Frasers Commercial Trust - DBS Research 2018-04-23: Repositioned For Growth

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FRASERS COMMERCIAL TRUST ND8U.SI

Frasers Commercial Trust - Repositioned For Growth

• Frasers Commercial Trust (FCOT) 2Q18 DPU of 2.40 Scts (-4% y-o-y) below expectations
• Weakness due to larger than expected equity raising and softer occupancy across various buildings
• Increased leasing enquiries and upturn in the Singapore office market bodes well for future earnings

Laggard office play. 

• We maintain our BUY call with a revised Target Price of S$1.65. 
• Following the recent market correction, Frasers Commercial Trust (FCOT) now trades below its book value and recent placement price of S$1.48. Furthermore, over the past 18 months, FCOT's share price has lagged other office REITs such as CapitaLand Commercial Trust (CCT) and Keppel REIT (KREIT) arising from concerns over the impact of HP vacating Alexandra Technopark (ATP) and lack of growth. 
• However, FCOT has announced strategies to address these issues, which should result in FCOT’s share price closing the c.2% yield differential between FCOT and its large cap peers closer to the historical average spread of c.0.8%.

Where we differ – Back on the growth path.

• Consensus has a HOLD call due to concerns that FCOT is ex-growth. However, we believe the acquisition of the Farnborough Business Park (FBP) puts FCOT back on the growth path as the UK now provides a growth avenue.
• The UK offers attractive yields relative to the tighter yields for office assets in Singapore and Australia, FCOT’s original core markets. Moreover, with its sponsor expanding into the UK business park space, FCOT has increased its visible acquisition pipeline to over S$4bn. Thus, with resumption of growth, we believe FCOT should be accorded a premium as implied by our Target Price of S$1.65.

Clarity over HP lease.

• The news that HP Inc will stagger its exit from Alexandra Technopark (ATP) removes the HP lease uncertainty as an overhang on FCOT. 
• In addition, we believe the market should react positively as the change in tenant mix at ATP provides an opportunity for FCOT to raise rents post the completion of the AEI currently undertaken. Both these factors should act as re-rating catalysts.

Key Risks to Our View:

• A key risk to our view is the market ignoring FCOT’s ability to mitigate the loss of HP as a tenant and slower than expected recovery in office rents.

WHAT’S NEW - DPU rebased

2Q18 DPU impacted by larger than expected fund raising

• Frasers Commercial Trust (FCOT)'s 2Q18 DPU of 2.40 Scts fell 4% y-o-y and was below expectations mainly due to larger amount of shares issued in the recent S$100m equity placement than we had earlier assumed. We had anticipated an equity placement of S$79m. The results were also below expectations due to slower ramp up of occupancy at Central Park in Perth. The fall in DPU was also impacted by Farnborough Business Park only contributing from the end of January.
• Nevertheless, 2Q18 DPU was flat q-o-q with DPU boosted by distributions of gains from the earlier disposal of hotel development site at China Square Central (S$2.9m versus S$1.9m in 1Q18 and S$0.9m in 2Q17) as well as the payment of management fees in units (management fees were paid in cash in 2Q17). The distribution of capital gains and payment of management fees in units are in line with prior guidance by management to temper the effects of the loss of income at Alexandra Technopark (ATP).
• The 2Q18 DPU consists of 0.80 Scts advanced distribution for the period 1 January to 31 January 2018 which was paid out on 12 March 2018 and ahead of the recent equity placement as well as distribution of 1.60 Scts for the period 1 February to 31 March 2018.

Lower occupancies pressurised underlying earnings

• Underlying revenue and NPI were down 18% and 25% y-o-y, primarily due to 
  1. the loss of HP as an anchor tenant at ATP (occupancy of 70.4% vs 91.0% in 2Q17), 
  2. lower office occupancies at CSC (91.6% vs 96.0% in 2Q17), 55 Market Street (87.9% vs 92.9%) and Central Park (68.3% vs 82.2%) and 
  3. depreciation of the AUD vs SGD. 
• Earnings was also impacted by the planned AEI at the CSC retail podium, absence of one-off income at Central Park in the prior quarter and higher maintenance expenses at Caroline Chisholm Centre which was flagged previously.
• Consequently, 2Q18 NPI at CSC, 55 Market Street and ATP fell 18%, 13% and 26% y-o-y respectively. The Australian properties, Central Park, Caroline Chisholm Centre, and 357 Collins Street also reported 26%, 4% and 4% y-o-y decline in NPI.
• Overall committed portfolio occupancy fell to 79.4% from 91.8% in 2Q17 largely due to declines in several properties as described above.

Flattish rental reversions

• We understand portfolio-wide FCOT achieved flattish rental reversions largely on the back of the recovery in spot rents in Singapore.
• Post the renewals over the quarter, another 11.4% of leases by gross rental income are due to be renewed for the remainder of FY18, down from 24.3% at end 1Q18. The majority of the leases expiries mainly relate to those at ATP and Central Park.

AEI’s on track for completion

• FCOT guided that the S$45m AEI at ATP remains on track for completion by mid-2018, which should aid FCOT securing new tenants at ATP. We understand thus far, FCOT has backfilled 100,000 sqft of space vacated by HP, up from 61,000 sqft in its previous guidance. HP, which had taken up to 497,000 sqft of space, will leave ATP by end December 2018 on a staggered basis,. We understand, replacement tenants have signed leases close to HP’s expiring rents around S$4 psf/mth.
• Meanwhile, the S$38m enhancement of the retail podium at CSC commenced in 1Q18 and is expected to be completed in 1Q19. The AEI is expected to result in an improved tenant mix focusing on F&B, wellness and services and there is potential to increase NLA for the retail podium from 64,000 sqft to c.75,000 sqft. These two AEIs should boost FCOT’s earnings over the coming few years as occupancies recover to stabilised levels and FCOT drives rents higher.

Greater leasing enquiries bodes well for future occupancies

• While occupancies in general fell in 2Q18, we understand leasing enquiries have picked up across FCOT’s properties in Singapore and Perth. This bodes well for FCOT as it endeavours to reduce the vacancy rate especially at ATP and Central Park.
• In addition, with the Melbourne office market remaining buoyant and spot office rents in Singapore recovering, prospects of FCOT achieving higher signings rents are also on the offer.

Stable gearing and borrowing costs

• Post the recent acquisition and equity placement, gearing settled at 35.3%, close to 34.8% level at end 1Q18. Costs of debt was also steady at 2.99% versus 3.04% at end 31 December 2017.
• NAV per unit fell to S$1.51 from S$1.55 due to the impact from the recent equity raising and depreciation of the AUD vs SGD.

Rebasing DPU expectations

• On the back of slower than expected ramp up of occupancies at Central Park and recent softness in several of FCOT’s buildings, we have rebased our DPU expectations, and now project quarterly DPU of 2.40 Scts going forward. This results in our FY18-20F DPU being cut 3-4%. 
• While we expect FCOT’s DPU to remain supported by capital distributions as it ramps up occupancies at ATP, beyond FY18, we expect modest 1% p.a. growth in DPU to reflect the underlying improvement earnings and benefits from the recent acquisition of Farnborough Business Park.
• Consequently, after tempering our occupancy assumptions and better reflecting recent depreciation of the AUD vs SGD, we have also reduced our DCF-based Target Price to S$1.65 from S$1.71.

Maintain BUY with revised Target Price of S$1.65

• Despite weaker than expected 2Q18 results, we reiterate our BUY call on FCOT with a revised Target Price of S$1.65.
• We believe at current levels, the market is under- pricing FCOT on the back of concerns that FCOT will not be able to backfill the space vacated by HP and that it is ex-growth. However, we believe these assumptions would not hold as
  1. Alexandra Technopark (ATP) is now in a fundamentally stronger position post its AEI and offers good value for prospective tenants given it is offers rents at S$1.00-$2.50 discount to the nearby Mapletree Business City and is only 15-20 minutes from the CBD, and
  2. expansion into the UK will now kick start the REIT’s inorganic strategy, and DPU growth outlook.

Mervin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2018-04-23

SGX Stock Analyst Report BUY Maintain BUY 1.65 Down 1.710