K-REIT – Daiwa

KREIT acquires another Australian office building

What has changed?

• K-REIT Asia (KREIT) announced its 2Q FY10 results on 19 July 2010. The DPU of 1.64 cents was 2.5% above our estimate, while net-property income (NPI) of S$18.4m was 18.9% above our estimate.

Impact

• Gross revenue of S$ 22.7m was 11.8% above our estimate. We attribute the difference to higher-than-expected rental revenue from Prudential Tower and 275 George Street. This was offset largely by a lower-than-expected income contribution from ORQ and higher-than-expected trust expenses. As a result, total distribution of S$21.97m was 2.4% above our estimate.

• In the same briefing, the manager announced the acquisition of 77 King Street for A$120m. 77 King Street is a prime commercial building located in Sydney’s central business district (CBD). The building is fully occupied currently with a weighted-average lease expiry of 5.8 years. The building will add a net leasable area (NLA) of 147,250 sq ft to KREIT’s current property portfolio of about 1.5m sq ft. KREIT will have a total exposure (in terms of NLA) of about 22% to Australia after this acquisition.

• Management expects the acquisition to have DPU accretion of 6.6% on a proforma basis. This acquisition will be funded by a combination of debt and equity. We expect KREIT’s aggregate leverage to increase to 20.4% from 15.2% (at 30 June 2010) after the acquisition is completed in the 4Q10.

Valuation

• We maintain our six-month target price of S$0.99, based on our RNG valuation (a finite-life Gordon Growth model) at S$0.99. We have not changed our midcycle core revenue assumptions or our effective cap assumptions of 5.44% (consisting of a discount rate of 6.94% and an internal growth rate of 1.5%). We have assumed that the acquisition should be value-neutral.

Catalysts and action

• We maintain our 5 (Sell) rating on KREIT and believe its DPU yields are unattractive relative to those of other office S-REITs.