OUE Commercial REIT - DBS Research 2018-08-03: In Transition

OUE Commercial REIT - DBS Group Research Research 2018-08-03: In Transition OUE COMMERCIAL REIT SGX:TS0U

OUE Commercial REIT - In Transition

  • OUE Commercial REIT (OUECT)’s 2Q18 DPU of 1.06 Scts (-7.8% y-o-y) below expectations.
  • Drag from lower occupancies at One Raffles Place Shopping Mall and higher borrowing costs.
  • Impact from positive rental reversions to temper the loss of income support in FY19.



Range-bound.

  • We maintain our HOLD call on OUE Commercial REIT (OUECT) with a revised Target Price of S$0.67.
  • While we see long-term value in OUECT as it trades at c.15% discount to its book value and spot office rents in Singapore have started to recover, we believe the stock will trade range-bound in the near term given the headwinds from the loss of income support in FY19 and an expected fall in DPU in FY18 and FY19. 



~ SGinvestors.io ~ Where SG investors share

Where we differ – Lower target price.

  • While we and consensus both have HOLD recommendations on OUECT, our Target Price is now lower than the consensus average, as we believe the loss of income support in FY19 and overhang from the potential dilution from the conversion of the convertible perpetual preferred units (CPPU) in the medium term would likely result in OUECT trading below book. This is despite the quality of OUECT’s buildings which are in the Grade A category and/or in prime locations.


Upside from acquisitions or faster office recovery.

  • While we are cautious on OUECT’s near term share price performance, we would turn more bullish if the trust is able to pursue DPU accretive acquisitions and/or spot Grade A office rents rise faster than expected. 
  • In addition, clarity over its capital structure, in particular how it intends to mitigate the potential medium-term dilution from the CPPUs may also lead us to be more positive on the stock. 


Valuation: 

  • On the back of a softer than expected 2Q18 results and incorporating a weaker CNY, we lowered our Target Price to S$0.67 from S$0.73.


Key Risks to Our View: 

  • The key risk to our view is a faster than expected recovery in spot Grade A office rents resulting in higher than expected rental income for the REIT. 


WHAT’S NEW - Soft 1H18 results


2Q18 DPU down 7.8% y-o-y

  • OUE Commercial REIT (OUECT) reported 2Q18 DPU of 1.06 Scts (-7.8% y-o-y) with 1H18 DPU coming in at 2.18 Scts (-8.4% y-o- y). This was below expectations with 1H18 DPU only representing c.48% of our FY18F DPU.
  • The underperformance was mainly due to larger than expected impact from transitional vacancy at One Raffles Place (ORP) Shopping Mall as well as our over estimation of distribution adjustments.
  • Overall, the lower 2Q18 DPU was also caused by the impact of negative rental reversions in the prior quarters which also resulted in 2Q18 revenue and NPI falling 2.6% and 2.4% y-o-y. The decline in DPU was also a function of higher borrowing costs arising from the redemption of the convertible perpetual preferred units (CPPU).

Still healthy occupancies

  • OUE Commercial REIT (OUECT)’s overall portfolio committed occupancy remains healthy at 95.2%, although this is down slightly from 96.4% achieved in 2Q17 and 96.9% at end 1Q18.
  • The dip in occupancy is mainly due to declines at OUE Bayfront office (97.6% versus 98.9% at end 2Q17 and 98.2% at end 1Q18) and Lippo Plaza (95.1% versus 100% at end 2Q17 and 99.2% at end 1Q18) – impact from loss of tenant who was looking to expand but there was lack of space in the building.
  • However, occupancy at ORP office improved y-o-y to 96.6% from 95% at end 2Q17 but slightly down from 97.1% at end 1Q18.

Positive rental reversions

  • OUE Commercial REIT (OUECT) guided that it achieved positive rental reversions in 2Q18, the first time in many quarters. This improvement was mainly a result of leases signed at OUE Bayfront.
  • Signing rents at OUE Bayfront ranged between S$11.50-12.80 psf/mth compared to average expiring rents of S$11.71 psf/mth.
  • Lippo Plaza also had a better quarter with signing rents of between RMB9.80-11.00 psm/day which was generally higher than expiring rents of RMB9.86 psm/day.
  • ORP had a more challenging quarter with committed rents of S$9.00-11.00 psf/mth, below average expiring rents of S$10.66 psf/mth.

More than half of leases renewed

  • More than half of OUE Commercial REIT (OUECT)’s leases that were due in FY18 have been renewed year to date which leaves another 8.3% of leases by gross rental income up for renewal for the remainder of FY18. The majority of these leases related to ORP and Lippo Plaza, with only 2.2% of leases at OUE Bayfront set to expire.
  • For FY19, around 26.7% of leases are due to be renewed. Should Singapore office rents continue the upward trajectory, we believe there are strong prospects for OUECT to report positive rental reversions next year.

Stable gearing at c.40%

  • OUE Commercial REIT (OUECT)’s gearing remains stable at c.40%. The original increase from c.37% at end FY17 is mainly due to the debt funded redemption of S$100m worth of CPPUs in January 2018.
  • Borrowing costs ticked up marginally to 3.5% from 3.4% at end 1Q18 but was stable from 3.5% level at end 4Q17.
  • Going forward, there is upside pressure on borrowing costs with higher benchmark interest rates. However, this is mitigated as c.74% of OUECT’s debt is on fixed rates and upon refinancing of c.S$463m of debt this year, OUECT should achieve lower margins once it enters its new 3-5 year facilities.

Moderating DPU estimates

  • On the back of the weaker than expected 2Q18 results and impact from transitional occupancy at ORP shopping mall before a co-working operator starts operating in early 2019 as well as lower SGD/CNY on the back of the recent depreciation (we are now assuming FX rate of 4.9 versus 4.85 previously), we lowered our FY18-20F DPU by 2-5%. This also leads us to cut our DCF-based Target Price to S$0.67 from S$0.73 previously.

Near term headwinds

  • Over the next 12-18 months, we expect some near-term headwinds, softer contribution from ORP shopping centre, loss of income support in FY19, flow on effects of the negative rental reversions over the past year and potentially the further weakening of the CNY versus SGD.
  • Nevertheless, beyond FY19 assuming the office market in Singapore remains on an uptrend and there is no conversion of the CPPU’s into units, we believe prospects of a recovery in DPU.


Maintain HOLD, revised Target Price of S$0.67

  • With limited re-rating catalysts and potentially weak DPU performance near term, we maintain our HOLD call with a revised Target Price of S$0.67.





Mervin SONG CFA DBS Group Research Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-08-03
SGX Stock Analyst Report HOLD Maintain HOLD 0.67 Down 0.730



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