Frasers Tower - DBS Research 2019-04-08: Whose Hands Will It Land On?


Frasers Tower - Whose Hands Will It Land On?

  • Frasers Property Limited reportedly looking to sell Frasers Tower, a quality future-ready office asset which we believe can hold its value over time
  • A successful sale would result in a significant gain for the group
  • While Frasers Commercial Trust may be among the interested parties, with the property being a positive upgrade to its portfolio, a deal is unlikely to be accretive

1. Frasers Property Limited (FPL) could reap significant profits from sale of Frasers Tower

Frasers Tower on Cecil Street reportedly on the market for close to S$2bn (c.S$3,000 psf), if done, could drive S$0.17- 0.20 upside to earnings/NAV.

  • FRASERS PROPERTY LIMITED (SGX:TQ5) is reportedly talking to several interested parties on the potential sale of Frasers Tower on Cecil Street, a recently completed office building with premium Grade A specifications.
  • The reported price is close to S$3,000 sqft for the 685,000-sqft NLA tower (663,000-sqft office, 22,000- sqft ancillary retail) implying a total sale price of close to S$2.05bn.
  • Frasers Property acquired the site back in 2013 in a government land sale (GLS) for S$924m or S$1,112 psf per plot ratio for the 99-year leasehold site and awarded the construction contract to Hyundai Engineering for S$287m. We estimate total construction cost (including interest) to be close to S$1.3-1.4bn.
  • Assuming a sale of the building at S$2.05bn, this implies a net gain (after tax) of S$500-580m or a positive impact of S$0.17-0.20/share to earnings for Frasers Property.
  • We also envision that over time, the RNAV-to-NAV gap will narrow as the group continues to realise value of its investment properties in its books through strategic sale or injection to its managed REITs.
  • The sale will also enable the group to realise its value on the balance sheet and drive ROE towards 10%, which we believe will be a re-rating catalyst for the stock, albeit being a one-off occurrence.

What are the returns for the buyer?

  • The potential buyer of Frasers Tower is acquiring a quality office asset with strong property attributes compared to recently completed properties in the vicinity of Cecil Street (e.g. SBF Centre and Oxley Towers, which are mainly offices built for strata sale).
  • In our opinion, Frasers Tower is built to BCA Green Platinum specifications with a well-thought-out design (end-of-trip facilities, greenery across the building) which we believe encapsulates the attributes of a modern and “future-ready” office property.
  • With most of the leases signed towards the beginning of last year, based on our estimates, at 93% occupancy and at S$10 psf rent, the initial yield of Frasers Tower is estimated to be close to c.3.2-3.4% (at 100% occupancy).
  • However, the reversionary yield (after one office cycle) could be closer to 4.4-4.7%, assuming that the market rents reach S$13-14 psf for offices in the longer term.

2. But is Frasers Commercial Trust (FCOT) ready for Frasers Tower?

Double down in Singapore office sector (at the right time) + Achieving a portfolio Upgrade = Double Happiness (双喜) for FCOT.

  • While we do not rule out FRASERS COMMERCIAL TRUST (SGX:ND8U) from being among the interested parties (as the REIT has a rights of first refusal for the property), we acknowledge that Frasers Tower, in its entirety as S$2.0bn, will be considered too large for Frasers Commercial Trust to stomach at one go.
  • To mitigate the impact of a potentially large acquisition, we believe that Frasers Commercial Trust might look to take a partial stake in Frasers Tower in an aim to gradually build up its AUM and market cap.
  • Based on our estimates, assuming that Frasers Commercial Trust acquires Frasers Tower (a 50-100% stake), this will result in Frasers Commercial Trust having a heavier weighting to Singapore, which will change from 54% currently (in value) as of end- December 2019 to 60-76% (at an assumed 50-100% stake of Frasers Tower).
  • We see the acquisition to be double positive for the longer term. The portfolio will see an upgrade in quality as it grows beyond a portfolio of Singapore assets that are located closer to the fringe of the Central Business District (CBD) to one that enables the REIT to directly leverage on the expected upward trajectory in office rents over 2019-2021 given the lack of new office supply.
  • If Frasers Commercial Trust does decide to acquire, the key is to win sufficient support from investors and its sponsor that the deal will likely be marginally accretive or dilutive to Frasers Commercial Trust which is trading at a fairly high cost of equity of 6.5%.
  • The group (both Frasers Property and Frasers Commercial Trust) will have to weigh between the ability to generate a fairly significant near-term gain (if it is a third-party sale) or one that is more strategic in nature, which involves nurturing Frasers Commercial Trust and putting the REIT on a path of growth.

Will FCOT's yield gap to peers compress as its portfolio improves in quality?

  • Based on our analysis, Frasers Commercial Trust currently trades at a yield of c.6.5%, which implies a close to 1.6% spread against the larger-cap office REITs, which has widened in recent times given
    1. uncertainty coming from the loss of major tenant – HP at Alexandra Technopark, and
    2. volatility of the SGD-AUD exchange rate from its Australian-based assets (c.39% of assets).
  • With Frasers Tower, we believe that there is opportunity to close the gap given the improvement in portfolio quality, coupled with a bigger proportion of Grade A office properties in its portfolio compared to before.
  • Looking at SPH REIT (SGX:SK6U) as an example, where it derives a significant portion of its income from Paragon (76% of income), the stock trades at a -0.2% spread, tighter than more established retail peers in the retail space. We believe such an opportunity would present itself for Frasers Commercial Trust if it does decide to bite the bullet and take on Frasers Tower.
  • Only time will tell where the overall strategy will head.

Derek TAN DBS Group Research | Mervin SONG CFA DBS Research | Carmen TAY DBS Research | https://www.dbsvickers.com/ 2019-04-08
SGX Stock Analyst Report BUY MAINTAIN BUY 1.980 SAME 1.980