CapitaLand Group - DBS Research 2020-01-23: A Whole New World


CapitaLand Group - A Whole New World

Aiming for the global stage - Merger of CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT)

  • In the theme where “big is better” CapitaLand (SGX:C31)-managed CapitaLand Mall Trust (SGX:C38U) and CapitaLand Commercial Trust (SGX:C61U) are proposing to merge to form a REIT behemoth - CapitaLand Integrated Commercial Trust (CICT) - with a combined market cap of c.S$16.8bn and an AUM of c.S$23bn.
  • The combined entity will the third largest REIT in the Asia Pacific region and comprises of a diversified portfolio of integrated developments, office and retail properties. A bigger platform, CICT will be empowered with greater financial capacity and better ability to compete globally to take on bigger projects and/or redevelopments to drive shareholders.
  • Together with its other behemoth REITs (Ascendas REIT (SGX:A17U)) and Ascott Residence Trust (SGX:HMN), the group will manage the top 5 listed REITs in Singapore with a mandate to acquire and grow globally.

Merger metrics:

Rationale & Our View:

Big is better but will cost of capital compress?

  • While CapitaLand Mall Trust and CapitaLand Commercial Trust are successful vehicles in their own right, we believe this double combination is akin to a double leap for both REITs onto the global stage. Post deal, CapitaLand Integrated Commercial Trust (CICT) will be the third largest REIT in the Asia Pacific region, behind Link REIT (823 HK) at 0.9x P/NAV and 3.5% yield, which we believe be the longer term target for CICT to achieve in the longer term.
  • While investors may feel uncertain if the combined CICT will trade at a more conducive cost of capital than current, we believe the key is the REIT’s next deal to drive further growth to take valuations higher.

A leap in terms of scale and operational efficiency.

  • The combined REIT with be another real estate behemoth within the CapitaLand group of REITs with a diversified exposure across office, retail and integrated developments. With scale, there is ability to achieve operational efficiencies as the combined REIT will be able to manage cost collectively.
  • The fee structure will be a combination of the fees charged by the two entities (CapitaLand Commercial Trust and CapitaLand Mall Trust properties will maintain their current fee structure) with newly acquired properties following CapitaLand Mall Trust’s fee structure.
  • The merged entity will also see a reduction in single asset concentration risk with the top 5 assets decreasing to c.43% post-merger.

Ability to leverage on larger scale opportunities.

  • The larger portfolio will have an even split between office, retail and integrated developments, which we believe will enable the REIT to gain resilience across various market and business cycles, thus de-linking the cyclicality of its income to economic changes.

Increased capacity to acquire and grow.

  • With a post deal gearing of c.38%, CapitaLand Integrated Commercial Trust (CICT) will have a debt funded capacity of up to S$2.9bn (to 45% gearing ratio) and most importantly, significantly higher development limit of S$2.4bn (10% of combined S$24bn AUM) and an additional S$3.6bn (+15% limit) to undertake AEIs/redevelopment. This will enable CICT to act swiftly to undertake third party opportunities which may not be available to the respective REITs on their own.
  • Of note is that post combination, CICT will have the capacity to take on “trophy” properties like ION Orchard (50% stake at S$1.6bn-S$1.7bn) or Jewel in the longer term.

Overseas expansion offers upside.

  • CapitaLand Integrated Commercial Trust (CICT) aims to be pre-dominantly Singapore focused in the future with overseas properties taking up to c.20% of its assets. Based on merged asset value of S$22.9bn and Germany (CapitaLand Commercial Trust’s assets) comprising only c.4% of the expanded AUM, there is a potential acquisition capacity of S$4.6bn in developed markets.

CapitaLand Commercial Trust 4Q19 Results Commentary:

4Q19 DPU of 2.28 Scts, +2.7% y-o-y.

  • CapitaLand Commercial Trust's 4Q19 DPU was higher y-o-y at 2.28 Scts. This takes FY19 DPU to 8.88 Scts (+2.1%), in line with expectations.
  • FY19 revenue and NPI were also up 4.7% and 2.1% y-o-y on the back of higher rental from 21 Collyer Quay, Capital Tower and Asia Square Tower 2 (AST2), coupled with acquisitions of Gallileo and Main Airport Centre (MAC). This more than offset the decline in revenues at Six Battery Road and Bugis Village.
  • Overall portfolio occupancy remains healthy at 98.6%, an improvement from the 97.9% (3Q19). The improvement mainly came from Raffles City (98.1% in 4Q19 vs 97.9% in 3Q19) and Asia Square Tower 2 (95.4% vs 94.0% in 3Q19).

Positive rental reversions

  • On the back of higher spot market rents (+1% q-o-q to S$11.55psf) over the quarter, signing rents were 11-20% higher (mid-point of disclosed signing rent range) than disclosed expiring rents. This should translate to higher income in the coming quarters. We note that there was a negative 7.4% negative rental reversion at Asia Square Tower 2, which we understand to mainly come from the expiry of a tenant with a larger floor plate.

Higher gearing due to acquisition of Main Airport Centre and development of CapitaSpring; borrowing cost flat q-o-q

  • Gearing remained stable at 35.1% post acquisition of Main Airport Centre and drawdown of debt for the development of CapitaSpring.
  • Average cost of debt was flat q-o-q at 2.4% (2.6% at end 4Q18). Meanwhile, c.91% on CapitaLand Commercial Trust’s borrowings remain on fixed rates.
  • NAV per unit was S$1.82 (ex-distributions). The REIT also reported a marginal uplift in asset valuations driven by a mix of stronger cashflows and a slight 5 bps compression in cap rates in Dec-19 vs Jun-19.

CapitaSpring pre-committed occupancy up at 34% from 31%

Merger with CapitaLand Mall Trust:

  • On a pro-forma basis, the deal is estimated to be 6.5% accretive to unitholders of CapitaLand Commercial Trust.
  • While investors may initially balk at CapitaLand Commercial Trust losing its “office proxy” status, given that the office cycle is nearing maturity, our view is that the implied pricing at S$2.1238 (at 1.16x P/NAV) is a decent price to crystallise the investment. This is based on a +1 SD of CapitaLand Commercial Trust’s 10-year P/NAV range.
  • Investors will be able to continue to partake in the longer term growth in CICT, albeit in a more measured growth profile.
  • The more diversified earnings base with lower concentration risk (in terms of tenants/buildings) is a positive trait for investors.
  • CapitaLand Commercial Trust trades at 4.6% yield and at 1.16x P/NAV.
  • Impact on CapitaLand Commercial Trust: BUY, Target Price of S$2.30 but adjusted to S$2.42 based on 0.82x of our Target Price of S$2.95 for CapitaLand Mall Trust.

CapitaLand Mall Trust 4Q19 Results Commentary:

DPU exceeded our forecast; Partial cushioning from the release of retained income.

  • Gross revenue and NPI for 4QFY19 was S$203.4m and S$140.7m, representing 12.7% and 13.1% increase on a y-o-y basis respectively.
  • The increase in revenue and NPI was due to incremental contributions from Westgate and the relaunch of Funan on 1 November 2018 and 28 June 2019 respectively.
  • This was partly offset by lower contributions from Lot One, as the movie theatre within the mall underwent rejuvenation works.
  • Distribution income and DPU reported for full year 2019 came in at S$441.6m and 11.97 Scts respectively representing a 7.5% and 4.1% increase on a y-o-y basis.
  • Distributable income was marginally below our FY19 estimate of S$451.4m while DPU exceeded our forecast at 11.74 Scts.
  • The higher DPU was partly cushioned by a S$7.7m release of taxable income that was previously retained in 1H19. The remaining S$1.5m of retained taxable income was previously released in 3Q19.

Flattish rental reversions for FY19.

  • Overall portfolio rental reversion was +0.8% for full year FY19. While most of the malls registered positive rental reversions in the range of 1% - 2%, The Atrium@Orchard was an anomaly with a rental reversion of -6.5%.
  • Management shared that the retail space that was vacated by a tenant in the finance industry was re-leased to a lifestyle tenant.
  • Removing the effect of this particular lease, the asset would have instead registered a positive 1% rental reversion, which would represent an overall portfolio reversion of 1.1%
  • Occupancy cost inched down 20bps to 18.2% in FY19 from 18.4% in FY18.

Portfolio metrices remained largely stable.

  • High occupancy was maintained in 4Q19 at 99.3% (3Q19: 99.2%), with notable improvements in Clarke Quay and the stabilisation of Funan mall at 99% as at end FY19.
  • Shopper traffic increased 1.4% y-o-y while tenant sales ecreased 1.4% y-o-y.
  • Plaza Singapura, Funan and Tampines Mall registered the highest valuation gains this round at S$39m, S$24m and S$20m respectively. Funan’s office component was revalued at a tighter cap rate of 3.9% as compared to 4.0% as at end 1H19, a similar trend to the offices in Raffles City Singapore which saw cap rate narrow 5 bps to 3.95%. Retail cap rates remained status quo across all assets during this round of revaluation.
  • Overall portfolio registered a 13.2% valuation gain in 2H19, or S$149m in revaluation gains.
  • Weighted average expiry by GRI stood at 2.1 years, with 21.3% of leases by GRI expiring in FY20.
  • Aggregate leverage improved from 34.4% to 32.9% in the past one quarter while average cost of debt remained the same at 3.2%.

A marriage between two titans; Proposed merger with CapitaLand Commercial Trust

Indexation – who is next?

Derek TAN DBS Group Research | Rachel TAN DBS Research | Singapore Research Team DBS Research | 2020-01-23
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