Soilbuild Business Space Reit - DBS Research 2017-04-17: 1Q17 Results In Line, Gloomy Outlook Priced In

SOILBUILD BUSINESS SPACE REIT SV3U.SI

Soilbuild Business Space Reit - 1Q17 results in line - gloomy outlook priced in

Top-line growth mainly contributed by Bukit Batok Connection.
DPU declined 4.4% to 1.49Scts due to enlarged unit base – Manager started paying fees partially in cash.
Ability to turn 72 Loyang Way a re-rating catalyst.

Gross revenue for 1Q17 was S$22.0m, which grew by 9.2% y-o-y.
Net property income (NPI) rose by 11.7% to S$19.2m y-o-y. The improvement was mainly due to the increase in revenue contribution from Bukit Batok Connection (S$2m in revenue).
Higher revenue contributions from Solaris, Tellus Marine and Tuas Connection were offset by a reduction in revenue from West Park.
Property operating expenses declined S$0.2m y-o-y to S$2.8m mainly due to a reduction in property tax for West Park.
Finance expenses increased by S$0.6m to S$3.9m, mainly due to S$40m unsecured loan drawn down in 2H16, increase in weighted average borrowing cost (increased to 3.37% from 3.25% a year ago), and higher notional interest expense on the S$55m interest-free loan (the same amount of S$0.2m has been offset in finance income).

Distributable income was S$15.6m, 6.6% higher y-o-y. However, distribution per unit (DPU) was 1.49 Scts, or 4.4% lower y-o-y, due to the enlarged unit base growing faster than earnings, as well as Manager’s decision to pay the property management and lease management fees in cash as they were paid in units in 1Q16.
We interpret this decision as a positive move to mitigate the dilutive effect on DPUs. Assuming property and lease management fees remained payable in units this quarter, DPU would have fallen by a smaller 1.2% instead.
1Q17 DPU represents 27.5% of our full-year forecast, in line with our expectations, given weakening DPU prospects arising from the potentially prolonged vacancy at 72 Loyang Way as the security deposit will dry out in mid-May 2017.

Portfolio occupancy rate increased to 91.8% from 89.6% over the quarter. This was mainly lifted by the increase in occupancy at Tuas Connection (from 86.3% to 93.0%) mainly due to the manager securing short-term leases and West Park BizCentral (from 90.7% to 92.9%) which saw back-filling of vacated space.
Elghtrium saw its occupancy drop below 100% to 97.9% for the first time in three years, after the exit of Huawei (which used to occupy 13% of the property), and the vacant space is yet to be filled up in full.
Only 6.6% of portfolio NLA were renewed or newly signed over the quarter, mostly on new leases. Three leases were renewed at a 3.6% reversion rate and two leases were forward renewed at 6.0% lower.

Cost of debt remains stable at 3.37% and weighted average debt maturity stands at 2.6 years. Interest rate exposure is 86.5% fixed.
SBREIT has no debt due in FY17, and S$155m (or 32.3%) of total debt will be due in FY18, comprising of S$100m MTN and S$55m interest-free loan.
We have assumed that SBREIT will refinance the interest-free loan at the prevailing market rates and have priced in an increase in interest cost expenses in our model.

According to regulations, 72 Loyang Way must be occupied by tenants from the marine & offshore industry, out of which 70% must be leased to one anchor tenant.
Since the default of the master tenant, Technics, the manager has sought regulatory waiver to uplift the restriction on tenant’s industry for the 30% non-anchored space until 2020, and has been making progress by leasing out 9.9% of property NLA to two tenants over the quarter. However, the challenge remains at sourcing the tenant for the 70% of space, especially when the outlook for firms in the marine & offshore industry remains weak.
Despite the expected run-down of the security deposit, we have largely factored the vacancy and rental decline in our model.

Despite ongoing operational headwinds, we believe negatives are already priced in at a yield of c.8.0%, the highest among the mid- cap industrial peers. We believe that the ability to find a replacement tenant at 72 Loyang Way will be a catalyst for a re-rating.
In addition, current market talk of a potential consolidation within the mid-cap industrial space could lift sentiment and prices higher.
Our TP is adjusted slightly higher to S$0.73 to account for lower cost of equity assumptions. Maintain BUY.

Singapore Research Team DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-04-17

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