Keppel REIT - DBS Research 2018-01-24: On A Rising Tide

Keppel REIT - DBS Vickers 2018-01-24: On A Rising Tide KEPPEL REIT K71U.SI

Keppel REIT - On A Rising Tide

  • Keppel REIT's 4Q17 DPU of 1.43 Scts (-3% y-o-y) in line with expectations.
  • Near term DPU pressure as spot rents likely to be below expiring rents in 1H18, prior negative rental reversions, and absence of capital distributions.
  • But FY18 to mark the cyclical low in DPU with a recovery in sight given the upturn in spot office rents.



Rally to continue. 

  • We maintain our BUY call on Keppel REIT (KREIT) with a revised Target Price of S$1.41. Keppel REIT’s share price typically leads a recovery in spot office rents by 6-12 months. 
  • According to CBRE, Grade A CBD rents rose 3% q-o-q to S$9.40 psf per month in 4Q17, following the first increase in 10 quarters in 3Q17. Thus, we believe we are on the cusp of an upturn and the rally in Keppel REIT’s share price can be sustained despite gaining over 30% over the past 18 months.


Where we differ –


2018 to mark the low in DPU. 

  • With Keppel REIT guiding that it will prioritise the use of its cash to fund its equity contribution for the 311 Spencer Street development rather than temper near term earnings pressure, we believe consensus which has a HOLD rating on Keppel REIT despite the rally over the last 12 months is likely to reiterate its cautious stance given the potential fall in FY18 DPU. However, with FY18 marking the cyclical low in Keppel REIT’s DPU, we believe the market will be more forward looking and focus on the projected growth in DPU from 2019 onwards which would be the first y-o-y increase in DPU for over five years. 
  • In addition, some investors have been critical of Keppel REIT as its DPU was supplemented with capital distributions. With a clean yield going forward, the negative perception should no longer impede Keppel REIT’s share price performance.

Recovery in office rents. 

  • We believe the expected recovery in office rents should act as a catalyst to close the discount to Keppel REIT’s book value of c.S$1.40. The earlier-than-expected upturn in spot rents should provide confidence that market rents should eventually recover to S$12-14 psf per month.


Valuation

  • With office rents rising faster than expected, we lifted our DCF-based Target Price to S$1.41 from S$1.39.


Key Risks to Our View

  • Key risks to our positive view are weaker-than-expected rents causing DPU to come in below expectations.



WHAT’S NEW - Yet to benefit from recovery in spot rents 


4Q17 DPU of 1.43 Scts in line 

  • 4Q17 DPU fell 3% y-o-y, taking FY17 DPU to 5.70 Scts (-11% y-o-y). This was in line with our expectations despite the absence of capital gains of c.S$3m which we had projected. 
  • With no capital distributions for the whole of FY17 versus S$11m paid out in FY16, the stronger underlying performance in 4Q17 was partially due to some one-off pre-termination payments at Ocean Financial Centre (OFC) worth c.S$4m.

Improvement in revenue and NPI 

  • Despite the impact from prior negative rental reversions in Singapore, Keppel REIT reported a 11% and 15% increase in 4Q17 revenue and NPI respectively.
  • Even stripping out the c.S$4m in one-off pre-termination payments, 4Q17 NPI would have been up around 1% y-o-y. The better performance was largely attributed to higher earnings from Bugis Junction Tower as occupancy improved from 93.7% in 4Q16 to 97.6%. Occupancy in the prior year was impacted by the closure of a gym whose space has been largely back filled by Keppel REIT.
  • Earnings contribution from Keppel REIT’s other assets OFC (excluding one-off income), 275 George Street and 8 Exhibition Street were steady.
  • Meanwhile, distribution received from Keppel REIT’s JV assets - 8 Chifley Square and David Malcolm Justice Centre - rose 10% and 8% respectively on account of increases in rents. In addition, income from Keppel REIT’s associates was mixed with One Raffles Quay (ORQ) down 1% y-o-y with Marina Bay Financial Centre (MBFC) up 6%. ORQ was impacted by prior weakness in rents, with MBFC benefiting from some one-off income.
  • Overall portfolio occupancy improved marginally y-o-y (99.2% in 4Q16 and 99.7% in 4Q17) on account of lower vacancies at Bugis Junction Tower.

Negative rental reversions in 4Q17 

  • Due to spot rents still tracking below expiring rents, Keppel REIT reported negative rental reversions in 4Q17. This resulted in c.4% drop in rents for FY17 versus 3% fall reported for 9M17.
  • In addition, Keppel REIT guided that the average signing rents in Singapore for FY17 was S$9.80 psf per month with demand largely driven by the TMT sector (38.2% of new leases committed in FY17), followed by banking, insurance and financial services (14.6%) and real estate, property services (13.5%) Going forward, while Grade A CBD rents have risen to S$9.40 as end December 2017, slightly higher than our initial assessment of S$9.30, there remains some risk of negative rental reversions especially in 1H18 as the majority of leases in Singapore due for renewal and review range between S$8.50-S$12.00 psf.
  • For FY18, 8.3% and 14.2% of leases are due to expire and subject to rent reviews respectively. However, we understand the majority of these leases are weighted towards 2H18 which potentially reduces risk of rental reversions if we have a strong upturn in office rents in 1H18.

Steady gearing and borrowing costs 

  • Keppel REIT’s all-in costs of debt was relatively stable at c.2.6%. However, this is expected to edge higher in 2018 as the recent refinancing of S$425m worth of bank loans is marginally more expensive than Keppel REIT’s overall headline borrowing rate.
  • Gearing also remains stable at c.39% but should climb closer to the 40% level once the recently acquired 311 Spencer Street development is completed in 4Q19. The proportion of fixed-rate loans edged up slightly to 77% from 76% at end September.
  • Over the quarter, Keppel REIT recorded c.S$52m worth of revaluation gains which were mainly related to uplift in valuation for 275 George Street as the cap rate for the property has fallen to 5.63% from 6.25%. Valuation for Keppel REIT’s Singapore portfolio remains stable with no change in cap rates being used (3.75%).
  • Offset the uplift in property values was an increase in units outstanding resulting in NAV per share (excluding distributable income) coming in at S$1.40.

KREIT moving to a clean yield 

  • Keppel REIT guided that rather than using its capital gains to temper any shortfall in DPU it would use its cash to fund the development of 311 Spencer Street. Consequently, we have lowered our FY18-19F DPU by 2-3% as we no longer assume Keppel REIT distributes its capital gains to achieve a steady DPU profile.
  • Nevertheless, we lifted our DCF-based Target Price to S$1.41 from S$1.39, to account for faster than expected increase in spot rents thus far and guidance that a large proportion of leases that are due expire or reviewed in FY18 are weighted towards 2H18 which reduces the risk of Keppel REIT reporting negative rental reversions given our view that office rents should hit S$10 psf by year end.


Maintain BUY with a revised Target Price of S$1.41 

  • With more than 10% total return expected over the coming 12 months, we maintain our BUY call with a revised Target Price of S$1.41.
  • While there may be some concern by some investors over Keppel REIT’s DPU falling in FY18 and low yield versus its trailing 5-year average, we believe with spot rents rising faster than expected, investors will continue to take position in Keppel REIT on expectations of a multi-year recovery in DPU from FY19 as well as leverage to the strong Singapore economy which is projected grow at 3% in 2018 according to our DBS economists. 
  • In our view, the strong macro condition provides upside risk to our rental forecasts.





Mervin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2018-01-24
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.39 Up 1.41



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