Manulife US REIT - RHB Invest 2018-02-07: Fundamentals Remain Sound

Manulife US REIT - RHB Invest 2018-02-07: Fundamentals Remain Sound MANULIFE US REIT BTOU.SI

Manulife US REIT - Fundamentals Remain Sound

  • Manulife US REIT’s FY17 results are in line. While the market is slightly concerned over the impact of faster-than-expected US Fed rate hikes, we note that this is on the backdrop of a stronger US job market and higher wage growth, which is positive for office demand. 
  • Manulife US REIT also offers scope for organic growth (via rental growth and escalations) and inorganic growth potential from acquisitions. We see minimal impact from recent changes in the tax structure. 
  • Its valuation remains attractive, offering an attractive FY18F yield of 6.5%, which is over 100bps higher than that of S-REITs that specialise in office space. 
  • Maintain BUY, with a USD0.98 Target Price (8% upside).

Minimal impact from recent changes in tax structure. 

  • In light of the recent US tax reforms, Manulife US REIT (MUST) made two key changes to its existing tax structure. The changes would result in the replacement of existing US sub-REITS with entities that will directly hold individual office assets, and the incorporation of a Barbados entity which will allow it to enjoy the withholding tax exemptions on the interest and principal amount of shareholder loans. 
  • The net impact of changes is expected to be minimal (about -1% of income), mainly due to additional local taxes that have to be paid in Barbados.

To double assets under management (AUM) in the next two years.

  • Management is actively looking for acquisition opportunities in key US cities, and will target Grade-A/trophy quality assets – which it sees as less vulnerable to market cycles. 
  • While its acquisition targets look ambitious, we believe there is still room for the REIT to make 1-2 yield-accretive acquisitions a year. The key reasons are its strong sponsor pipeline, sourcing abilities, and favourable US office yields of 5.5-9% (vs the portfolio average yield of 5.5%). 
  • Manulife US REIT also unveiled asset enhancement plans for Figueroa (2Q18, capex: USD5m) and Exchange (3Q18, capex: USD12m) to enhance competitiveness.

Room for organic rental growth. 

  • While Manulife US REIT has limited leases due for renewal this year (ie < 3%), we expect management to proactively renew some of its 2019 leases this year. 
  • On the supply front, we note that the micro-market supply across locations where its assets are at remains limited. As average rental rates across its office properties are still 5-10% below current passing rates, we expect rental reversions to stay positive, at mid-single digits.
  • Note that rental reversions are in addition to step-up rental rates of ~2.7% pa.

Rate hike threat mitigated by strong economic growth. 

  • While expectations of more US Fed rate hikes this year generally have a negative impact on yield instruments like REITs, we note that rate hikes are coming on the back of a strong US labour market and office demand, which should benefit Manulife US REIT. 
  • Also, almost all of its borrowings are on fixed terms, with an average debt maturity of 3.4 years – which shields it from the risk of increasing borrowing costs.

Maintain BUY, with an unchanged Target Price of USD0.98. 

  • We tweak our FY18F-20F DPU by -1% to +1%, factoring in the tax structure changes and slightly higher rental rates. Our DDM-derived Target Price assumes a CoE of 8% and terminal growth rate of 2%. 
  • Key risks are its ability to retain key tenants, an unexpected slowdown in office demand and changes to its efficient underlying tax structure. 

Vijay Natarajan RHB Invest | 2018-02-07
RHB Invest SGX Stock Analyst Report BUY Maintain BUY 0.980 Same 0.980