Keppel REIT (KREIT SP) - Maybank Kim Eng 2017-07-19: Time For A Breather

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KEPPEL REIT K71U.SI

Keppel REIT (KREIT SP) - Time For A Breather

Positives priced-in; Cut to HOLD on unchanged Target Price 

• The underlying performance of KREIT’s portfolio was broadly inline. While prospects of more negative rental reversions could weigh on its organic income, we expect management to ease DPU weakness with capital distributions. 
• We kept DPU largely unchanged and maintain our SGD1.18 Target Price, based on a target yield of 5.25%. 
• While KREIT remains a good proxy to a bottoming office market, we believe valuations are now fair following its 18% rally YTD. Downgrade to HOLD (from BUY) as we await a better entry point. 
• Asset sales could present upside surprise as the REIT continues to trade at a discount to the physical market. 
• Prefer CapitaLand Commercial Trust (CCT SP, CP SGD1.69, BUY, Target Price SGD1.81) for more attractive valuations. (See report: CapitaLand Commercial Trust (CCT SP) - Potential For Inorganic Growth)

Performance inline; More negative reversions likely 

• Underlying performance was broadly inline. However, the lack of capital distributions YTD led to a lighter 1H at just 46% of our full-year estimate.
• Nonetheless, we expect management to ease DPU weakness by gradually returning the SGD48m of undistributed gains over the next few years.
• While rental reversions held steady at 0% in 1H17, we expect more negative reversions in the year ahead. Although market rents could start to recover, we believe it is unlikely to rise above expiring rents of midSGD8 to SGD13 psf over the next 1.5 years.

Spencer St. a good deal; But no income near term 

• We view its recent deal for a 50% stake in 311 Spencer Street positively. Total consideration of AUD347.8m for the property under development will be paid over time and is expected to return an attractive average yield of 6.4% pa for the first 15 years of its lease. 
• Nonetheless, with the property under construction till late 2019, we do not expect any income contribution in the near term to cushion DPU headwinds.

Rents bottomed; Capital values inched up 

• Preliminary data from CBRE suggests that Singapore’s office market may have bottomed as Grade A rents were unchanged at SGD8.95 psf pm in 2Q17. Reflecting strong investment demand, capital values for Grade A offices inched up 2% QoQ to SGD2,750 psf. 
• With implied valuations still at a discount to the physical market, asset sales to unlock shareholder value presents upside risks to our neutral view.

Swing Factors

Upside

• Appreciation in capital value of its properties.
• Divestments of fringe assets to reduce leverage.
• Earlier than expected rebound in office rents.

Downside

• Sharper than expected declines in office rents or occupancy.
• Overpaying for acquisitions.
• Higher financial leverage implies bigger exposure to interest-rate spikes than peers.

Derrick Heng CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-07-19

Maybank Kim Eng SGX Stock Analyst Report HOLD Downgrade BUY 1.180 Same 1.180