CapitaLand Commercial Trust - DBS Research 2017-07-20: An Investment That Keeps Giving

CapitaLand Commercial Trust - DBS Vickers 2017-07-20: An Investment That Keeps Giving CAPITALAND COMMERCIAL TRUST C61U.SI

CapitaLand Commercial Trust - An Investment That Keeps Giving

  • 2Q17 DPU of 2.27 Scts (+3% y-o-y) in line with our expectations.
  • Improvement largely due to 100% ownership of CapitaGreen versus 40% previously.
  • CCT to distribute S$171m in net gains from recent asset disposals to stabilised its DPU.

Upside remains. 

  • We maintain our BUY call on CapitaLand Commercial Trust (CCT) with a revised Target Price of S$1.85.
  • CapitaLand Commericial Trust’s share price has rallied over the past two years on account of management’s ability to deliver steady DPU growth amidst a downturn in office rents. With signs that office rents may have hit a cyclical low in 2Q17, which is earlier than market expectations, increased investor interest in CCT on anticipation of a recovery in the office market will trigger a further rally in CCT’s share price.
  • This share price behaviour is consistent with prior episodes where CCT’s share price leads the spot office rents by 6-12 months.

WHAT’S NEW: Delivers again 

2Q17 DPU up 3% y-o-y 

  • 2Q17 DPU came in at 2.27 Scts, which is 3.2% higher y-o-y. This represents c.24% of our FY17F DPU (before adjusting for recently announced disposals) and is in line with our expectations. 
  • 2Q17 DPU of 2.27 Scts is a preliminary estimate based on year-to-date number of outstanding shares which is subsequent to change if additional conversion of convertible bonds into shares occurs before the book closure date. The actual DPU will be announced on book closure date on 27 July 2017.
  • Similar to 1Q17, the increase in DPU was largely attributed to the acquisition of the remaining 60% interest in CapitaGreen and continued improvement in the underlying performance of CapitaGreen (NPI up 20% on higher effective occupancies and absence of rent free/fit-out periods). The boost from CapitaGreen also resulted in group 2Q17 NPI rising 34% y-o-y. 
  • The uplift in DPU and NPI was further caused by better performance at Capital Tower (+11% increase in NPI) on the back of higher occupancies (99.4% versus 98.7% in 2Q16). This was partially offset by lower contributions from Golden Shoe (-36% fall in NPI) ahead of the closure for the redevelopment into a new office tower as well as the sale of 50% interest in One George Street, which was completed on 19 June 2017. 
  • NPI for CCT’s other buildings were relatively stable in 2Q17.
  • Overall portfolio occupancy at end 2Q17 stood at 97.8%, marginally up from 97.1% at end 1Q17 and 97.2% at end 2Q16. 
  • Other highlights for the quarter include a drop in occupancy at 20 Anson to 84.2% from 91.7% at end 1Q17 because of a loss of tenants who returned space after a merger or downsized their space requirements.

Downward pressure on passing rents despite early signs of potential recovery 

  • Despite some signs that spot office rents may have bottomed in 2Q17, with CBRE reporting flat q-o-q rents and JLL and Cushman & Wakefield estimating a 1-2% increase q-o-q, CCT continues to face downward pressure on its passing rents, given CCT’s success in securing favourable rents three years ago. Thus, over the quarter, CCT reported negative rental reversions at Six Battery Road and One George Street.
  • At Six Battery Road, it achieved committed rents of between S$10.40-13.80 versus average expiring rents of S$12.37, while at One George Street, it signed rents of between S$8.65-10.40 versus average expiring rents of S$9.71.
  • Subject to the pace in recovery in spot rents, risk of negative rental reversions continuing going forward remains moderate to high, given average expiring rents for 2H17, 2018 and 2019 stand at S$10.58, S$11.45 (80% of lease) and S$10.24 (69% of leases) respectively versus current Grade A core CBD rents of S$8.95.
  • For the remainder of 2017, CCT faces minimal tenancy risks with only 2% of office leases up for renewal (by GRI). However, this steps up to 15% and 33% of leases up for renewal in 2018 and 2019. 

Expected near-term decline in gearing post additional conversion of CB’s 

  • Gearing declined to 36% from 38.1% at end 1Q17 following the sale of 50% interest in OGS. In addition, the fall in gearing was attributed to 2.8% increase in property values as CCT’s valuers on average reduced cap rates by 15bps to better reflect recent market transactions and buoyant investment demand for office assets. CCT’s office buildings are now valued on a cap rate of between 3.60-4.10%.
  • Post balance date, gearing has subsequently fallen to 35.2%, following additional conversion of CB’s into shares.
  • With the upcoming disposal of Wilkie Edge as well as the recent announcement that it will redevelop Golden Shoe Car Park into a Grade A office tower with CapitaLand and Mitsubishi, gearing is expected to settle around the 35% level.
  • Average cost of debt was stable at 2.6%, with 85% of debt on fixed rates.
  • On the back of favourable prices achieved for the sale of 50% interest in OGS and uplift in the value of its office portfolio, excluding distributable income, NAV per unit was S$1.80 at end 2Q17 or S$1.77 as at 14 July after the additional conversion of CBs.

Expect DPU to remain flat for the next few years 

  • To offset the loss of income from the sale of Wilkie Edge, Golden Shoe and 50% interest in OGS, CCT guided that to achieve a stable DPU, it intends to distribute the S$171.7m in net gains from these asset disposals over time.
  • Therefore, we now assume, CCT will maintain a DPU of around 9.08 Scts in line with its FY16 over the next few years, until underlying earnings recovery on the back of rising spot office rents and when the redeveloped Golden Shoe office tower is completed.
  • Post results, we have also raised our DCF-based Target Price to S$1.85 from S$1.69. The higher valuation was achieved after rolling our valuation forward to FY18, incorporating the latest property sales and the recently announced Golden Shoe redevelopment (for more details see our report titled “Polishing our golden shoe” dated 13 July 2017), and lowering our beta assumption from 0.80 to 0.75 to better capture the heightened investment demand for Grade A office buildings.

Where we differ – CCT to trade above book. 

  • Consensus has pegged target prices at a discount to CCT’s latest book value of c.S$1.77. However, we believe this is unwarranted, given CCT has been able to demonstrate the conservative valuation of its properties, through the recent sale of three office buildings at 14- 39% premium to book. 
  • This understated valuation remains in such buildings as Capital Tower and 999-year leasehold HSBC Building, which are priced at S$1,844 and S$2,275 psf respectively, a discount to recent transactions of between S$2,400-S$2,700 for comparable buildings. Thus, in our view, CCT can trade at a premium to book, implied by our TP of S$1.85.

Further catalysts in sight. 

  • While the re-rating catalyst in the form of CCT selling its properties at premium, which we had earlier identified, has now been realised, positive newsflow to maintain the upward trajectory in CCT’s share price remains. 
  • We believe the expected sale of Asia Square Tower 2 and Chevron House at between S$2,600-2,800 psf as well as the Beach Road land tender will highlight the fact that CCT’s Grade A portfolio is on sale, given it currently trades on an implied psf of c.S$2,250.


Maintain BUY, with TP of S$1.85 

  • With an excess of 10% total return over the coming 12 months, we maintain our BUY call with a revised TP of S$1.85.
  • We believe the upcoming sale of Asia Square Tower 2 and Chevron House, as well as the office land tender bid at Beach Road, will highlight the fact that CCT’s book is conservatively valued. This, in our view, will trigger a share price re-rating, causing CCT to rightfully trade above its NAV per share of S$1.77.

Key Risks to Our View

  • Key risks to our positive view are weaker-than-expected rents, and/or CCT not distributing capital gains, causing DPU to come in below expectations as well as investors focusing more on underlying DPU rather than headline DPU.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | 2017-07-20
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.690 Same 1.690