FCOT – DMG

A counter with much room for growth

We initiate coverage on FCOT with a BUY rating. Based on our DDM model, by assuming a terminal growth rate of 2.0% and a COE of 10.3% (with a risk-free rate of 1.5%, 0.8x beta and 6% equity risk premium), we arrive at our target price of S$1.23. We like FCOT due to (1) potential divestment of KeyPoint will allow the trust to par down its gearing with a possibility of enhancing unitholders' returns via share buy backs/redemption of CPPU, (2) growth in DPU from the acquisition of the additional 50% stake in Caroline Chisholm Centre, (3) the JV to turn China Square Central into part of China Place will benefit both the trust and unitholders with long term growth potential.

Potential upside from the divestment of KeyPoint. Apart from being able to reinvest the capital into higher yielding properties and strengthening the asset portfolio, we believe the divestment of KeyPoint could significantly lower the gearing of the trust from its current 39.5% by c.14ppt (assuming 100% of proceeds are used to par down gearing). Alternatively, if part of the Series A Convertible Perpetual Preferred Unit (CPPU), which represents a distribution yield of 5.5%, based on the issue price of S$1.00 per CPPU, is redeemed by using the proceeds from this divestment, the trust could possibly save 100bps in terms of the interest being paid, thus directly benefitting the unitholders.

FCOT posted a strong 3QFY12 results. FCOT reported 3QFY12 DPU of 1.70S¢ (+23.2% YoY), equivalent to 25.1% of our FY12 DPU estimate. Revenue for this period grew to S$35.7m (+17.0% YoY) while net property income rose by 7.1% YoY mainly due to an increase in contribution from the additional 50% stakes in Caroline Chisholm Centre (+ 76.7%) and positive rental reversion in China Square Central (+11.0%). In the subsequent quarters, we expect FCOT to continue to register strong numbers on the back of 1) contributions from Caroline Chisholm Centre, 2) redeem a portion of CPPU using the proceeds from the divestment of KeyPoint, 3) lower interest payments and 4) positive rental reversion from China Square Central.

DPU growth as a result of both acquisitions and positive rental reversion. We forecast FCOT's DPU to come in at 6.76S¢ (+17.5% YoY) in 2012 and 7.68S¢ (+13.6% YoY) in 2013. Given FCOT's strong potential together with the recent drop in Singapore government 10 year bond yield to 1.33%, we initiate coverage on FCOT with a DDM based (COE: 10.3%, terminal growth: 2.0%) TP of S$1.23. Our TP represents a spread from 10-year government bond of 4.8% and a potential upside of 14.4%.