Soilbuild Business Space Reit - DBS Research 2017-07-18: Still Very Attractive Yield

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SOILBUILD BUSINESS SPACE REIT SV3U.SI

Soilbuild Business Space Reit - Still Very Attractive Yield

• 2Q17 DPU down 6% as anticipated.
• Recovery seen at 76 Loyang Way’s non-anchor space, though still a key challenge.
• Occupancy rate found to be a key determinant to DPU and price.
• Downgrade to HOLD as TP has been reached, high yield still attractive.

Target Price reached but with no imminent catalyst, downgrade to HOLD.

• With a dividend yield of over 7%, Soilbuild Business Space REIT (SBREIT) offers one of the highest yields in the industrial space.
• Operational headwinds and continued near-term downtrend in DPUs are likely to dampen investors’ confidence in the REIT's ability to maintain returns. Given that its share price has achieved our TP of S$0.73, downgrade to HOLD.

Where we differ: Stronger earnings recovery in FY19. 

• DPUs are expected to remain under pressure in the immediate term, mainly on the back of difficulty in backfilling the space at 72 Loyang Way (c.8% of top line) and we have conservatively assumed the property to remain vacant till 2H18. 
• A recovery in DPUs will likely come only from 2H18, upon the expiry of the master lease at Solaris, a business park asset which is projected to continue to perform strongly. As a result, our FY19F DPU forecast is 4.4% higher than the market average.

Potential catalyst: Sooner-than-expected vacancy improvement.

• We found a high correlation of 0.93 between occupancy rates and share price. Further signs of a sustained recovery in occupancy rates as in 1H17 will restore investors’ confidence in DPU sustainability which will lead to potential NAV revaluation gains and thus a price recovery.

Valuation

• Trimmed FY18F by 4% to account for lower occupancy, primarily from the slow backfill of vacancy at 72 Loyang Way.
• Maintain DCF-backed Target Price at S$0.73. 
• Downgrade to HOLD as we see no imminent catalyst, while yield of over 7% is still attractive.

Key Risks to Our View

• Look out for asset revaluation. NAV fell by 10.0% in FY16 due to softening asset valuations and enlarged unit base. Gearing was pushed up to 37% from 36%. We expect additional revaluation losses of up to 10% to occur in FY17. 
• Gearing could inch up by another c.100bps, while still within the comfortable level, limits funding options for acquisitions.

2Q17 RESULTS: DPU decline not a surprise; occupancy improvement at 72 Loyang Way’s non-anchor space 

Top line up, thanks to timely acquisition. 

• Gross revenue for 2Q17 was S$21.6m, S$2.0m or 10.1% higher y-o-y. The increase was largely attributed to higher contribution from new asset Bukit Batok Connection (S$2m in revenue). Higher revenue contributions were also received from West Park BizCentral, Solaris, Tuas Connection and Tellus Marine, but were offset by a reduction in revenue from 72 Loyang Way.
• Property operating expenses were S$0.6m higher y-o-y at S$2.8m mainly due to higher property expense of S$0.4m at West Park BizCentral which was due to a one-off property tax reversal adjustment made in 1HFY16 arriving from revision of FY15 and FY16 annual values by the tax authority. Net Property Income (NPI) was 8.1% higher at S$18.7m y-o-y accordingly. 
• Finance expenses increased by S$0.4m to S$4.0m, mainly due to the S$40m unsecured loan drawn down in 2H16 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).

DPU down 6% as expected due to enlarged unit base and absence of fees payable in units. 

• Distributable income was S$15.4m, 4.3% higher y-o-y. However, distribution per unit (DPU) was 1.47 Scts, or 5.8% lower y-o-y. This was due to the enlarged unit base as well as Manager’s decision to pay the property management and lease management fees in cash as opposed to units in 2Q16. In the longer term, this decision should mitigate the dilutive effect on DPUs. 
• 2H17 DPUs represent 51% of our full-year FY17 forecast, in line with our expectations.

Continued improvement in occupancy including 76 Loyang Way. 

• Portfolio occupancy rate continued to improve from its low of 89.6% at the end of 2016 to 92.6% as at 2Q17. This was mainly lifted by Tuas Connection (from 86.3% to 93.0%) from securing short-term leases, West Park BizCentral (from 90.7% to 91.2%), as well as 76 Loyang Way (from 9.9% to 22.8%). Occupancy at Eightrium bounced back to 100% after a slight dip last quarter following the exit of Huawei.
• Over the quarter, 8.0% of portfolio NLA were renewed or newly signed. Three leases were renewed at flat rate, nine new leases were signed and eight leases were forward renewed at 9.8% lower. 
• With 7.6% of portfolio NLA expiring in 2H17, the key focus remains on retaining existing tenants and improving occupancy in multi-tenanted buildings.

Recovery at 72 Loyang Way, though still a key challenge.

• 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. Seventy percent of the property is still under regulations to be leased out to one anchor tenant from the marine & offshore industry. 
• Occupancy improved from 9.9% to 22.8% for the non-anchor space. However, the challenge remains at sourcing the anchor tenant. With the full utilisation of the security deposit received for 72 Loyang Way in May 2017, the distributable income will be negatively impacted until the Manager finds a suitable replacement anchor tenant. 
• We have further cut our occupancy expectations to below 30% for FY18F, which lowers our FY18F DPU forecast by c.4%.

No financing requirement in FY17. 

• Cost of debt is still 3.37% and weighted average debt maturity stands at 2.3 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 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.

Downgrade to HOLD, Target Price S$0.73. 

• The stock has reached our Target Price of S$0.73. Without imminent catalysts, we maintain our TP and downgrade the stock to HOLD. 
• Although DPU is expected to decline further in FY17-18F, we believe such negativity has already been absorbed by the market. 
• A high yield of over 7% is attractive for many to stay invested. We believe that the ability to source a replacement tenant at 72 Loyang Way will be a catalyst for a re-rating, though the odds are low in the immediate term. 
• In addition, current market talk of a potential consolidation within the mid-cap industrial space could lift sentiment and prices higher (Please refer to our report: Catalyst Abound, published on 17 March 2017)

Singapore Research Team DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-07-18

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