Keppel REIT - RHB Invest 2019-04-18: Unattractive Despite Office Momentum

KEPPEL REIT (SGX:K71U)

Keppel REIT - Unattractive Despite Office Momentum

Maintain NEUTRAL with new Target Price of SGD1.12 from SGD1.06, 10% downside. Our Target Price is still at low end of consensus.
Keppel REIT's 1Q19 results met. While office rent reversions came in strongly at +14%, earnings outlook remains weak due to absence of rental support, tenant movement at its properties, and divestment of OFC.
Keppel REIT's share price however remains supported by share buyback, and strong fund flows into the REITs sector. We lower our COE assumptions by 30bps to 7.2%, resulting in higher Target Price.

KEPPEL REIT (SGX:K71U)’s gearing has come down to 35.7% with the recent divestment of 20% stake in Ocean Financial Centre (OFC) giving it ~SGD0.5bn debt headroom for acquisitions (assuming 40% gearing).
Management noted that it is exploring new markets like South Korea and Japan in addition to its existing markets of Australia and Singapore, but will mainly target Grade-A CBD properties.
Keppel REIT also recently issued its maiden SGD200m in convertible bonds to boost funding options and lower funding costs.

About 136,400 sqf (attributable ~57,100 sqf) of leases were signed during the quarter with 50% of them being new leases. New leases mainly came from technology, media and telecommunications, and banking sectors.
Management noted that rent reversions came in strongly at +14%, with Marina Bay Financial Centre Tower-3 (MBFC-3) being the key contributor for positive growth. Looking ahead, management guided for rent reversion at high single digits.

With distribution of SGD2.7m rental support income in 1Q19, Keppel REIT has no further rental support income left.
Management plans to offset some of the near-term drop in income via higher capital distribution (it has an estimated SGD108m of capital gains available from past divestment gains).

UBS, one of the key tenants at One Raffles Quay (ORQ) occupying ~230,000 sqf, recently announced that it will be vacating the space post its lease expiry at end-2020.
With the current strong momentum in the office leasing market, management expects strong demand for the space, but noted that there could be potential earnings impact of c.3-9 month during the fit-in period of the new tenant.

Construction of 311 Spencer Street (311 SS, 50% stake) is on track for completion by 1H20 with earnings contributions kicking in immediately post completion. Keppel REIT has about AUD113m in progress payments that are still pending.

Keppel REIT's 1Q19 Revenue and NPI (100% basis) were marginally higher y-o-y, boosted to higher other income of SGD3m (1Q18: SGD0.7m). Other income was boosted by one-off income (compensation from early lease terminations and others) of SGD2.4m during the quarter. Rental support income was also higher 25% y-o-y at SGD2.7m.
Management also paid out SGD3m in capital distribution for the quarter to offset the impact of loss in income from divestment of the OFC stake. Overall, 1Q19 DPU came in-line accounting for 25% of our estimates.

Keppel REIT received commitments to refinance the remaining loans (~SGD211m post repayments and convertible bond issuance). All in, finance costs are expected to remain around current levels of 2.88% pa. 91% of debt is currently in fixed terms.

Weighted average lease expiry (WALE) stood at ~5.7 years. Tenant retention rate for the quarter was 69%.

Since commencing in Jul 2018, Keppel REIT has bought back 34m shares in 2018, below book value (in the SGD1.10-1.20 price range), which have been cancelled.
Management sees share buyback as a good tool to bridge the share price discount to its NAV. Management plans to get a fresh buyback mandate in the upcoming AGM, which should allow it to buy back up to 1.5% of outstanding shares over six months.

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2019-04-18

SGX Stock Analyst Report NEUTRAL MAINTAIN NEUTRAL 1.12 UP 1.060