Keppel REIT - RHB Invest 2018-01-24: Fully Valued

Keppel REIT - RHB Invest 2018-01-24: Fully Valued KEPPEL REIT K71U.SI

Keppel REIT - Fully Valued

  • Keppel REIT's FY17 results were in line with expectations. Negative rent reversions are likely to persist in 1H18 despite a pickup in the office market, as expiring rents were signed closer to the previous peak in 2014. 
  • Contributions from 311SS would only start in 2020, while progress payments via debt would increase interest expense slightly. The tapering off of rent support would also dent DPU over the near term. 
  • With gearing close to 40%, we do not rule out the possibility of equity fund raising. 
  • Downgrade to SELL (from Neutral) with revised Target Price of SGD1.06 (from SGD1.05, 20% downside).

Negative rent reversions likely to persist. 

  • Keppel REIT (K-REIT) signed 26 leases (~297,300 sq ft) in 4Q17, at an estimated rent reversion of -6%, steeper than FY17’s -4%. 
  • On the positive side, K-REIT is seeing a good pickup in demand, which is in line with recent positive economic data. Key sectors driving office demand include TMT, banking, insurance and financial services, as well as the real estate and property services sectors.
  • About 22.5% of its portfolio NLA is due for renewal and review in 2018, with the bulk of it coming in 2H18. K-REIT noted that rents for leases expiring are in the range of SGD8.50-12psf per month. As the expiring rents in 2018 were signed closer to office market peak in 2013/2014, we believe spot rents are still 5-10% lower than expiring rents. Thus, we expect negative rent reversions to persist for the next two quarters before flattening out in 2H18.

311SS to start contributing in 2020. 

  • In Jul 2017, K-REIT announced the acquisition of a 50% stake in a premium office tower to be developed at 311 Spencer Street (311SS), Melbourne, Australia. Construction is progressing as scheduled and should complete by 4Q19. 
  • The aggregate purchase consideration was AUD347.8m (c.SGD362.4m), of which K-REIT has paid c.SGD140m, with the remaining to be paid progressively. 
  • Upon completion, the building will be fully leased by the Assistant Treasurer (State of Victoria) on a 30-year net lease, with average rental yield for the first 15 years of 6.4%.

Equity fund raising in the cards? 

  • The aforementioned acquisition’s payment would be done via a combination of debt and cash. With K-REIT’s current gearing at 38.7%, the increased borrowing is expected to bring gearing to c.40%, closer to max allowable gearing limit of 45%. 
  • With SG Grade A office properties currently being transacted at yields of around 3-4%, the limited debt headroom would also reduce potential yield-accretive acquisitions.

Rental support tapering off. 

  • K-REIT has SGD11.5m remaining in terms of rental support income, which would end by 2019. For FY17, K-REIT distributed SGD12.8m (-23.4%YoY), and for this year we expect it to be lower by 33%.

Downgrade to SELL with slightly higher Target Price of SGD1.06. 

  • We lower our FY18F-19F DPU by 3-5%, taking into account lower rental support and higher interest expense, and have added our forecast for FY20F. We have also lowered our COE assumptions to 6.1% (from 6.5%) to better reflect the current low interest rate environment. 
  • Key risks to our assumption are stronger-than-expected office demand, and continued fund flows into the REIT sector. 
  • The stock offers an FY18F yield of 4.3%.

Vijay Natarajan RHB Invest | http://www.rhbinvest.com.sg/ 2018-01-24
RHB Invest SGX Stock Analyst Report SELL Downgrade NEUTRAL 1.06 Up 1.050