CapitaLand Commercial Trust - DBS Research 2018-07-19: Leader Of The Pack

CAPITALAND COMMERCIAL TRUST SGX:C61U

CapitaLand Commercial Trust - Leader Of The Pack

2Q18 DPU of 2.16 Scts (-1.6% y-o-y adjusted for rights issue impact) in line with expectations.
Benefit from Asia Square Tower 2 and Gallileo acquisitions not fully realised yet.
Negative rental reversions but narrowing gap between expiring and spot rents bodes well for positive rental reversions in the future.
Upside risk to DPU estimates from deployment of proceeds from sale of Twenty Anson.

We keep our BUY call on CapitaLand Commercial Trust (CCT) with a Target Price of S$2.12. With the correction over the past few months, we believe CCT remains undervalued ahead of a multi-year upturn in office rents in Singapore.
In addition, with its property valuations below physical market transactions, CCT is trading at attractive valuations at the current share price. Also, the recent expansion into Europe provides another growth avenue which we believe the market has not fully appreciated.

Consensus’ target prices have moved from buildings such as Capital Tower and 999-year leasehold HSBC Building priced at S$1,847 and S$2,275 psf respectively, a discount to recent transactions of S$2,400-2,700 for comparable buildings.

With Singapore office rents rising faster than expected and increasing for the fourth consecutive quarter, hitting S$10.10 psf/mth at end-2Q18, up 13% from the lows in 1H17, we believe this should generate increased investor interest in CCT.
Focus should turn to the expected multi-year recovery in office rents as new supply over the coming three years is limited. This, and the continued rise in office rents, should act as re-rating catalyst for CCT’s share price.

We maintain our DCF-based Target Price of S$2.12. With 20% capital upside and 4.9% yield, we retain our BUY call and CCT as our top pick in the office sector.
CCT remains out top pick in the office space, as it is the largest and most liquid office REIT. Furthermore, we continue to like CCT for its exposure to the expected multi-year recovery in office rents due to minimal new office supply over the next three years.

CapitaLand Commercial Trust (CCT) delivered 2Q18 DPU of 2.16 Scts which was down 4% y-o-y or adjusting for the rights issue in the prior year, down 1.6% y-o-y. This took 1H18 DPU to 4.28 Scts (-6.1% y-o-y or -3.7% after adjustment for rights issue) which represents c.48% of our FY18F forecasts and is in line with our expectations.
The decline in 2Q18 DPU was mainly due to the drag from the higher shares on issue from the recent equity placement and rights issue in the prior year as well as loss of income from the sale of Wilkie Edge and redevelopment of Golden Shoe.
However, underlying 2Q18 revenue and NPI rose 12.0% over the past year.
Overall portfolio occupancy remains healthy at 97.8%, marginally up from 97.3% and 97.6% at end-1Q18 and 2Q17 respectively. The uptick in occupancy was largely due to improvements at 6 Battery Road (99.9% versus 98.5% in 2Q17) and Twenty Anson (95.8% versus 84.2% in 2Q17). Further progress has been made at AST2 with occupancy now at 91.9% compared to 90.8% at the end of 1Q18.

Based on the disclosed expiring rents and committed rents achieved over the quarter, it appears CCT may have faced negative rental reversions in 2Q18, following small positive rental reversions in 1Q18.
However, the gap between spot Grade A office rents and average expiring rents has narrowed. For 2Q18, spot rents of S$10.10 psf/mth are now marginally below average expiring rents of S$10.73 psf/mth. This compares to spot rents of S$9.40 psf/mth and average expiring rents of S$11.09 psf/mth in 4Q17. The narrowing gap and if spot rents continue to climb as expected, should bode well for CCT starting to deliver positive rental reversions ahead. In addition, signing rents for CCT’s various buildings remain above the various sub market rents.
Over the quarter, AST2 achieved committed rents of S$8.40-9.86 psf/mth.
Post the leases signed in 2Q18, only 2% and 24% of office leases by gross rental income are up for renewal for the remainder of FY18 and FY19, down from 5% and 31% respectively.

On the back of a 10-bp compression in cap rates for CCT’s Singapore office buildings, CCT reported a 1.3% increase in property values for its Singapore portfolio, resulting in NAV per unit (excluding distribution income) rising to S$1.80 from S$1.74.
CCT’s Singapore office buildings are now valued using a cap rate of between 3.5-4.0% versus 3.6-4.10% previously. The higher property values resulted in aggregate leverage being stable at 37.9% offsetting the impact from higher borrowings to fund the acquisition of Gallileo.
On the back of higher benchmark interest rates, average borrowing costs ticked up marginally to 2.8% from 2.7% at end-2Q18. The proportion of fixed rate borrowings fell to 85% from 90% in the preceding quarter.

Following the divestment of Twenty Anson on an exit yield of 2.7%, CCT’s gearing is projected to drop to c.35%, should it use the proceeds from the sale to pare down debt.
Completion of the sale is risk to our earnings/DPU estimates.
We believe the likelihood of CCT expanding into Europe is high given the need to build scale in Europe following its maiden acquisition there, the lack of investment opportunities for prime Grade A offices in Singapore and the better yield spreads on offer in Europe.
Europe currently represents c.5% of CCT’s portfolio by asset value versus its long-term target of having 10- 20% of assets outside Singapore.
Given our view that CCT is likely to buy in Europe sometime in 2H18, we maintain our earnings and DPU estimates for now.

Mervin SONG CFA DBS Group Research Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-07-19

SGX Stock Analyst Report BUY Maintain BUY 2.120 Same 2.120