K-REIT – CIMB

Clocking K-angaroo miles

A 50:50 debt-equity funded acquisition of a Perth office development could be accretive though mainly through cheap S$ debt. Accretion is offset by a resultant higher gearing. The longer lease provides visibility but could limit upside from a buoyant Perth office market.

We tweak our DPUs by -0.3/+0.8%, fine-tuning our assumptions and assuming a 50:50 debt-equity funded acquisition. Our DDM target prices rises slightly because of these changes and the rollover of our target price. Downgrade to Neutral from Outperform given the limited upside.

What Happened

K-REIT has entered into a conditional agreement with Mirvac Projects to acquire a 50% interest in a new office tower development (slated for completion in 2H15) in Perth, Australia. Total consideration is estimated at A$165.0m (S$211.2m, 7.15% cap rate), paid through an initial 50% in Mar 13 and five further progressive tranches from Dec 13. The first tranche will be funded by debt. Management has yet to decide on the funding mode for the remaining tranches. Regular income at an effective rate of 7.0% will be paid throughout the construction phase. Development risk will largely be taken on by Mirvac. 98% of the NLA is pre-committed to the government of Western Australia.

What We Think

We are net-neutral on the deal as the accretion is offset by higher gearing. The capital value of S$1,274 psf appears a tad above recent market transactions, arguably for a relatively newer asset. Cap rates were fairly in line with some recent premium grade office transactions. While we like the visibility from a 25+25 year lease and 3-5% annual rental step-ups, the long lease could also result in limited upside for K-REIT in the buoyant Perth office market. A higher asset leverage of an estimated 45% after the first 50% payment could imply a need for equity fundraising for the remaining tranches. We estimate that a 50:50 debt-equity transaction could still be accretive though this is aided mainly by cheap S$ debt.

What You Should Do

K-REIT has outperformed the STI by 25% since we upgraded it to Outperform in Apr. With limited further upside and equity fundraising needs (as gearing creeps up) expected to limit accretion from a potential acquisition of MBFC Phase 2, we downgrade K-REIT from Outperform to Neutral.