CapitaLand Commercial Trust - DBS Research 2019-07-04: Premium Justified

SGinvestors.io

CAPITALAND COMMERCIAL TRUST (SGX:C61U)

CapitaLand Commercial Trust - Premium Justified

• 1-3% upside to FY20-21F DPU on the back of an assumed $500m European acquisition on 4.5% NPI yield and S$200m equity raising.
• BUY; Target Price lifted to S$2.40 on the back of higher earnings and lower risk-free rate and cost of debt.
• Lower interest rates for longer and strong DPU growth to underpin tighter yields and CapitaLand Commercial Trust’s share price.

Rally to continue.

• We keep our BUY call on CAPITALAND COMMERCIAL TRUST (SGX:C61U) with a revised Target Price of S$2.40.
• We believe CapitaLand Commercial Trust is poised to benefit from an expected multi-year upturn in office rents in Singapore on limited supply. The company’s expansion into Europe also provides another growth avenue which we believe the market has not fully appreciated. These factors in our view should sustain the continued rally in CapitaLand Commercial Trust.

Where we differ: Deserves to trade up to 1.3x P/Bk.

• We believe CapitaLand Commercial Trust should trade up to 1.3x P/Bk, on the back of
  1. a multi-year upcycle in office rents, and
  2. CapitaLand Commercial Trust showing the conservative valuation of its properties via the sale of three office buildings at 14-39% premiums to book over the past two years.
• Its book value remains understated with buildings such as Capital Tower and 999-year leasehold 21 Collyer Quay priced at S$1,847 psf and S$2,275 psf respectively, a discount to the S$2,400-2,700 psf for comparable buildings sold recently. Furthermore, with interest rates expected to stay lower for longer, CapitaLand Commercial Trust’s premium to book is justified as investors hunt for yield instruments with growth. CapitaLand Commercial Trust has a projected 3-year DPU CAGR of 6%.

A myriad of growth opportunities.

• While Singapore office rents are up c.25% from the lows in 1H17, we believe recovery remains on track given the current supply squeeze. With c.30% of leases up for renewal in 2020-2021, CapitaLand Commercial Trust is leveraged to higher rents ahead.
• Deploying its lowly geared balance sheet of c.35% would also act as a catalyst for the stock. To that end, we have penciled in a S$500m acquisition in Europe in FY20.

Valuation:

• After incorporating our assumption of S$500m acquisition and imputing a lower risk-free rate and cost of debt, we raised our DCF-based Target Price to S$2.40 from S$2.10 previously.

WHAT’S NEW - Underpinned by lower interest rates for longer

Pricing in lower interest rates for longer, and utilising its strong balance sheet

• The market is expecting 2-3 rate cuts by the US Federal Reserve in 2H19 which our DBS economist views as an insurance policy against potential slowing economic growth due to the recent trade tensions.
• To better reflect an environment where interest rates should stay lower for longer, we have cut our risk-free rate assumption to 2.5% from 3.0% and target cost of debt to 3.0% from 3.25% previously. We do not believe CapitaLand Commercial Trust’s borrowing costs will fall by 50-75bps as per the cut in the Fed Funds rate as we anticipate CapitaLand Commercial Trust may decide to use a lower yield curve to extend its debt maturity from 3.6 years as at 31 March 2019.
• Furthermore, given CapitaLand Commercial Trust’s strong balance sheet, lower cost of debt in Europe, tight yields for Singapore office assets and wide asset yield spreads (difference between asset yield and borrowing costs), we anticipate CapitaLand Commercial Trust will look to grow its European portfolio in FY20. Thus, we have penciled in a S$500m acquisition on an 4.5% NPI yield, partially funded with a S$200m equity raising at S$2.00 per share. This, combined with lower borrowing costs, results in 1-3% increase in our FY20-21F DPU.
• Likewise, we have raised our DCF-Target Price to S$2.40 from S$2.10.
• We believe given the strong outlook for Singapore rents, healthy 3-year DPU CAGR of 6% and more importantly cap rates likely to stay tight for longer in Singapore, CapitaLand Commercial Trust deserves to trade at a premium valuation, up to 1.3x P/Bk versus our previous expectations of 1.15x P/Bk.
• With expectations that news flow should remain positive as CapitaLand Commercial Trust reports stronger rental reversions over the next few quarters, we reiterate our BUY call with a revised Target Price of S$2.40

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2019-07-04

SGX Stock Analyst Report BUY MAINTAIN BUY 2.40 UP 2.100