Elite Commercial REIT - UOB Kay Hian 2022-08-08: 1H22 Counter-Cyclical Yield Play That Hedges Against Inflation


Elite Commercial REIT - Counter-Cyclical Yield Play That Hedges Against Inflation

  • Elite Commercial REIT's NPI grew 17.7% y-o-y in 1H22, driven by the maiden acquisition of 58 commercial buildings completed on 9 Mar 21. DPU declined 2.7% y-o-y to 2.56 pence as cost of debt edged higher by 0.2ppt q-o-q to 2.3%.
  • The overhang from lease break options is largely resolved. Elite Commercial REIT’s properties have rent reviews every 5 years benchmarked against UK CPI and rental escalation of 15.4% is expected starting Apr 23.
  • Elite Commercial REIT is a recession-resistant counter-cyclical yield play. Maintain BUY. Target price: £0.79.

Elite Commercial REIT's 1H22 Results

  • Elite Commercial REIT (SGX:MXNU) reported 1H22 DPU of 2.56 pence (-2.7% y-o-y), which is in line with our expectations.
  • Resiliency supported by sovereign tenants. Gross revenue and NPI grew 17.7% y-o-y in 1H22, driven by the maiden acquisition of 58 commercial buildings for £212.5m completed on 9 Mar 21. Portfolio occupancy remains high at 98% as of Jun 22.
  • Elite Commercial REIT has collected 99.9% of rent for 3Q22 in advance and within seven days of due date.
  • Incurred higher cost of debt. Interest expense increased 35% y-o-y due to increased borrowings to fund the acquisitions. Aggregate leverage eased 0.9ppt q-o-q to 41.9% but cost of debt rose by 0.2ppt q-o-q to 2.3%. Elite Commercial REIT generated savings in tax expenses after qualification of its UK entity as a UK REIT group.
  • Income stability with long WALE. Elite Commercial REIT has a long WALE of 5.2 years as of the Jun 22 post-renegotiation of lease terms.
  • Mid-year valuation. Elite Commercial REIT plans to conduct a mid-year valuation exercise to update the valuations of its properties after the renegotiation of lease terms. The valuation for its portfolio of 155 commercial properties increased 3.5% due to the removal of lease break options for a majority of its leases. It has recognised gain of £10.2m in fair value of investment properties in 1H22.
  • Elite Commercial REIT's NAV per unit increased 2% to £0.62.

Benefitting from higher inflation.

  • The leases with the UK government are full repairing and insuring triple net leases whereby operational expenses are borne by the tenant. Thus ELITE is insulated from negative impact from higher inflation and higher cost of electricity. The leases provide high NPI margin of 97.1% in 2021. The leases have rent reviews every five years benchmarked against the UK Consumer Price Index (CPI).
  • The built-in rental escalation is subject to an annual minimum increase of 1% and maximum of 5%. Based on consensus estimate of 8.6% for the UK’s CPI in 2022, we estimate the step-up in rents at 15.4% for Apr 23.

Elite Commercial REIT is recession-resistant counter-cyclical yield play.

  • Elite Commercial REIT benefits from recession-resistant and counter-cyclical cash flows from its sovereign tenants.
  • 99.3% of Elite Commercial REIT’s gross rental income is derived from leases with the UK government. The UK government is rated AA by S&P and Aa3 by Moody’s. Its primary occupier DWP uses Elite Commercial REIT’s properties primarily as Jobcentre Plus, which provides front-of-house claimant-facing unemployment and other ancillary services.
  • Majority of 136 DWP leases have no break clauses. 27 of the DWP leases are straight leases without break clauses. Break clauses were removed from 108 leases, of which rents for 97 leases were maintained while rents for 11 leases were reduced. The reduction in rents for the 11 commercial properties is estimated at 36% (before positive impact of rental escalation).
  • DWP also signed a new 5-year lease for one commercial property at East Street, Epsom. Properties with rental income secured till Mar 28 contributed 87.5% of gross rental income as of Jun 22.
  • Break options for 12 leases were exercised. Tenants have exercised break options for 12 leases (DWP: 10, National Records of Scotland: 1 and HM Revenue & Customs: 1.)
  • Elite Commercial REIT will consider three options for the 12 commercial properties:
    • re-let to other potential new tenants,
    • divestment with vacant possession or following re-letting, or
    • alternative uses, such as conversion or redevelopment.
  • Maximising value of John Street and Sidlaw House. DWP and HM Revenue & Customs have vacated from John Street, Sunderland and Sidlaw House, Dundee on 1 Apr 22 and 29 Jun 22 respectively. Elite Commercial REIT's management intends to divest John Street to recycle capital. It is also exploring available options for Sidlaw House.

Elite Commercial REIT - Earnings forecast revision and recommendation

Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2022-08-08
SGX Stock Analyst Report BUY MAINTAIN BUY 0.79 DOWN 0.810