K-REIT – Daiwa

No reward for dilution, excess capital

Rating downgraded to 5 (Sell) from 4 (Underperform)

We have downgraded our rating for KREIT to 5 from 4, because we believe the recent three-month unit-price performance is unjustified. 

We estimate that the current market value of KREIT, more than any other office S-REIT, can only be justified if investors are willing to pay effective cap rates of 4.5-4.6%, similar to cap rates in the physical market. We regard this as risky, given the historic volatility of the Singapore office market and the imposing CBD supply pipeline for 2010-12. 

No reward for rights-issue dilution ahead of acquisitions

We do not believe KREIT should receive the benefit of the doubt for holding excess cash when there is a high degree of risk that it might not come through with a successful, DPU accretive acquisition. The opportunity cost is high, in our opinion, especially for the unitholders that have been diluted already. 

A high-yield acquisition in a high-yield market

We do not believe the acquisition of a single asset in Australia (a 50% stake in 275 George Street for A$166m) does much to improve KREIT’s financial efficiency or investment attractiveness. If anything, it only serves to deplete its recent rights issue and divert focus, if the manager’s ultimate objective is to land a major acquisition in Singapore. 

DPU forecasts revised down by 2.8-5.6% for FY10-11

We have revised down our DPU forecasts by 2.8% for FY10 and 5.6% for FY11after adjusting downward our rental-renewal assumptions. We have revised up our DPU forecast by 0.6% for FY12 after an upward adjustment to our rental-renewal assumption for KREIT’s associate, One Raffles Quay. 

Six-month target price lowered to S$0.96 (from S$1.06)

We have lowered our six-month target price, based on parity to our RNG valuation method (a finite-life Gordon Growth model), to S$0.96 from S$1.06. Our core operating-income estimate assumes average (monthly) passing rents of S$8.50 for Prudential Tower, S$6.50 for Keppel Towers and GE Tower as well as Bugis Junction Towers, and S$10.00 for One Raffles Quay (one-third stake). We have removed the presence of the recently completed Brisbane office acquisition (for A$166m) so that our valuation only considers Singapore income-producing assets discounted at Singapore cap rates and capital-market conditions. We have assumed that all excess cash (as at 31 December 2009) would be used to retire debt.