SPH REIT - DBS Research 2019-10-11: Dominant Malls Continue To Shine

SPH REIT (SGX:SK6U)

SPH REIT - Dominant Malls Continue To Shine

Strong operating metrics in Singapore portfolio drive results to achieve another new high.
Healthy reversions and tenant sales imply sustainable organic growth.
Pricing in S$500m of acquisitions in our estimates.
BUY, Target Price raised to S$1.25.

SPH REIT (SGX:SK6U) continues to trade in a “sweet spot” and with S$300m proceeds from perpetual securities, we believe deployment of these funds is imminent. We raise our acquisition assumption to S$500m (vs S$200m previously) and raise our Target Price to S$1.25, implying 12% upside.

Consensus is generally cautious on the retail sub-sector, especially in the Orchard area. However, we believe that with limited upcoming retail supply in the Orchard submarket and the REIT’s well-executed strategies leading to a turnaround at Paragon, the portfolio should be able to face challenges and stand the test of time.
SPH REIT’s low gearing of 27.5% and potential deployment of proceeds into a new acquisition could drive DPUs higher.

SPH REIT’s growth momentum continued into 4Q19, both organically and inorganically. For the full year, gross revenue and net property income (NPI) jumped 7.9% and 8.3% y-o-y respectively, mainly on contributions from Figtree Grove (Sydney) and full year contribution from Rail Mall. On an organic basis, growth would have been closer to c. 1%.
In 4Q19, gross revenues and NPI grew by c.10% and c.12% respectively on the back of acquisitions. For the year, DPU was c.0.6% y-o-y higher at 5.6 Scts, in line with our estimates. See SPH REIT's dividend history.

Portfolio valuation improved on the back of higher cashflows and a 25-bp compression in cap rates for Seletar Mall from 4.75% to 4.5%. Valuers had marked down cap rates due to the recent tight compression seen for retail assets. Paragon’s cap rates remained stable at 4.5% (retail) and 3.75% (medical suites/office) while that for Figtree Grove and Rail Mall remained flat y-o-y at 6.0%.
Gearing dropped to 27.5% (vs c.31% in 3Q19) mainly on the back of stronger valuations, and the recent issuance of S$300m perpetual securities which was accounted as equity on the balance sheet.

Portfolio occupancy remained high at 99.1%. Similar to the previous quarter, portfolio rental reversion remained stable at 8.4% (+11.9% in FY18) on the back of healthy leasing momentum. This was mainly anchored by Paragon, which represented the bulk of renewals in FY19, delivering positive reversion of c.9.7% (9M19 of 8.6%), an improvement q-o-q. The Rail Mall also surprised with positive reversion of c.9.4% (vs 9.1% for 9M19), mainly on renewals. Clementi Mall’s reversion was stable at 5.0%. Figtree Grove reported negative rental reversion of 2.7% for FY19, but the overall impact is marginal.
SPH REIT continues to see strong operational trends across its malls. Paragon reported a steady increase in visitor traffic to 19m (vs 18.8m a year ago) and improved sales conversion with tenant sales rising 2.2% y-o-y to S$708m. Clementi Mall also saw a 3.0% rise in tenant sales to S$237m on flattish traffic while Figtree saw a slight improvement in sales to A$187m, a 2.2% rise y-o-y.
Overall occupancy costs improved y-o-y on the back of stronger tenant sales performance.

SPH REIT has pre-emptively raised S$300m in NC5 perpetual securities @ 4.1% coupon, priced at a tighter rate given strong demand from investors. With capacity on its balance sheet and guidance that the manager is in exclusive due diligence for a potential acquisition, we believe that an acquisition is on the horizon.
With interest rates set to remain lower for longer and the REIT’s conservative gearing of c.27.5% (vs 35% for S-REITs on average), the time is ripe for SPH REIT to get into acquisition mode. We have priced in S$500m (A$540m) acquisitions at 5.0% yield to be funded by perpetual securities and debt. With the timeline for Seletar Mall still uncertain on the back of ownership changes at United Engineers, which holds a 30% stake in the mall, the focus will likely remain in Australia for now.

Derek TAN DBS Group Research | Rachel TAN DBS Research | https://www.dbsvickers.com/ 2019-10-11

SGX Stock Analyst Report BUY MAINTAIN BUY 1.25 UP 1.200