CCT – OCBC

Entering a challenging phase; Downgrade to HOLD

Results above expectations. CapitaCommercial Trust’s (CCT) 3Q09 results were above our expectations. Gross rental income increased 16.1% YoY to S$92.6m, aided by positive rental reversions but the rate of increase on a QoQ basis slowed to 1.7%. Net property income increased by 15.5% YoY and 5.1% QoQ to S$77.1m, on the back of lower property tax and cost savings effort. DPU of 1.85 S cents was announced for 3Q09 and this was 17.1% ahead of our expectations. CCT’s outperformance was attributable to the resilience of its asset portfolio which continued to turn in healthy positive rental reversions.

Mixed set of operating metrics. Average monthly passing rent for CCT’s office portfolio continued to increase in 3Q09, growing by 4.3% QoQ to S$8.49 psf pm. In addition, the pace of lease renewals had not slowed down in 3Q09 despite the continuing pressure on market rent. CCT signed new leases and renewals of 234,510 sq ft, which was 68.3% more than that the amount signed in 2Q09. CCT’s Grade A office occupancy rate remained firm, increasing from 97.4% in 2Q09 to 97.9% in 3Q09. However, the weak office market had started to take its toll on CCT’s prime office space occupancy rate, which resulted in the decline in overall portfolio occupancy rate from 96.2% in 2Q09 to 94.0% in 3Q09. This is the lowest
occupancy rate since 4Q04.

Expect greater challenges from 1Q10. With the bulk of the leases expiring in 2009 already renewed, we expect rental income to stay relatively stable for the rest of the year. However, negative rental reversions are likely to set in from FY10 onwards as the higher rents secured in 2007 are due for renewal in 2010. Some of these expiring rents (at Six Battery Road and Raffles City Tower) are significantly higher than the current Grade A office rents of S$8.80 psf pm. Even though the rate of decline in office rents had slowed, the downward pressure on rents is expected to persist which could widen the negative reversionary gap.

Fair value raised to S$1.13; downgrade to HOLD. We have raised our fair value from S$1.07 to S$1.13, after moderating our office rent decline expectation for 2009 (-23% YoY in market rent) and 2010 (-15% YoY). Our DPU estimates for FY09 and FY10 have also been raised by 5.8% and 8.4% to 6.7 S cents and 6.4 S cents, respectively, translating to DPU yields of 6.4% and 6.1%. CCT’s share price had performed well since our last BUY rating on 23rd July, gaining by 20.7%. In light of the limited upside potential, we are now downgrading CCT to HOLD.