KEPPEL-KBS US REIT (SGX:CMOU)
Keppel KBS US REIT - Your Faith Will Be Rewarded
- Keppel-KBS US REIT’s 4Q18 DPU of 1.25 UScts and CY18 DPU of 5.23 UScts in line with expectations.
- Low double-digit rental reversions and upturn in spot office rents to drive future earnings.
- Expect 14% y-o-y growth in CY19 DPU owing to full-year contribution of announced acquisitions.
Catch the next wave.
- We maintain our BUY call and a revised Target Price of US$0.80 for KEPPEL-KBS US REIT (SGX:CMOU).
- We continue to believe that Keppel-KBS US REIT offers investors the opportunity to catch the next leg of the US office market upturn.
- Keppel-KBS US REIT’s 13 freehold office assets are located in seven key regional markets in the US which are seeing positive dynamics. These markets should also benefit from tenants seeking cheaper rents and the flow of capital as investors pursue markets where asset prices have yet to rally as much as some gateway cities. This thesis has been borne out with Keppel-KBS US REIT exceeding its IPO forecast (excluding the impact of the rights issue) since its listing a year ago.
Where We Differ: Concerns priced in.
- Despite the recent rally over the past month, Keppel-KBS US REIT’s share price remains depressed compared to its IPO price, due to the disappointment over having a rights issue so soon after its listing, potential for another US office REITs listing and concerns over a negative ruling on its tax structure. However, we believe the majority of these concerns have also been priced in given Keppel-KBS US REIT now trades at c.9% forward yield, c.15% discount to book value during a period when rents are still on an upswing and favourable provisional tax regulations being introduced in December.
Delivering strong results.
- The correction in Keppel-KBS US REIT’s share price in 2018 has cast doubts over the quality and ability of Keppel-KBS US REIT’s portfolio to perform. Thus, we believe as Keppel-KBS US REIT demonstrates the value created from its recent acquisitions, investors’ concerns should be allayed, resulting in a re-rating of the stock.
Valuation:
- After adjusting for a lower-than-expected debt balance at end- FY18, we raised our DCF-based Target Price to US$0.80 from US$0.78.
Key Risks to Our View:
- The key risk to our view is lower-than-expected rental income arising from loss of tenants or slower upturn in spot office rents, and changes to tax regulations in the US.
WHAT’S NEW - Meeting expectations
CY18 DPU of 5.23 UScts in line with expectations
- Keppel-KBS US REIT reported a 4Q18 DPU of 1.25 UScts and will pay a 2H18 DPU of 2.4 UScts (ex dividend date of 31 January 2019).
- After using the rights adjustment factor for CY18, Keppel-KBS US REIT delivered a DPU of 5.23 UScts which is in line with our forecast of 5.21 UScts.
- For the period since its listing on 9 November 2017 to 31 December 2018, Keppel-KBS US REIT delivered a DPU of 6.01 UScts after applying the rights adjustment factor.
- Excluding the impact from the recent US$93.1m rights issue and acquisition of Westpark portfolio on 30 November 2018, we understand DPU based on Keppel-KBS US REIT’s initial portfolio exceeded the original IPO forecasts by c.1%.
Occupancy generally higher than expected
- Over the course of 2018, Keppel-KBS US REIT’s main assets have generally outperformed initial IPO occupancy assumptions.
- Average and year-end committed occupancy for Bellevue Tech Center (c.13% of NPI) stood at 95.9% and 98.1% respectively versus IPO forecasts of 92.3%.
- The Plaza Seattle (c.26% of NPI) achieved average and year-end committed occupancy of 89.4% and 93.4% respectively compared to the original guidance of 81.9%.
- For 1800 West Loop South (c.10% of NPI), while average committed occupancy of 80.9% was higher than the 75.0% IPO forecast, the year-end figure did fall to 75.6%.
- Meanwhile, demand for large-space tenants has been softer than expected, resulting in average and year-end committed occupancy hitting 81.9% and 82.4% respectively, down from IPO forecasts of 86.3%.
- Overall portfolio occupancy remains high at 91.6%, marginally higher than 90.1% at end-3Q18 and 89.8% at end-1Q18.
Strong positive rental reversions
- We understand Keppel-KBS US REIT was able to achieve low double-digit rental reversions over 4Q18, faster than the mid-single-digit rental reversions over the prior few quarters.
- Passing rents for Keppel-KBS US REIT’s properties are generally still 10- 15% below market, Keppel-KBS US REIT should not only continue to report positive rental reversions but more importantly with c.11.7% and 15.6% of leases by cash rental income up for renewal in FY19 and FY20 respectively, we believe Keppel-KBS US REIT is well placed to capture the upturn in spot rents and drive rental income higher.
Modest revaluation gains
- Keppel-KBS US REIT reported c.S$15.3m largely due to the closing of the discount between the purchase price and valuation of Westpark portfolio.
- Despite the revaluation gains, aggregate leverage rose to 35.1% from 33.3% on account of the acquisition of Westpark portfolio.
- Average cost of debt also increased to 3.53% from 3.47% as the debt associated with acquisition of Westpark portfolio was higher than Keppel-KBS US REIT’s initial borrowings at IPO.
- Owing to the impact of the rights issue, NAV per unit fell to US$0.80 from US$0.87 at end-3Q18.
Expect 14% jump in CY19 DPU with Target Price lifted to US$0.80
- Despite Keppel-KBS US REIT’s main assets generally outperforming occupancy expectations, Westmoor Center in our view may take longer to hit 86% committed occupancy in 2019 as originally guided in Keppel-KBS US REIT’s prospectus. Thus, we have lowered our expectations to 83%, slightly higher than the year-end 2018 committed occupancy of 82.4%. The impact from lower earnings from Westmoor is partially offset by reduced interest expenses due to the lower-than-expected year-end debt balance. Thus, we have tweaked our CY19 down by 0.4%.
- However, going into 2019, we expect DPU to jump 14% y-o-y, owing to the upturn in spot rents, prior quarters of rental reversions, the inbuilt 2-3% annual rental escalations and full impact of the recent acquisition of Westpark portfolio and Maitland Promenade I (completed on 17 January 2019).
- Post the 4Q18 results, we have also raised our DCF-based Target Price to US$0.80 from US$0.78 previously, owing to lower-than-expected debt balance at end-2018.
Spot rents still on an upward trajectory
- According to CoStar, spot rents in Keppel-KBS US REIT’s key submarkets are expected to remain on an uptrend, growing by 1.7-7.5% over the coming 12 months.
- However, this is lower than the 1.2-10.4% range previously, as CoStar has moderated its growth assumptions on the back of the potential impact from the US-China trade wars.
Maintain BUY
- With 4Q18 results in line with expectations, we reiterate our BUY call with a revised Target Price of US$0.80.
- We remain bullish on Keppel-KBS US REIT given expectations of a 14% y-o-y jump in CY19 DPU and its attractive valuations. Currently, Keppel-KBS US REIT offers an 8.8% forward yield and trades at a c.15% discount to book. We believe Keppel-KBS US REIT does not deserve to trade at a discount to book as the markets in which its properties are located are on an upturn.
- Furthermore, with the recent provisional US tax regulation indicating that Keppel-KBS US REIT’s existing tax structure is in compliance with the new tax laws enacted in late 2017, we believe the regulatory risk which caused Keppel-KBS US REIT’s share price to correct in late 2018 has diminished significantly.
Mervin SONG CFA
DBS Group Research
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Derek TAN
DBS Research
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https://www.dbsvickers.com/
2019-01-28
SGX Stock
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