Keppel REIT - DBS Research 2018-10-16: “Steady Pom PiPi” (Steady As She Goes)


Keppel REIT - “Steady Pom PiPi” (Steady As She Goes)

  • Keppel REIT’s 3Q18 DPU of 1.42 Scts (-3% y-o-y) in line with expectations.
  • Impacted from prior rental reversions and weaker AUD but 8.7% positive rental reversions year to date points to recovery in DPU in 2019.
  • Potential for share buyback to resume after release of results with Keppel REIT trading below recent buybacks.
  • Maintain BUY, Target Price S$1.41.

What’s New

3Q18 DPU of 1.36 Scts (-3% y-o-y)

  • Keppel REIT delivered 3Q18 DPU of 1.36 Scts. The 3% y- o-y decline was largely due to the impact from prior quarters' negative reversions, depreciation of the AUD, higher borrowing costs and transitionary vacancy (overall portfolio occupancy of 98.0% versus 99.6% in 3Q17). Some of these factors also resulted in overall 3Q18 revenue and NPI falling 9% and 11% y-o-y respectively.
  • Overall 3Q18 results were in line with expectations with 9M18 DPU of 4.20 Scts representing c.76% of our FY18F DPU. However, this may be below consensus expectations as 9M18 only represents c.71% of consensus FY19F DPU of 5.90 Scts.

Declines in contribution across the portfolio except Bugis Junction

  • Earnings from Keppel REIT’s Singapore properties were generally weaker y-o-y with the exception of Bugis Junction which reported a 3% and 6% y-o-y increase in 3Q18 revenue and NPI, largely due to improvement in occupancy (100% versus 97.6% in 3Q17).
  • Meanwhile, revenue and NPI for Ocean Financial Centre (OFC) fell 8% and 10% y-o-y respectively, owing to the early pre-termination of some ANZ leases in the prior quarter. Despite backfilling 70% of the pre-terminated space, we understand there were some non-renewals of leases over the quarter, which resulted in occupancy at OFC falling to 95.5% from 99.7% in 2Q18 and 99.7% in 3Q17.
  • Associate income from Marina Bay Financial Centre (MBFC) and One Raffles Quay (ORQ) also fell 13% and 16% y-o-y respectively, owing to higher borrowing and marketing costs. In addition, occupancy at ORQ fell to 96.1% from 100.0% in 2Q18 and 3Q17.
  • Contribution from the Australia properties also suffered due to the depreciating AUD. 3Q18 NPI for 275 George Street and 8 Exhibition Street fell 32% and 14% y-o-y respectively, while income from 8 Chifley Square and David Malcolm Justice Centre both fell 2% y-o-y.
  • Excluding the fall in AUD, 3Q18 NPI for 275 George Street and 8 Exhibition Street declined 26% and 7% y-o-y respectively. While committed occupancy was 99.3% at end-September 2018 for 275 George Street versus 93.4% at end-2Q18 (99.7% in 3Q17), earnings for the property was impacted by new tenants not moving in yet. For 8 Exhibition Street, it was affected by occupancy falling y-o-y to 97.2% from 99.7% in 3Q17 previously.

Higher signing rents and 8.7% positive rental reversions year to date

  • For the first nine months of 2018, Keppel REIT disclosed that it had achieved signing rents in Singapore of c.S$10.88 psf/mth which is up from S$10.74 psf/mth and S$10.05 psf/mth in 1H18 and 1Q18 respectively.
  • In addition, year to date, it has achieved 8.7% positive rental reversions, up from mid-single-digit rental reversions for 1H18. This increase in rents is largely due to the continued increase in Grade A CBD rents which according to CBRE rose to S$10.45 psf/mth from S$10.10 psf/mth at end- June 2018 and S$9.40 at end-December 2017.
  • On account of the renewals over the quarter, only 0.3% and 6% of leases are set to expire in FY18 and FY19 respectively, down from 2.9% and 10.2% at end-2Q18.
  • For the remainder of the year, another 6.7% of leases are subject to rent reviews which are mainly related to the DBS leases at MBFC Tower 3. We understand negotiations are ongoing and are expected to be concluded in mid-November.
  • Keppel REIT also disclosed that the majority of leases at 275 George Street in FY19 (28.6% of leases for the buildings) have already been renewed.

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Further details on new HSBC lease

  • Keppel REIT during the 3Q18 results call disclosed that HSBC will be undertaking a ten-year lease with two five-year extension options at MBFC Tower 2 after it relocates from 21 Collyer Quay in April 2020. Fit-out works are expected to commence in 2H18.
  • While signing rents were not disclosed, we understand that rents are higher than passing rents for the top floors at MBFC Tower 2, with a market review every five years.
  • HSBC is expected to occupy c.140,000 sqft of space in the top floors at MBFC Tower 2 and will be taking signage rights for the building.

Relatively stable capital structure

  • Keppel REIT’s capital structure was relatively stable over the quarter, with gearing up marginally to 39.1% from 38.8% at end-2Q18. Borrowing costs also inched up to 2.80% from 2.77% in 2Q18, although up from 2.58% in 3Q17. The proportion of fixed rate debt was stable at c.76%.
  • Going forward, we understand Keppel REIT will progressively increase the proportion of AUD debt to better match its asset base in Australia, subject to the management of its overall borrowing costs. Currently, Australia contributes c.13% of its assets with 4-5% of its debt in AUD.
  • Adjusted NAV per unit (excluding minorities and perpetual securities) came in at S$1.38, down from S$1.40 at end-June 2018, largely due to the depreciation of the AUD.

Bugis Junction Tower not officially for sale

  • Based on recent press reports and market speculation, Keppel REIT was rumoured to be selling Bugis Junction Tower. However, management reiterated that it does not have any intention to sell the building, unless it receives a compelling offer.
  • We believe given the tight yields for office buildings in Singapore, if Keppel REIT were to receive a high price for Bugis Junction Tower and is able to recycle the proceeds into a higher-yielding property, the market should react positively to this potential transaction.

Potential for share buyback to resume

  • Keppel REIT’s last share buyback occurred on 30 August 2018. We understand the share buyback was stopped due to Keppel REIT entering a blackout period ahead of its 3Q18 results rather than due to Keppel REIT’s share price hitting a particular level.
  • Thus, in our view there is potential for the share buyback to resume after the release of the latest results.
  • Year to date, Keppel REIT has bought back 5.3m shares (c.0.16% shares outstanding) between S$1.15 and S$1.19 and at an average price of S$1.17.
  • Keppel REIT is authorised to buy back up to 169m shares.

Finds the perfect blend of management with fresh ideas and long-term corporate experience

  • Keppel REIT recently announced that Deputy CEO, Mr Paul Tham would be appointed CEO with effect from 1 January 2019. He will succeed current CEO Mr Tan Swee Yiow who will be appointed CEO of Keppel Land. Mr Tan will remain as a non-executive director of Keppel REIT.
  • Mr Tham is also concurrently the CFO of Keppel Capital, the asset management arm of Keppel Corporation, Keppel REIT’s sponsor and was appointed Deputy CEO on 1 February 2018.
  • While some investors may be cautious on another change in CEO, Keppel REIT’s fourth CEO in the last two years, we believe the appointment of Mr Tan in March 2017 has brought a degree of stability to the management of Keppel REIT. Furthermore, with Mr Tan remaining as a board director, we believe Keppel REIT has now found the perfect blend of a new CEO with a fresh perspective in Mr Tham, combined with the corporate memory and experience of Mr Tan, who was Keppel REIT’s first CEO and led the development of many of Keppel REIT’s office buildings.

Maintain BUY, Target Price of S$1.41

  • With 3Q18 results in line with expectations, we maintain our BUY recommendation and Target Price of S$1.41.
  • We continue to like Keppel REIT for the leverage to the upturn in the Singapore office market as well as the fact that it trades at a c.17% discount to its latest book value and below Keppel REIT’s recent share buybacks.
  • In addition, while Keppel REIT is still suffering from the negative rental reversions due to the downturn in the office market between 2015 and 2017, with signing rents now higher than expiring rents, this should provide a tailwind to earnings in 2019, resulting in a recovery in DPU after declines over the past few years.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-10-16
SGX Stock Analyst Report BUY MAINTAIN BUY 1.410 SAME 1.410