FCOT – CIMB

Near-term catalysts in sight

• Near-term catalysts from early refinancing; initiate with Outperform. FCOT is a commercial REIT investing primarily in offices in the region. We use DDM (discount rate 9.4%) to value FCOT at S$0.99. Since taking over in 2008, FCOT’s management has stabilised its capital structure and assets and divested non-core holdings. With a stabilised portfolio and capital structure and a strong sponsor in F&N, we see no reason for its depressed 40% discount to book and forward yields of 7-8%. We see catalysts from early re-financing and improvements in occupancy and rentals.

• DPU upside just from refinancing. FCOT’s entire debt will be maturing in 2012. With a high cost of debt of 4.3% vs. 3% for most REITs in their recent refinancing, we anticipate an 11% DPU uplift even with a minimal rate reduction of 50bp.

• Further kicker from expiry of master lease. The master lease for its largest local asset, China Square Central (net rents of S$4+ psf), will be expiring in 2012. With significant leases due for expiry in 2012 and F&N’s expertise in retail management, direct management of the asset could allow FCOT to ride the rental upside. Possible AEI and hotel development to unlock value could also be low hanging fruits for FCOT.

• We do not see an overhang from CPPUs, with limited dilution of 4% on full conversion. Redemption of the CPPUs at par could even allow accretion if overall funding costs for FCOT come in below the CPPU rate of 5.5%.

Valuation and recommendation

DDM-derived valuation. We use DDM to value FCOT, the methodology we use to value all the REITs under our coverage. We use a discount rate of 9.4%, derived from a risk-free rate of 3.8%, an equity risk premium of 4.3% and a beta of 1.3x. We also assume a terminal growth rate of 2%.

Initiate coverage with Outperform and target price of S$0.99. We initiate coverage with a target price of S$0.99, which represents a total return of 30% from a forward yield of 7% and price upside of 23%. Since taking over the reins in 2008, FCOT’s management has stabilised FCOT’s capital structure and assets and divested noncore holdings. With a stable portfolio and capital structure and a strong sponsor in F&N, we see no reason for its depressed 40% discount to book and forward yields of 7.1% (vs. office S-REITs’ averages of 0.8x P/BV and 6.1% DPU yield). We do not see an overhang from CPPUs (with limited dilution on full conversion) and even anticipate accretion from potential redemption at par on favourable funding rates. We thus initiate with an Outperform, anticipating catalysts from early re-financing at favourable costs of borrowing and improvements in occupancy and rentals.