Frasers Commercial Trust - DBS Research 2018-10-22: Improving Prospects

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FRASERS COMMERCIAL TRUST (SGX:ND8U)

Frasers Commercial Trust - Improving Prospects

• Frasers Commercial Trust (FCOT)'s 4Q18 DPU of 2.40 Scts (flat y-o-y) in line with expectations.
• Underlying 4Q18 DPU excluding capital distribution down 7% y-o-y due to recent sale of 55 Market Street, lower occupancy, and weaker AUD.
• Green shoots at Alexandra Technopark with sequential improvement in occupancy and AEI nearing completion.
• UK acquisition using proceeds from sale of 55 Market Street to result in end of capital distributions in FY20.

Laggard office play.

• We maintain our BUY call with a revised Target Price of S$1.70.
• Frasers Commercial Trust (FCOT) currently 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. To address these issues, FCOT has announced various strategies 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.1%.

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) and deployment of proceeds from the sale of 55 Market Street 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 and demonstrated ability to sell assets above book, we believe FCOT should be accorded a premium as implied by our Target Price of S$1.70.

Backfilling of vacant space at ATP.

• With the AEI at Alexandra Technopark largely completed and seeing an increase in leasing enquiries, we believe Alexandra Technopark’s occupancy should rise over the next few quarters from c.70% currently. As occupancy increases, this should remove the overhang on FCOT’s share price from the vacancy created by HP leaving the property.

Valuation:

• After incorporating a S$250m acquisition in UK, we increased our DCF-based Target Price to S$1.70 from S$1.65.

Key Risks to Our View:

• A key risk to our view is the slower than expected recovery in office rents and improvement in occupancy at Alexandra Technopark.

WHAT’S NEW - Showing positive signs

4Q18 DPU of 2.40 Scts

• As expected Frasers Commercial Trust (FCOT) delivered 4Q18 DPU of 9.60 Scts (-2% y-o-y).
• To maintain a stable DPU, similar to prior quarters, 100% of its management fees were paid in units and S$2.4m worth of gains from the disposal of the hotel development rights at China Square Central (CSC) were distributed (S$0.9m in 4Q17).
• Overall S$12.8m in gains were estimated to have fallen 7% and 13% y-o-y to 2.13 Scts and 8.13 Scts respectively.
• The weakness in underlying 4Q18 DPU was largely attributed to higher amortisation of lease incentives. Partially offsetting this was contribution from Farnborough Business Park which was completed in January and 9% y-o-y increase in NPI from Caroline Chisholm Centre due to lower repair and maintenance expenses as FCOT completed its period maintenance of the building.
• For Farnborough Business Park, we understand 4Q18 NPI were one-off in nature.
• Owing to the lower divestment and lower AUD, overall group 4Q18 revenue and NPI fell 15% and 19% y-o-y respectively.

Forward renewals achieved with overall portfolio committed occupancy inching higher due to sequential improvement at ATP

• Due to forward renewals achieved over the quarter, 13.1% and 10.6% of city fringe business park rents up 1.8% q- o-q to S$5.80 psf/mth), we believe prospects of positive rental reversions will increase next year.
• At Alexandra Technopark there was some progress expected to be completed in 2H19.
• For the whole of FY18, we estimate the actual new lobbies and amenities. Hence, we expect committed occupancies to improve over the next few quarters.

Uplift in property valuations

• As per its usual year-end review, FCOT’s valuers assessed that its properties at 3.75% and 4.5% respectively.
• The Australian portfolio also used 7% and 5% cap rates for Central Park and 357 Collins Street.
• On account of the revaluation gains and NAV per unit also rose to S$1.59 from S$1.50 previously.
• Meanwhile, borrowing costs dipped slightly to 3.02% from 3.05% at end 3Q18 with the proportion of fixed rate debt stable at c.81%.

Stable DPU for FY19 before recovery in FY20 upon improvement in occupancy at Alexandra Technopark and acquisition in UK

• With the sale of 55 Market Street resulting in a net gain of c.S$139.9m combined with c.S$25m left from gains from the disposal of the hotel developments in a strong position to distribute some gains to maintain its guidance for a stable DPU while occupancy at Alexandra Technopark ramps up and there is absence of earnings following the disposal of 55 Market Street. To that end, we now forecast FY19F DPU of 9.60 Scts slightly down from our previous forecast of 9.65 Scts after lowering capital distributions to c.S$11m from c.S$12m previously to account for management’s stable DPU guidance.
• Nevertheless, we believe the deployment of proceeds from the sale of 55 Market Street into the UK will result in a clean DPU in FY20 i.e. without the support of capital distributions.
• On that front, we have pencilled in S$250m, 100% debt funded acquisition in July 2019 based on a 6% NPI yield, lower than the c.6.3% yield for the Farnborough Business Park acquisition earlier this year. We have assumed 2.8% borrowing costs for this acquisition.
• Combined with effective occupancy at Alexandra Technopark climbing to c.85% in FY20 (lower than our previous 90% estimate due to slower than expected progress this year) from an estimated 64% in FY18, we believe, this should result in DPU commencing its recovery path with a 2% increase in FY20, following the difficult last few years. Our new FY20F DPU of 9.77 Scts is 1% higher than our previous FY20F forecast but our new underlying FY20 DPU is 8% higher due to the ability of FCOT’s ability to recycle assets.
• Post the assumed acquisition, we estimate gearing to settle between 36-37% range, below the 45% regulatory limit and in line with gearing of other listed S-REITs.
• On the back of higher earnings estimates due to another acquisition in the UK, we also raised our DCF-based Target Price to S$1.70 from S$1.65 previously.

Maintain BUY with revised Target Price of S$1.70

• With 4Q18 results in line with expectations, we maintain our BUY call and a revised Target Price of S$1.70.
• We remain bullish on FCOT’s prospects due to
  1. the overall Singapore office market continuing its growth trajectory which should result in higher signing rents,
  2. recovery in occupancy at Alexandra Technopark which should allay concerns over FCOT’s ability to backfill the space vacated by HP, and
  3. boost to not only earnings but increased investor confidence in management’s ability to find an accretive acquisition in the UK next year.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-10-22

SGX Stock Analyst Report BUY MAINTAIN BUY 1.70 UP 1.650