Frasers Commercial Trust - DBS Research 2017-07-25: Still Room To Catch Up

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FRASERS COMMERCIAL TRUST ND8U.SI

Frasers Commercial Trust - Still Room To Catch Up

• FCOT's 3Q17 DPU of 2.40 Scts (-0.4% y-o-y) in line with our expectations.
• Weaker occupancies in Singapore offset by stronger AUD.
• No news on HP leases but risk of HP leaving Alexandra Technopark already priced in.

Laggard office play. 

• We maintain our BUY call with a revised Target Price of S$1.61. 
• While Frasers Commercial Trust (FCOT) has rallied year to date, it has lagged the other office REITs such as CapitaLand Commercial Trust (CCT) and Keppel REIT (KREIT) given concerns over HP Inc and HP Enterprise leaving (c.18% of group gross rental income) Alexandra Technopark (ATP) in September and November 2017. 
• We believe there is room for FCOT share price to catch up, as the current 1.8% yield differential between FCOT and its large cap peers is higher than the historical average spread of 0.8%.

WHAT’S NEW

Waiting for the HP decision 3Q17 in line with expectations 

• While waiting for the decision on whether HP Inc and HP Enterprise decide to stay or leave (c.18% of group gross rental income) Alexandra Technopark (ATP) in September and November 2017, 3Q17’s DPU came in at 2.40 Scts (- 0.4% y-o-y). This took 9M17 DPU to 7.41 Scts, which represents 75% of our full FY17F DPU and is in line with our expectations.
• The marginal dip in 3Q17 DPU was caused by a 0.8% y-oy decline in NPI, which was impacted by lower effective occupancy rates at Alexandra Technopark (NPI down 6% y-o-y) and China Square Central (NPI down 5% y-o-y).
• While effective occupancy at Alexandra Technopark was in the low 90%, committed occupancy has since risen to 94.8%. 
• For China Square Central, occupancy fell to 80.8% from 89% in 3Q16 on planned vacancies as some areas of the property are affected by construction works for the nearby Hotel and Retail redevelopment.
• As a consequence of the weakness experienced in the above properties, NPI from Singapore fell 5% y-o-y. Offsetting this was the stronger AUD, which resulted in the contribution from the Australian portfolio rising 5% yo-y. This was despite effective occupancy at Central Park dipping to 72.3%.
• Overall, FCOT’s portfolio occupancy remains healthy at 92.6%, although slightly down from 93.3% a year earlier.
• The weighted-average occupancy for the Singapore and Australian portfolio stands at 91.2% and 94.4%, respectively.
• Tempering the dip in 3Q17 DPU was a marginally higher capital distribution of S$0.92k versus S$0.86k in 3Q16.

Negative rental reversions at China Square Central office 

• Over 2Q17, FCOT reported 2.6% negative rental reversions at the office component of China Square Central, which was not unexpected given the downturn in the Singapore office market. Pleasingly, we understand that Cerebos, a key tenant at China Square Central, which represented c.2.6% of overall gross rental income, has renewed its lease over the quarter.
• Flat rental reversion was also achieved at ATP but it relates to a small space of around 5,200 sqft.
• For the remainder of FY17 and FY18, around 8.2% and 30.9% of leases are for renewal. The majority of these renewals relate to the HP leases located at ATP.
• Unfortunately, FCOT has not been able to provide an update on whether HP will partially or fully vacate ATP.
• Nevertheless, FCOT is on track to complete the S$45m AEI works at ATP by mid-2018.

Stable gearing at 36% 

• Consistent with 2Q17, FCOT’s gearing was stable at c.36%, with overall cost of debt at c.3%.
• The proportion of fixed debt was also maintained at 91%.
• NAV was steady at S$1.52 (excluding distributable income).

TP raised to S$1.61 

• With the AUD holding onto its appreciation over the past few months, we raised our AUD/SGD assumptions from 1.01 to 1.05-1.08 over the next few years. This leads us to raise our TP to S$1.61 from S$1.52.
• Despite the higher resultant earnings from a stronger AUD, we have maintained DPU of 9.82 Scts for FY17-19F by reducing the amount of capital distributions being paid out.
• With S$40m worth of capital gains from the sale of the development site at China Square Central and the ability to adjust the proportion of management fees paid in units to 100%, we believe FCOT has the financial flexibility to maintain a stable DPU even if HP Inc and HP Enterprise both vacate ATP, which is worse that our current assumption of only HP Enterprise leaving ATP.

Maintain BUY 

• With a 13% capital upside and 6.9% yield, we maintain our BUY call with a revised Target Price of S$1.61.
• The HP lease has been an overhang over FCOT over the past year. However, we believe the impending news of HP partially or fully vacating will finally clear this overhang.
• While there is a risk that actual news of HP leaving may cause a correction in FCOT’s share price, we believe as this risk has already been well flagged and priced in. Moreover, FCOT has the ability to stabilise its DPU to mitigate this news. Thus, in our view, there is a high probability that the market has already sold the “rumour” of HP leaving and will buy the “fact” when the news comes out. 
• Confidence of our view is the fact that FCOT already trades at 1.8% spread to the large-cap office REITs versus its historical spread of c.0.8% 

Where We differ – Tailwinds to price-to-book. 

• While consensus has a BUY call on FCOT, it continues to peg FCOT at a discount to its book value of S$1.52. 
• We believe this is too conservative, given expectations of a recovery in the Singapore office market, further compression of cap rates in the Australian market, and potential tailwinds from an appreciating AUD. Therefore, once the HP lease is resolved, in our view, FCOT will re-rate to a slight premium to book as implied in our TP of S$1.61.

Clarity over HP lease. 

• We expect the announcement of whether HP Inc and HP Enterprises’ stay at ATP to finally remove the overhang over FCOT and act as a further re-rating catalyst i.e. the market has already sold the rumour of HP potentially leaving and will buy the fact. 
• Moreover, irrespective of whether HP partially or fully vacates ATP, FCOT should be able to maintain its current DPU through managing the proportion of payment of management fees in units and/or distribution of capital gains (c.S$40m) from the sale of the hotel development site at China Square Central, allaying any fears of a collapse in its DPU. 
• In addition, we believe the market should react positively as the change in tenant mix at ATP provides an opportunity to refurbish the property, resulting in higher rents.

Key Risks to Our View

• A key risk to our view is the market ignoring FCOT’s ability to mitigate the loss of HP as a tenant.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-07-25

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.61 Up 1.520