OUE Commercial REIT - DBS Research 2017-11-10: Holding Pattern For Now

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OUE COMMERCIAL REIT TS0U.SI

OUE Commercial REIT - Holding Pattern For Now

• 3Q17 DPU of 1.15 Scts (-12.9% y-o-y) above expectations.
• Rents remain under pressure but fell less than expected.
• Spot office rents in Singapore are recovering but there is risk of negative rental reversions.

Range-bound. 

• We maintain our HOLD call on OUE Commercial REIT (OUECT) with a revised TP of S$0.73. While we see longterm value in OUECT as it trades at c.15% discount to its book value, we believe the stock will trade range-bound in the near term, given headwinds from negative rental reversions despite a recovery in spot rents and dilution from the recent equity placement, which should translate to a drop in DPU.

Where we differ –

Higher target price. 

• While we and consensus both have HOLD recommendations on OUECT, we have a higher TP. This is because we believe the quality of OUECT’s buildings that are in the Grade A category as well as the prime location of the properties justifies a lower implied yield spread differential to the large cap office REITs of 1.4%. 
• Based on consensus DPU forecasts and TPs, the yield differential to the large cap office REITs is close to 1.8%, which we think is too wide considering the yield spread for Frasers Commercial Trust (FCOT) which has Grade B buildings and business parks, is already around 1.8%.

Upside from acquisition. 

• OUECT conducted an equity placement earlier this year raising c.S$150m but has yet to deploy the proceeds towards an acquisition. Potential acquisitions would provide upside risk to our DPU estimates and TP.

Valuation

• After the better than expected results, we raised our DCF-based TP to S$0.73 from S$0.69 previously.

Key Risks to Our View

• The key risk to our view is a faster than expected recovery in spot Grade A office rents resulting in higher than expected rental income for the REIT.

WHAT’S NEW - Impacted by recent equity placement 

Drop in 3Q17 DPU

• 3Q17 DPU fell 12.9% y-o-y to 1.15 Scts largely due to the impact from the S$150m equity placement in March this year. However, this was ahead of expectations owing to better than expected rents at OUE Bayfront and Lippo Plaza. 
• 9M17 DPU of 3.53 Scts (-11.8% y-o-y) represents c.78% of our original FY17F DPU. 
• Excluding the drag from the higher number of shares on issue from the equity placement, distributable income was up 3.4% y-o-y largely attributed to the lack of performance fees and higher income support drawn over the quarter.  However, underlying revenue and NPI were down 2.1% and 3.4% respectively. 
• Revenue was negatively impacted by negative rental reversions in prior quarters as well as lower occupancy at One Raffles Place Shopping Mall which is undergoing a tenant remixing exercise. 3Q17 NPI margins also compressed to 78.7% versus 80.0% in 3Q16 as OUECT had higher property taxes and paid more leasing commissions to increase the occupancy at its buildings. 
• Overall portfolio occupancy rose to 97.0% from 94.4% in 3Q16 and 96.4% in 2Q17. The largest improvement was seen at One Raffles Place (ORP) which boosted its occupancy to 97.3% from 91.7% in 3Q16 and 95.0% in 2Q17. Lippo Plaza remains fully occupied with OUE Bayfront maintaining its high occupancy of 98.2%. 

Pressure on rents

• Similar to prior quarters, average new and renewal office rents continue to be signed at a premium to their respective submarket rents. Nevertheless, with average expiring rents for the portfolio being above current spot office rents, OUECT faced negative rental reversions with average passing rents maintaining their downward trajectory.
• For OUE Bayfront, OUECT achieved committed rents of between S$11.50-13.50 psf/month compared to average expiring rents of S$13.43 and submarket rents of S$9.10. Meanwhile average passing rents as at the end of September was S$11.44, down from S$11.85 achieved in 3Q16 but marginally up from S$11.42 at end 2Q17.
• Likewise, One Raffles Plaza also suffered over the quarter. OUECT achieved committed rents of S$7.00-S$10.70 versus average expiring rents of S$10.82 and submarket rents of S$9.10. Average passing rents fell to S$10.10 from S$10.36 in 3Q16 and S$10.14 in 2Q17.
• Rental reversions at Lippo Plaza were flattish over the quarter. Committed rents stood at between RMB9.30-11.00 psm/day versus average expiring rents of RMB9.93 and submarket rents of RMB9.14.
• Average passing rents for the property were relatively flattish on a sequential basis at RMB9.86, although up from S$9.84 owing largely to the tenant remixing achieved at the retail segment of the property.
• On the back of renewals over the quarter, only 1.6% of leases (by gross rental income) are up for renewal in FY17. However, in FY18 and FY19, around 25.8% and 24.5% of leases (by gross rental income) are set to expire.

Capital structure – redemption of CPPUs

• OUECT’s gearing was relatively stable at 36.9%. The weighted average costs of debt rose marginally to 3.5% from 3.4% at the end of 2Q17.
• On the back of the REIT’s maiden issuance of S$150m 3.03% fixed rate notes due in 2020, the proportion of fixed rate debt increased to 91.8% from 80.7% in the preceding quarter.
• Post balance date, OUE also announced the redemption of c.S$75m worth of convertible perpetual preferred units (CPPU) to mitigate against the potential dilution to DPU if the CPPU’s were converted into new units in the future. The CPPUs were originally issued to fund the acquisition of ORP with an annual 1% coupon. Post redemption, there remains S$475m worth of outstanding CPPUs. The CPPUs can be converted into OUECT units at a conversion price of S$0.841 per CPPU. 
• The CPPU may not be converted into OUECT units for a period of four years commencing from 8 October 2015. OUECT has the sole right to redeem any number of CPPUs at the issue price at any time. Post the redemption of the CPPUs, we expect gearing to stabilise at the 38-39% level.
• NAV per unit stood at S$0.85 slightly down from S$0.86 owing due to a larger amount of units on issue.

TP raised to S$0.73 and DPU tweaked higher

• On the back of the stronger than expected results and incorporating faster pace of recovery in the Singapore office market in 2019, we raised our FY17- 19F DPU by 4-8% and raised our DCF-based TP to S$0.73 from S$0.69.

Melvin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-11-10

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 0.73 Up 0.690