Keppel REIT - DBS Research 2020-10-02: Kick-Starting Acquisition Mode

KEPPEL REIT (SGX:K71U)

Keppel REIT - Kick-Starting Acquisition Mode

Keppel REIT kick-starting acquisition to drive underlying DPU growth; estimate underlying FY21F DPU to increase 13% y-o-y.
Sponsor pipeline of > S$2bn in sight (including Keppel Towers redevelopment) in line with Keppel Corporation’s plans to monetise its assets.
Sponsor may look to improve liquidity over time, a catalyst for share price to re-rate.

Keppel REIT (SGX:K71U) is expanding its Australia portfolio into Sydney’s Silicon Valley, with the acquisition of 100% interests in freehold property, Pinnacle Office Park, Macquarie Park, Sydney for A$306m (c. S$303.3m) with an initial NPI yield of 5.25% from Goodman Group. This is probably the first asset acquisition made among the non-industrial and logistics REITs since COVID-19 pandemic started.
The long-awaited redeployment of capital post a series of divestments in the past few years will drive underlying DPU growth with the accretive acquisition and embedded rental escalations. Based on pro-forma FY19 numbers, underlying DPU accretion is estimated to be c.4%. Based on our estimates, underlying FY21F DPU is estimated to grow by 13% post acquisition partly driven by the acquisition, low base in FY20F and some interest savings from the low interest rate environment.
In addition, the redevelopment potential in one of the buildings would boost organic growth in the future when approvals are obtained from the authorities.
While Keppel REIT continues to have ample capital distributions of S$467m as at 2Q20 which will help to ensure a steady and sustainable DPU, the acquisition reduces the reliance on capital distributions with growth in underlying DPU and allows Keppel REIT more room for further acquisitions.

The agreed property value is A$306m (c. S$303.3m). Total cost of acquisition is c. A$329m (c. S$326.1m).
The asset comprises three office buildings located in Macquarie Park in Sydney with NLA of 35k sqm (378k sqft).
Committed occupancy is 96.3% with rental guarantee of A$2.1m for relevant vacant premises, until the later of 31 Dec 2021 and 12 (or six) months after the date of completion.
The initial NPI yield is 5.25% (including rental guarantee).
WALE of the asset is 4.8 years, extending portfolio WALE to 6.9 years (including 311 Spencer St).
All leases have fixed annual rental escalations of between 3% and 4%.
Key tenants include Aristocrat Technologies, Konica Minolta and Coles Supermarket.
The acquisition will be 100% funded by AUD-denominated loan.
Based on pro-forma financials vs FY19, the acquisition is 4.5% DPU accretive (3.2% accretion assuming that it is partially funded by the recent perpetual securities issued) while adjusted NAV will remain flat.
Pro forma aggregate leverage would increase to 38.7% vs 36.3% as at June 2020 and 35.8% as at December 2019.
One of the three free-standing buildings, 6 Giffnock Avenue has the potential for redevelopment that could increase its NLA by more than four times and increase total portfolio NLA by 37% to 48k sqm vs 35k sqm currently, subject to approval by local authorities.
The acquisition is expected to complete in 4Q20.

Despite Keppel REIT’s entry into a CBD fringe/regional office asset, we believe the asset will not lower the quality of Keppel REIT’s portfolio of assets which comprises Grade A office assets located in prime CBD of major cities in Singapore, Australia and Korea. This is because the asset is a Grade A office asset located in Macquarie Park, the second largest office market in New South Wales (some call it the Silicon Valley of Sydney).
We note that 61% of its tenants are from the technology, media and telecommunications sector which is one of the few sectors that are growing during these challenging times.
In addition, we believe that the acquisition is an opportunity for Keppel REIT to diversify its offerings to tenants which, post COVID-19, may look for split offices in suburban locations which are closer to employee homes due to lower commute needs.

Sponsor pipeline of more than S$2bn in sight including Keppel Towers (earmarked for redevelopment), in line with Keppel Corporation (SGX:BN4)’s plans to monetise S$3-5bn worth of assets. We estimate that Keppel REIT has a potential sponsor pipeline of more than S$2bn comprising office assets in Singapore and London. Although Keppel REIT has been acquiring third-party assets in the past few years, we believe the timing is right now to be in line with Keppel Corporation’s plans to unlock value from S$3-5bn worth of assets, which was unveiled on 29 September 2020.
In addition, Keppel REIT has recently raised another tranche of S$150m of subordinated perpetual securities at 3.15% which could set the stage for a more accelerated acquisition either from its sponsor or a third party. The possible participation in the redevelopment of Keppel Towers would bode well for Keppel REIT to drive organic growth including development returns.

We believe that Keppel Corporation may consider assisting in Keppel REIT’s liquidity by potentially paring down its c.48% stake towards an optimal 30-35%, similar to the levels that the Sponsor holds for other large-cap S-REITs.
We believe that the boost in liquidity and Keppel REIT’s position as a pure-play office play post CapitaLand Commercial Trust (SGX:C61U) - CapitaLand Mall Trust (SGX:C38U) merger, will drive a re-rating in share price towards its NAV over time, in line with an improvement in earnings.

We maintain our BUY rating on Keppel REIT and raised our Target Price to S$1.40 from S$1.35 previously to factor in the recently announced acquisition of Pinnacle Office Park and some interest savings from a lower average cost of borrowings.
See Keppel REIT Share Price; Keppel REIT Target Price; Keppel REIT Analyst Reports; Keppel REIT Dividend History; Keppel REIT Announcements; Keppel REIT Latest News.
We believe Keppel REIT’s best-in-class office portfolio, anchored by Singapore Grade A offices in prime CBD locations, is well-positioned to benefit from a potential recovery in a very tight net supply market.
Soon to be the only pure-office S-REIT post CapitaLand Commercial Trust (SGX:C61U) / CapitaLand Mall Trust (SGX:C38U) merger, coupled with improved liquidity over time, this will be highly valued by investors, and a catalyst for share price to re-rate.
In addition, Keppel REIT is set for inorganic growth with more than S$2bn of potential sponsor pipeline which could be accelerated given Keppel Corporation’s plan to unlock asset value.

Rachel TAN DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-10-02

SGX Stock Analyst Report BUY MAINTAIN BUY 1.40 UP 1.350