OUE Commercial REIT - DBS Research 2020-12-10: Awaiting Recovery


OUE Commercial REIT - Awaiting Recovery

  • OUE Commercial REIT has the most attractive valuation among the office S-REITs and is still trading at its trough.
  • As the hospitality segment contributes c.30% of its revenue, OUE Commercial REIT is a “pseudo” proxy to the hospitality recovery theme.
  • Overhang remains on recent news that OUE Commercial REIT may divest part of its crown jewel, OUE Bayfront.
  • Maintain BUY; target price of S$0.50.

Selling part of a diamond - a win-win deal?

  • Business Times reported that an entity linked to Allianz Real Estate is said to be conducting an exclusive due diligence to acquire a partial stake in OUE Bayfront, OUE Commercial REIT (SGX:TS0U)’s crown jewel.
  • OUE Bayfront is one of the prime Grade A office assets commanding premium rents of above S$14 psf at the top end of the range. The expected price is said to be S$3,200 psf, representing a S$1.28bn valuation for the asset, c.8% above its last valuation as at FY19. This implies an estimated yield of 3.1- 3.4%.
  • While the expected price looks attractive in comparison to the divestment of Robinson Point by Tuan Sing in August at S$3,721psf / 2.6% yield, the valuation appears to be in line with pre-COVID-19 transactions.

Our View

Selling a diamond in its portfolio.

  • Assuming Allianz is acquiring a 50% stake in OUE Bayfront, the quantum works out to be S$640m based on the expected deal price. If the divestment is successful, we see a few positives emerging from this proposed sale.

A “true market value” for OUECT; will unitholders get a taste of this sweetness?

  • The sale will give investors a valuation yardstick of the true value of OUE Commercial REIT’s portfolio, where its properties can achieve close to book value vs its current valuation of 0.6x P/NAV, which is at - 2 standard deviation (SD) levels.
  • While some argue that the discount could come from its diverse real estate class (office + hotels) and illiquidity vs peers, this selling price enables existing investors to crystallise its NAV and the share price might re-rate towards NAV over time. If a sale materialises, we believe that the manager should look to pay out some of these gains to unitholders in the form of a “special dividend” to reward shareholders for the years of portfolio restructuring and mergers.

Opportunity to re-capitalise its capital structure.

  • We understand that the property is encumbered and OUE Commercial REIT will need to refresh its capital structure and refinance its existing debt. With the debt refinancing, OUE Commercial REIT could reduce its cost of debt given the low interest rates (latest reported cost of debt to be 3.4%) which will be DPU accretive.
  • The remaining proceeds could be used to repay part/ all of the outstanding Convertible Perpetual Preference Units (CPPU) of S$375m (where its sponsor OUE (SGX:LJ3) is holder). If the latter happens, it may result in a slight dilution to distributions. However, we expect the overall strategy to realign its capital structure and remove this overhang from its existing CPPU units (convertible to c.520m shares or 10% of its share base) to bear fruit over time.

Retaining part of the Singapore crown.

  • While selling part of OUE Bayfront may be considered as parting with the “diamond” in its portfolio, we see the REIT participating in the future NAV and earnings growth of the asset through the proposed remaining 50% stake and as the active manager of the property.

Is Downtown Gallery next on the pipeline?

  • Could the partial sale of OUE Bayfront lead to an opportunity to buy Downtown Gallery (valued at S$270m as at FY19), the only remaining sponsor pipeline asset? The opportunity to acquire Downtown Gallery could have some near-term risks arising from the increased flexible work arrangements, which could be challenging for its retail tenants but over time. But this gives OUE Commercial REIT the opportunity to own and manage the asset in its entirety.
  • As the office transaction market remains active, we believe this could keep office valuations stable despite vacancy risk concerns from the increased implementation of flexible work arrangements arising from the pandemic.

Comments on OUECT's 3Q20 Business Updates:

3Q20 q-o-q results improved with lower rental support.

  • OUE Commercial REIT's 3Q20 distributable income rose 16% y-o-y to S$34.2m mainly due to contribution from the merger with OUEHT. Similarly, revenue and NPI grew 12% and 11% y-o-y with the contributions from the merger partially offset by rental rebates to retail tenants.
  • OUE Commercial REIT's 3Q20 estimated DPU (based on 100% payout) fell 19% y-o-y to 0.6 cents. With a semi-annual distribution policy, any distribution of retention will be disclosed at FY20 results announcement.
  • From 3Q20, OUE Commercial REIT is raising the base management fees to be paid in cash from 20% to 50% to reduce the dilution. The impact is c. S$1.5m.
  • On a q-o-q basis, we note that revenue, NPI and distributable income grew by 10-11%, mainly due to lower rental reliefs recognised of S$5m in 3Q20 vs c.S$14m in 2Q20.
  • 2Q20 office portfolio revenue is estimated to decline by 7% y-o-y mainly from One Raffles Place (-1.5% y-o-y) and Lippo Plaza (-48% y-o-y) partially offset by OUE Downtown (+15.8% y-o-y) and OUE Bayfront (+4.3% y-o-y). Retail and hospitality portfolios continue to be impacted by the COVID-19 pandemic.
  • Gearing and average cost of debt were stable q-o-q at 40% and 3.1% respectively in 3Q20.
  • OUE Commercial REIT is in its documentation stages to refinance the remaining debt expiring in FY20 of S$425m and has started the process to early refinance the S$450m debt due in FY21. This will extend the average term of debt to 2.6 years, vs 1.6 years in 3Q20.

Office occupancy improved marginally on strong positive rental reversions with a pick-up in leasing activities; shopper traffic and sales have recovered close to pre-COVID levels.

  • Overall commercial portfolio occupancy (including Mandarin Gallery) increased marginally by 0.7ppt q-o-q to 92.3% vs 91.6% as at 2Q20. Office portfolio occupancy rose 1ppt q-o-q to 92.3% mainly from Lippo Plaza (+1.7ppts) and One Raffles Place (+1.5ppts) while retail portfolio occupancy declined 0.5ppt q-o-q.
  • Singapore office properties continue to enjoy strong positive rental reversions of between 2.9% and 22.1% in 3Q20 with minimal leases expiring in FY20 and 19% expiring in FY21.
  • Occupancy at Mandarin Gallery contracted 0.5ppt q-o-q while average passing rent was stable at S$22.62psf / per month (+0.7% q-o-q).
  • Shopper traffic and sales have recovered to c.80% and 70% of pre-COVID levels respectively with F&B leading the recovery ( > 90% to higher than pre-COVID levels) with hair & beauty.

Hospitality – RevPAR +60.5% q-o-q led by increase in number of flights and SHN business.

  • On q-o-q, RevPAR increased 60.5% to S$88 with both hotels seeing higher occupancy and average room rates.
  • Crown Plaza recorded a higher RevPAR of S$115 from the air crew business segment. With the increase in flights following some relaxation in travel restrictions, Crown Plaza has ended the SHN business to undertake more air crew business.
  • Mandarin Orchard Singapore has improved following the SHN business which started in 3Q20.
  • Staycation and work-from-home packages have received strong interests.

Outlook / COVID-19 impact to OUECT

  • Despite a slowdown in office demand in its SG office portfolio, OUE Commercial REIT continues to expect positive rental reversions from flat to low single digits. While there has been minimal downsizing / rightsizing impact at the moment, tenants are looking for shorter lease terms given the uncertain economic outlook.
  • Management continues to see expansion demand from financial / insurance sectors and new demand from the tech sector.
  • While Mandarin Gallery has seen good rebound in shopper traffic and tenant sales post Circuit Breaker, management expects some non-renewals from half of the 10.8% remaining leases expiring in FY20. OUE Commercial REIT will continue to provide some rental relief especially to retail tenants that are still struggling (e.g. retail tenants at One Raffles Place) but do not expect this to be significant.
  • Rental collections remain healthy at > 90% and rental deferments are manageable at S$1.2m.
  • Hospitality segment will continue to be supported by its minimum rents while it progressively recovers with further relaxation of travel restrictions and positive development of COVID-19 vaccine.
  • In response to the news that OUE Commercial REIT may look to divest some of its assets, management will evaluate all offers (if any) and continue to look for opportunities to recycle into higher-yielding assets if the price is right.
  • See OUE Commercial REIT Share Price; OUE Commercial REIT Target Price; OUE Commercial REIT Analyst Reports; OUE Commercial REIT Dividend History; OUE Commercial REIT Announcements; OUE Commercial REIT Latest News.

Rachel TAN DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-12-10
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