Manulife US Real Estate Inv - DBS Research 2017-08-10: Gaining From US Upturn

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MANULIFE US REIT BTOU.SI

Manulife US Real Estate Inv - Gaining From US Upturn

• Manulife US REIT's 2Q17 DPU of 1.58 UScts in line with expectations.
• Continues to benefit from US market upturn with passing rents up 0.8% q-o-q and 12.4% rental reversions.
• DPU accretive acquisition of 500 Plaza Drive in New Jersey for US$115m and estimated 7.5% initial yield.

Play on an improving US office market. 

• We maintain our BUY call with a revised TP of US$1.07. 
• We continue to like Manulife US REIT's (MUST) attractive prospective 7.0/7.7% yield in FY17/18, inbuilt annual rental escalations of around 3% and exposure to the favourable demand and supply fundamentals in various US office markets where MUST’s properties are located. This translates to 7% DPU CAGR between FY17 to FY19, one of the highest among REITs in Singapore.

Where we differ – Ability to execute and growth premium. 

• While consensus is bullish on MUST’s US exposure, pegging their target prices at P/Bk of c.1.10x, we believe MUST deserves to trade at a higher P/Bk of c.1.20-1.25, given its ability to execute on DPU accretive acquisitions as seen by its latest 500 Plaza Drive purchase and upside risk to its portfolio values as demonstrated by portfolio revaluation gains over the past 12 months. 
• Moreover, in our view an additional growth premium is justified, given MUST’s DPU CAGR is two to three times higher that of other listed REITs in Singapore.

Acquisitions to be the next growth driver. 

• With gearing expected to stabilised at the 33-34% level post the acquisition of 500 Plaza Drive, given the debt headroom available, we believe additional acquisitions will remain a key share price re-rating catalyst going forward. 
• We understand markets that are of interest are core submarkets that enjoy demand from a diversified type of industries (i.e. manufacturing, financial, technology and law firms) which imply stability across market cycles. 
• We have not assumed any further acquisitions in our forecast beyond the announced 500 Plaza Drive purchase.

Valuation

• After incorporating the recent acquisition of 500 Plaza Drive, recent US$80.5m equity placement and rolling forward to FY18, we raised our DCF-based TP to US$1.07 from US$1.01.
• With 16% capital upside and 7.0-7.7% yield, we maintain our BUY call with a revised TP of US$1.07.

Key Risks to Our View

• Lower-than-expected rental income. The key risk to our view is lower-than-expected rental income, arising from non-replacement/renewal of leases and/or slower-than-expected recovery of office rents in the US.

WHAT’S NEW

Earnings play out as expected. Robust results continue 

• MUST continue its trend of outperforming its IPO forecasts with 2Q17 DPU coming in at 1.58 UScts, beating its own projections by 7.5%. This took 1H17 DPU to 3.23 UScts which represented c.50% of our original FY17F DPU and which was in line with our expectations. 
• The 1H17 DPU consist of 3.20 UScts advanced distributions which are to be paid to existing unitholders prior to the recent equity placement. The new unitholders from the equity placement are not entitled to this advanced distribution.

Increase in rents as expected 

• As expected average passing rents for MUST’s initial portfolio maintained its upward trajectory, rising 0.8% q-o-q to US$40.01.
• Within the portfolio, Figueroa had the highest increase at 1.4% q-o-q to US$38.63 psf per year, with Michelson and Peachtree rising 0.4% and 0.2% q-o-q to US$50.20 and US$31.53 respectively.
• Year to date, 12.4% positive rental reversions were achieved, owing to the under rented status of some of MUST’s expiring leases and general increase in spot rents.

Portfolio occupancy remains high but some slippage 

• Overall portfolio occupancy remains high at 95.9% although this was a slight decline from 97.2% achieved as at end 1Q17. The main culprit was Figueroa where occupancy fell from 98% to 95.3%. We understand Colliers had returned some space which it had temporarily used while it was renovating one of its other floors.
• Occupancy at Peachtree also dipped from 94.4% to 93.4% due to the exit of a tenant, space which has been now partially filled by an incoming tenant.
• Meanwhile, occupancy at Michelson remains stable at 99.1%. 

Positive revaluation gains 

• MUST reported revaluations gains of c.US$20.2m over 2Q17. This largely reflects the 2.8% average uplift in property values on the back of higher income with cap rates remaining stable.
• Figueroa, Michelson and Peachtree recorded a 4%, 2.2% and 2% increase in valuations since the last valuation done at 31 December 2017. In addition, cap rates for Figueroa, Michelson and Peachtree now stand at 4.8%, 5.6% and 5.8% respectively, with the overall portfolio cap rate at 5.3%.
• As a result of this revaluation gain, recent US$80.5m equity placement, gearing fell to 30.4% from 34.2% as at 1Q17. However, gearing is expected to rise to 33.1% post the acquisition of 500 Plaza Drive acquisition.
• Average interest cost was stable at 2.46% with 100% of debt fixed.
• NAV per unit now stands at S$0.84 down from S$0.87 as at 31 December 2016, due to the recent equity placement.

Maiden acquisition and entry into the New Jersey market 

• MUST recently announced its maiden acquisition for US$115m, which is at a discount to US$116m valuation.
• The property to be acquired is 500 Plaza Drive, which is a 11-storey Class A office building located in Secaucus, New Jersey, US. The property is 3 miles from Manhattan via the Lincoln Tunnel and is within the Hudson County office market and Meadowlands office submarket.
• The property is within the 550-acre mixed use amenity base of Harmon Meadow and is surrounded by 1m sqft of retail space – 25 restaurants, 7 hotels, leisure and sports facilities, cinema. With a hotel and residential apartments under construction nearby, the area is leveraged to the “Live, Work and Play” lifestyle where by tenants locate their operations where their employees live and play.
• The freehold property has a net lettable area of 461,525 sqft with an occupancy rate of 98.9%. The building was completed in 1985 but it has recently been renovated in 2015/2016 at a cost in excess of US$16m. The initial NPI yield for the property is estimated to be around 7.5%.
• Key tenants include
  1. The Children’s Place, the largest pure-play children’s apparel retailer in North America,
  2. Quest Diagnostics a Fortune 500 company and leading provider of clinical laboratory testing,
  3. AXA, a French multinational insurance firm, 
  4. Xerox Business Services, an American global corporation that delivers knowledge-based services.
• 500 Plaza Drive has a WALE (by NLA) of 9.2 years with no expiries until 2020, which relates mainly to AXA (22.9% of cash rental income). 99.9% of leases by NLA have built-in rental escalations of around 1.5% per annum.
• The acquisition will be funded through local USD debt (5-year tenure with interest rate of c.3.75%) as well as a US$80.5m equity placement (97m units at US$0.83).
• According to MUST, the acquisition will benefit unit holders in several ways.
  1. Provide exposure to the North New Jersey office market which is in the early stages of a rising rental market as judged by Cushman & Wakefield. In addition, the office location is attractive to prospective tenants given it is a cost effective location and acts an alternative to the Manhattan Office Submarket.
  2. Enhances the overall portfolio’s income stability with the overall portfolio WALE increasing from 5.3 years to 6.1 years o Further diversifies the portfolio, with the addition of the North East US market as well as adding the medical & diagnostics (4% of the enlarged portfolio’s cash rental income) and retail trade (7.3% of the enlarged portfolio’s cash rental income) sectors. 500 Plaza Drive will represent c.18% of overall group NPI and c.12% of the enlarged portfolio by value.
  3. In addition, the acquisition is expected to be DPU accretive.
  4. We are generally positive on the acquisition and equity raising given the DPU accretion, diversification benefits as well as the increase in trading liquidity for the REIT. More importantly, the acquisition should allay fears that some investors have that MUST has been unable to find attractive assets to acquire on a DPU accretive basis.

Mervin Song CFA DBS Vickers | Derek Tan DBS Vickers | http://www.dbsvickers.com/ 2017-08-10

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.07 Up 1.010