SPH REIT - DBS Research 2020-01-13: “Railing” In Another Record

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SPH REIT (SGX:SK6U)

SPH REIT - “Railing” In Another Record

• Maintain BUY, DPU to approach a new high. SPH REIT is starting the year on a roll, posting a 12.8% y-o-y increase in net property income (NPI) for 1Q20, bolstered by the contribution of its Figtree Grove Shopping Centre in Australia.
• The double-digit rental reversions across all its Singapore malls came as a sweet surprise.
• We think that SPH REIT’s acquisition appetite remains strong with a well below average gearing of 30.2% forecasted for FY20.
• Maintain BUY, with a revised target price as we price in the latest deal. See SPH REIT Target Price.

Positive surprise with double-digit rental reversions

Record revenues in 1Q20.

• SPH REIT (SGX:SK6U) reported full year gross revenue and net property income (NPI) of S$60.1m and S$47.0m, a jump of 11.8% and 12.4% y-o-y respectively. This was on the back of better operational performance primarily within SPH REIT’s Singapore portfolio. Dividends declared for 1Q20 was 1.38 Scts, a 3.0% increase y-o-y. See SPH REIT Dividend History.
• The solid set of results this quarter stemmed from organic growth across SPH REIT’s Singapore portfolio. Paragon Mall and The Clementi Mall posted increased NPIs of S$1.8m and S$0.2m y-o-y in the quarter respectively. We expect inorganic growth to flow through starting from 2Q20 as Westfield Marion will post its maiden contributions next quarter after SPH REIT’s acquisition was completed on 6 December 2019.

Positive surprise with double-digit rental reversions.

• Portfolio occupancy remained high at 99.3%, a 20-bp improvement compared to the last reported quarter (99.1%). The Singapore malls registered an occupancy rate of 99.4% while occupancy at Figtree Grove Shopping Centre remained strong at 99.2%.
• Weighted average rental reversions across the Singapore portfolio increased by 10.9%, with all three Singapore malls clocking in double-digit rental reversions.
• Paragon Mall renewed 20 new leases (5.5% of asset net leasable area (NLA)) at a reversion of +10.7%. Several bigger retail spaces in the basement level were carved into smaller lots, unlocking higher rents.
• The Clementi Mall renewed 16 leases (2.5% of asset NLA) at a rental reversion of 10.6%, with more beauty services tenants added to the mix.
• The Rail Mall was a positive surprise this quarter, renewing 8 new leases at reversions of 12.8%. NPI contribution from the mall was flattish in comparison to the same period last year as SPH REIT stepped up on marketing efforts in the asset in order to increase shopper foothold. The Rail Mall has seen more food and beverage (F&B) tenants in its tenancy mix, as well as high retention rates.

Lease renewals on track for FY20.

• A total of 13% of portfolio leases by NLA will be due for renewal in FY20, with a good portion coming from The Clementi Mall and The Rail Mall. A third of leases will be up for renewal in The Clementi Mall and 30% of leases will be up for renewal in The Rail Mall. Given the dominant characteristics of The Clementi Mall and the ongoing rejuvenation at The Rail Mall, management remains optimistic that the current positive metrics can be maintained.
• Only 8% and 9% of leases by NLA will be expiring for Paragon Mall and Figtree Grove Shopping Centre respectively for FY20.

Higher gearing at 30.2% post Westfield Marion.

• Gearing stood at 26.8% as of end 1Q20. We expect gearing to inch up to 30.2% after accounting for the Westfield Marion transaction, which we do not view as an issue. The acquisition was partly funded by S$300m in proceeds from the issuance of perpetual securities and was partly funded by additional debt, which we estimate to be c.S$200m.

Updates on tax rulings in relation to perpetual securities.

• An update from the Inland Revenue Authority of Singapore (IRAS) and Monetary Authority of Singapore (MAS) confirmed that the perpetual securities issued recently will continue to be regarded as “debt securities” in accordance with the Income Tax Act. Correspondingly, the perpetual securities will enjoy tax concessions under this classification.

Acquisition of retail “fortress” in Adelaide

Westfield Marion is a “fortress” in Adelaide.

• SPH REIT announced the acquisition of a 50% stake in Westfield Marion along Diagonal Road, Adelaide for A$670m (c.S$636.5m) from a fund (Australian Prime Property Fund – Retail) which is managed by Lendlease Real Estate. The mall is South Australia’s largest shopping centre spanning c.1.5m sqft across a three-storey retail mall, with five storeys of office space and c.5,270 shopping spaces.
• Westfield Marion is considered a super-regional shopping centre in South Australia given its large operational footprint and wide catchment of c.497,000 residents spread out over 15km. The mall enjoys good visibility and infrastructure, enabling good accessibility to the mall for shoppers. The Marion trade area where the mall is located has favourable metrics with average per capital income and household income higher than Greater Adelaide. Population and spending growth within the total trade area (TTA) is projected to post c.0.8% and 3.6% compound annual growth rate (CAGR) over the next 15 years, which in our view, supports demand for retail space from tenants who want to relocate there.
• In the long term, with supportive government-led initiatives such as the investment into the Australian Space Agency located in Adelaide and A$3.8bn invested in the BioMed City project within the Adelaide Central Business District (CBD) will over time bring more highly skilled jobs to Adelaide. In our view, this points to stronger retail spending power in the long term and offers further upside to Westfield Marion’s performance in the long run.

A “destination” mall with strong catchment and diversified tenancy profile.

• Westfield Marion is located next to Oaklands train station connecting it to Adelaide CBD and has a diversified tenant base anchored by major department stores (David Jones, Myer and Harris Scarfe), supermarkets (Aldi, Coles and Woolworths) and three discount department stores (DDS) – Big W, Kmart and Target and a range of mini-anchors and specialty tenants.
• The mall has a long weighted average lease expiry (WALE) of 4.2 years with a majority of its majors and mini-majors having WALEs in excess of 10.6 years and 3.5 years respectively. We do note that there is close to c.30% of its leases up for renewal in year 1 that is rolling off, where the manager is actively looking to engage tenants to forward renew some of the leases.
• That said, given the mall’s reportedly dominant position within South Australia, we believe that most tenants will likely want to continue to have an operating presence there and the landlords (Scentre and SPH REIT) will likely have the upper hand in any future negotiations. According to Scentre, the total retail spend per capita for the Westfield Marion TTA is estimated at A$13,978 per annum in 2018, which is 3% above the Adelaide Metro average (A$13,534).

Infuses asset and tenant diversity.

• The acquisition of Westfield Marion will further diversify SPH REIT’s income diversity and bring its Australian exposure to 19.7% (vs 5.3% currently). While we remain very comfortable with its key asset Paragon in terms of its income contribution and operational metrics, we believe that this acquisition will further boost growth and earnings visibility as its portfolio’s WALE increases from 3.2 years to 5.1 years.
• Most of the specialty tenant leases have Consumer Price Index (CPI) escalations of 2.0-2.5% which provide an in-built organic growth momentum for the REIT in the long term. This, in the process, reduces its tenant concentration with top 10 tenants contributing only 15% (from 19.3%) of income.

Purchase at 1.4% discount to appraised value; estimated 10% discount to last valuation, initial yield of c.5.6%.

• The purchase consideration of A$670m is understood to be at a 1.4% discount to the latest appraised valuation of A$679.5m and at a c.10% discount to the reported A$737.5m book valuation of the 50% interest held by co-owner Scentre Group back in December 2018. The all-in cost of the deal is estimated to be c.A$691.3m. The initial yield is estimated to be c.5.6%; which is higher than the implied yield of 5.0% that the REIT is trading at. The manager expects DPU accretion of 1.6% for this deal and a net asset value (NAV) accretion of 0.4%.
• The manager intends to use proceeds from the recent S$300m perpetual securities for this acquisition and might look to tap the equity markets for capital. That said, we estimate an additional S$200m worth of debt to be taken up for the acquisition.

Where we differ: Paragon in prime position to benefit from higher tourist receipts this year.

• We are positive on higher tourist spending in FY20F, on the back of a myriad of demand drivers (increased diversion within Asia and a good line up of meetings, incentives, conferences and exhibitions (MICE) events in 2020) which bodes well for Paragon, a key mall along Orchard Road. Coupled with the limited upcoming retail supply in the Orchard submarket, we think that Paragon may deliver further rental upside in FY20.
• The asset posted double-digit rental reversions of +10.7% in the quarter and added S$1.8m to NPI y-o-y, one of the strongest performers.
• See SPH REIT Share Price; SPH REIT Target Price; SPH REIT Analyst Reports; SPH REIT Dividend History; SPH REIT Announcements; SPH REIT Latest News.

Singapore Research Team DBS Group Research | Rachel TAN DBS Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-01-13

SGX Stock Analyst Report BUY MAINTAIN BUY 1.20 DOWN 1.250