Keppel REIT - DBS Research 2019-04-18: Positioned To Score Goals

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KEPPEL REIT (SGX:K71U)

Keppel REIT - Positioned To Score Goals

• Keppel REIT's 1Q19 DPU of 1.39 Scts (-2% y-o-y) in line with expectations. 
• 14% positive rental reversion bodes well for expected upturn in DPU going forward. 
• c.S$500m debt headroom provides upside risk to DPU estimates. 

Positioned to score goals

• Leveraged to office upturn. We maintain our BUY call on Keppel REIT (SGX:K71U) with a revised Target Price of S$1.38. Keppel REIT’s share price typically leads a recovery in spot office rents by 6-12 months.
• According to CBRE, Grade A CBD rents had risen by another 3% q-o-q to S$11.15 psf/mth by end-1Q19, and is 25% higher from the low of S$8.95 psf/mth in 1H17. Thus, we believe office rents are on a sustained upturn and the share price rally which started in late 2018 should continue.

Where we differ –Discount to book unjustified.

• Consensus has a HOLD rating with a Target Price that implies Keppel REIT should trade at a discount to its book value. However, with FY18 likely to mark a cyclical low in Keppel REIT’s DPU, we are more forward looking and focus on growth in DPU from 2019 onwards which would be the first y-o-y increase in DPU in over five years with additional upside from potential deployment of c.S$500m debt headroom.
• In addition, with management conducting a share buyback over the last few months, the first S-REIT to do so, this sends a strong signal that Keppel REIT is significantly undervalued, considering several office buildings in less prime locations have been sold at a cap rate of between 1.7-3.2%, below the 3.60-3.65% used to value Keppel REIT’s best-in-class Grade A buildings in Singapore.

Recovery in DPU and positive rental reversions.

• We believe the expected recovery in DPU and delivery of positive rental reversions on the back of higher spot rents would be catalysts to narrow the discount to Keppel REIT’s book value of c.S$1.38.

Valuation:

• After lowering our cost of debt assumption to 3.25% from 3.50%, we raised our DCF-based Target Price to S$1.38 from S$1.31.

Key Risks to Our View:

• Key risks to our positive view are weaker-than-expected rents sing DPU to come in below expectations.

WHAT’S NEW - Well positioned

1Q19 DPU down 2% y-o-y

• As expected 1Q19 DPU fell 2% y-o-y to 1.39 Scts largely on the back of loss of income from the sale of a 20% stake in Ocean Financial Centre (OFC) in 2018.
• Stripping out the S$3m worth of capital distribution, underlying 1Q19 DPU would have come in at 1.30 Scts (down 9% y-o-y) which represented c.25% of our FY19F underlying DPU, in line with our expectations.
• Beyond the impact from the disposal of a partial stake in OFC, underlying DPU was also impacted by the depreciation of the AUD, albeit in constant currency terms, the Australian portfolio reported an increase in earnings. The softer headline results was also tempered by c.S$2.4m from one-off pre-termination income received over the quarter and impact from prior quarters’ positive rental reversions.
• 1Q19 revenue and NPI were up 1% and flat y-o-y to S$40m and S$31.3m respectively, largely due to c.S$2.4m worth of one-off pre-termination income received. Adjusting for the minority interest in OFC, 1Q19 NPI would have fallen 13% y-o-y.
• Overall portfolio occupancy remains high at 98.7%, a slight uptick from 98.4% at end-2018. Nevertheless, this is still down from 99.4% achieved in 1Q18, on the back of loss of tenant at ORQ in the middle of last year.

14% positive rental reversions

• Over the quarter, Keppel REIT achieved signing rents of c.S$12.03 psf/mth (up from S$11.10 psf/mth for whole of FY18) and 14.4% rental reversions largely driven by leases at MBFC.
• Going forward, Keppel REIT does not expect to sustain such high rental reversions but may deliver high single or low double digit rental reversions on the back of rising spot rents.
• For the remainder of FY19 and FY20, only 3.2% and 8.9% of leases by committed attributable gross rent are up for renewal with another 0.4% and 3.2% of leases subject to rent reviews in FY19 and FY20.

Dip in gearing

• Gearing fell to 35.7% from 36.3% in the previous quarter as Keppel REIT repaid some loans through working capital optimisation and part of the proceeds from the sale of a 20% interest in OFC.
• Average interest cost inched up to 2.88% from 2.81% while the fixed proportion of debt rose to 91% from 85%.
• Post balance date, Keppel REIT issued S$200m worth of 5- year convertible bonds (CBs) with coupon at 1.9%. This additional source of funds should realise interest savings of between S$1.5-2.0m compared to the use of conventional bank borrowings.
• On the back of higher shares in issue, NAV per unit fell slightly to S$1.38 from S$1.40 at end 4Q18.

UBS exit from One Raffles Quay not as bad as it seems

• UBS is expected to vacate c.230k sqft of space at One Raffles Quay (OPQ) which is approximately c.17% of the building at the end of 2020, when it moves to 9 Penang Road.
• With sufficient lead time and a rising office market, Keppel REIT is confident of backfilling the vacant space. Thus far, it has received interest from potential tenants.
• In addition, Keppel REIT is hopeful of achieving positive rental reversions when it signs new tenants for the space vacated by UBS.
• However, we understand there may be some impact to cashflows in 1H21 as a fit-out period or rent free period may need to be offered to prospective tenants.

Pricing in more dovish interest rate outlook resulting in higher Target Price of S$1.38

• As compared to earlier projections where our DBS economists were projecting the Federal Reserve to increase interest rates by four times in 2019 and an increase in the 10-year bond yield, they now assume no rate hikes and a flattish yield curve.
• Thus, we have assumed 3.25% cost of debt versus 3.50% previously which leads us to raise our DCF-based Target Price to S$1.38 from S$1.31 previously. Our Target Price implies a P/Bk of 1.0x which we believe is fair considering we are in the midst of an upturn in the office rents.
• Likewise, we have reduced our borrowing costs assumptions by 5-20bps which translates to 1-2% 9-21F DPU.

Potentially utilising c.S$500m debt headroom

• Going forward, assuming gearing increases to 40%, we understand Keppel REIT has c.$500m worth of debt headroom (including S$200m worth of CBs).
• We understand Keppel REIT is exploring acquisition opportunities in Singapore and Australia and potentially Korea and Japan.
• While Keppel REIT’s share price has rallied significantly year to date, management is reluctant to raise equity to fund acquisitions as the stock continues to trade below book value.

Maintain BUY

• With 1Q19 results in line with expectations, we maintain our BUY call, while raising our Target Price to S$1.38. 
• Given upside risk to our DPU estimates from the potential deployment of its strong balance sheet and combined with the expected multi-year upturn in Singapore office rents, we retain our positive outlook for the stock.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2019-04-18

SGX Stock Analyst Report BUY MAINTAIN BUY 1.38 UP 1.310