Manulife US REIT - RHB Invest 2018-11-07: Another Solid Quarter; BUY


Manulife US REIT - Another Solid Quarter; BUY

  • Maintain BUY, Target Price still at USD0.92, 20% upside with 8.1% FY19F yield.
  • Manulife US REIT delivered another solid set of quarterly numbers, backed by contributions from acquired assets and organic growth. Portfolio occupancy rate improved in four of its properties, with double-digit rental reversions recorded in 3Q.
  • Outlook of the US office market remains rosy, on strong jobs creation and limited micro-market supply. While there has been some concerns on potential tax reforms impacting its tax-efficient structure, we believe the probability of any drastic changes is low.
  • Manulife US REIT is one of our top sector picks.

Portfolio metrics improved.

  • Manulife US REIT’s portfolio occupancy rate rose 0.5ppt q-o-q to 96.5%, backed by improvements in Figueroa, Michelson, Peachtree and Phipps. This was partially offset by a slight drop in Exchange’s occupancy rate.
  • More importantly, renewed leases registered a strong positive rental reversion of 13.5%, indicating continued strength in the US office market and its asset quality. Note that the rental reversions are on top of inbuilt annual rental rate escalations.
  • Overall, the outlook for the US office sector remains positive, underpinned by strong jobs creation (569,000 in 3Q18), wage growth and limited micro-market supply across its property locations. We expect leasing momentum to remain positive in the coming quarters.

Some right-sizing of space by law firms.

  • Portfolio lease expiry (as % of gross rental income) for 2019 rose to 10%, vs 7.9% in 2Q18. Management noted that the increase was due to mutual agreements to right-size some of space occupied by law firms across its buildings. Manulife US REIT has also received some compensation for the spaces that will be vacated.
  • With continued strength in the office market, we see the move as a win-win – as Manulife US REIT can potentially fetch higher market rental rates for smaller spaces.

Speculation surrounding tax changes seems overdone.

  • Recently there has been speculation on potential tax reforms by the Trump administration which may impact the current tax-efficient structure used by Manulife US REIT. It surrounds changes to the US portfolio interest exemption rule, which shields withholding tax on interest and principal on shareholder’s loan.
  • While we have no clear visibility on this, the probability of any drastic change is low as the existing structure is used by a large number of private funds and will have a broader impact on foreign investments in the US. Even if implemented, we believe management is proactively evaluating counter-measures, ie increasing depreciation charges or changing the tax domicile entity, to limit the impact.
  • The worst-case impact is likely to be a 88% drop in distributable income.

Asset enhancement initiative (AEI) progress.

  • AEI works at Figueroa and Exchange are progressing well, and are on track for completion in 2019.

Valuations are compelling.

  • Manulife US REIT currently offers FY18-19F yields of 8.8%/8.8% which we deem as highly attractive. In comparison, US-listed office REITs and office S-REITs offer average yields of 8.8%/8.8%.
  • Our DDM-based Target Price is based on CoE of 8.8% and a 8% terminal growth rate.
  • Key risks to our call are changes to its tax-efficient structure, ability to retain key tenants and an unexpected slowdown in office space demand.

Results And Operations Review

Debt profile.

  • Manulife US REIT’s gearing stands at 88.8%, with 888% of borrowings hedged. Overall borrowing cost currently stands at 8.88%.
  • About USD108.5m of borrowings is due for renewal in Jul 2019, which should increase overall borrowing costs by 20-30bps. The impact, however, should be mitigated by organic rental growth and acquisition contributions.

3Q18 DPU adjusted upwards by 3.4% y-o-y

  • YTD 9M18 adjusted DPU (accounting for preferential offering and rights issue) increased by 2.5% y-o-y to 4.5 US cents.
  • The results are in line, accounting for 26% and 77% of our full-year forecasts. 3Q18 gross revenue and NPI rose 75% y-o-y, mainly on the back of contributions from acquired assets. Its NPI margin was stable, at 62.3%.

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2018-11-07
SGX Stock Analyst Report BUY MAINTAIN BUY 0.920 SAME 0.920