market in 2018. Thus, we maintain our BUY call with TP of S$1.23.

The impact on DPU from the potential loss of key tenants in 2017 and 2018 has reduced considerably. With forward renewal efforts, there are only 3% and 7% of leases left to be renewed in 2017 and 2018 respectively.
While expiring monthly rents over the next two years are in the low S$9 psf level, close to current Grade A rents of S$8.95, we believe the premium status of KREIT’s properties will help mitigate the potential decline in overall office rents.

On the back of the decision by KREIT not to distribute prior capital gains in the last quarter and the impact of the weak office market, as expected KREIT’s DPU is in the process of rebasing.
1Q17 DPU fell 14% y-o-y to 1.45 Scts and represented c.24% of our full year FY17F DPU. Excluding S$3m of capital distributions paid in 1Q16, 1Q17 DPU would have fallen by 9% y-o-y.

KREIT was negatively affected by lower contribution from Bugis Junction (NPI fell 27% y-o-y due to the restructuring of some leases and lower occupancy) and 8 Exhibition Street (NPI down 6% y-o-y on the back of higher operating expenses) as well as absence of income from 77 King Street which was sold in January 2016.
This partially offset the 23% y-o-y jump in associate income mainly due to one-off income from One Raffles Quay and Marina Bay Financial Centre as well as higher income contribution from David Malcolm Justice Centre (+45% y-o-y, full quarter of operations) and 275 George Street (+8% y-o-y).
Earnings from the Australian properties in SGD terms benefited from a c.6% y-o-y increase in the average AUDSGD exchange rate.

Minimal leases up for renewal or review in 2017 with small negative reversion in 1Q17
With only 2.8% (down from 3.9% at the end of 4Q16) and 1.7% of leases up for renewal and subject to rent reviews respectively, in our view, significant declines in earnings on a sequential basis should be minimised. Nevertheless, with the office market likely to remain soft until the end of this year, KREIT should continue to report negative rental reversions as seen by the 1% decline reported in 1Q17.
For FY18 leases, no significant forward renewals were done in 1Q17. Thus, the proportion of leases up for renewal and subject to rent reviews was stable at 6.9% and 15.4% respectively.
For the leases up for renewal and review in 2017 and 2018, we understand average expiry rents are in the low S$9’s psf, slightly above spot Grade A office rents of S$8.95 psf.

Gearing remains steady at 38.4% with all in costs of debt ticking up marginally to 2.57% from 2.51% as at end 4Q16.
The proportion of fixed-rate loans was stable at 75% with no refinancing due until 2018.
NAV per share (excluding distributable income) stood at S$1.42.

While KREIT should report y-o-y declines in DPU over the coming few quarters, we believe this has been well flagged to the market given KREIT’s decision not to pay out prior capital gains and the overall soft office market.
With KREIT still trading at a 25% discount to book and its Singapore portfolio trading at an implied price of S$2,400 psf, which is lower than recent market transactions of S$2,700 to S$3,500 psf, we believe KREIT offers an attractive entry into the potential recovery in the Singapore office market next year.
Thus, we maintain our BUY recommendation and TP of S$1.23

A key risk to our view is new office 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/ 2017-04-20

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.230 Same 1.230