FY07 results were in line

Comment on Results
A-REIT reported FY07 results that were in line with our expectations. Gross revenue and net income grew 25% and 15% y-o-y to S$283.0m and S$163.8m respectively. Distribution per unit (DPU) increased 9.2% y-o-y to 12.75 cents.
This improvement was due to the additional rental income from the acquired properties, higher occupancy of 96.6% as compared to 95.0% a year ago and organic growth of 2.7%.

Outlook
According to CBRE, there is an increase in capital value and rental rates by around 5% for all industrial space in 1QCY07. We remain positive on hi-tech space and Business and Science Park where demand is expected remain strong given the limited supply and increasing rental rates of office space in the Central Business District. Of note, A-REIT has 45% of its portfolio in the Hi-tech and Business and Science Park sectors. With both the stepped rental increase for the long-term leases and the positive rental reversions for the short-term leases, A-REIT is expected to continue to benefit from organic growth. Some 57% of under-rented leases are due for renewal in FY08.

Recommendation
A-REIT targets an asset size of S$5.0bn by 2010, with S$400.0m p.a. worth of acquisitions and development required. Hence, we have reduced our acquisition pipeline from S$500.0m p.a to S$400.0m p.a. from 2008 to 2010. Based on DCF Valuation rolled over to FY08), we have a target price of S$2.69. This derives a total return, including yield, of 17%. Upgrade our recommendation to Buy from Hold.

Slowing down

DPU growth slowed on fewer acquisitions. Ascendas REIT (AREIT) reported its 4Q07 results with revenue rising 16% YoY to S$74.0m and with its distribution per unit (DPU) at 3.3 cents (+13% YoY). FY DPU was 12.75 cents (+9% YoY) and in line with our forecast. While FY DPU grew it was less than half of the 22% achieved in FY06. The growth deceleration reflects the slower rate of acquisition.

No guidance for acquisition in FY08. Historically most of AREIT’s earnings growth has been on the back of acquisitions of domestic assets. In FY07, AREIT only acquired assets worth S$488m, well below that achieved in FY06 of S$656m and S$1,000m in FY05. AREIT has not given any guidance with respect to acquisitions in FY08, but it has a long-term target of S$400m per year. However, we see the current slower pace of acquisition and hence DPU growth as probably here to stay. Nevertheless, AREIT does have about S$148m worth of acquisitions previously announced but yet to complete. These assets are presently being constructed and S&P agreement is not expected to complete until the buildings are physical completed towards the end of FY08. So these acquisitions are unlikely to boost earnings meaningfully for AREIT in FY08.

Market competition is intensifying. The industrial market space is definitely getting more competitive. There are three industrial REIT players in the market, i.e. AREIT, Mapletree Logistics Trust and Cambridge Industrial Trust. A fourth player, MacarthurCook Industrial REIT, is to be listed today and JTC REIT could be listed in 2008. Growth strategies of these REITs vary very little, as they all adopt the same acquisition-led growth strategy. Hence we do not anticipate competitive pressures to buy assets to get any easier.

Maintain HOLD. The key worry is AREIT’s high price-to-book ratio of about 1.7 times. This implies that the market continues to anticipate strong growth. With the industrial REIT space getting very crowded, we see a high risk of market being disappointed. Hence AREIT has to either moderate expectation or alternatively propose a new approach to growth. Nevertheless, we have allowed for AREIT’s asset size to increase from its current S$3.3b to S$4.0bn over the next 2 years. On the target asset size basis, our fair value remains at S$2.31. We maintain our HOLD rating.

Overseas expansion by year-end?

FY03/07 results in line. Full-year DPU of 12.8cts is in line with our forecast but 1.5% below consensus estimate. Gross rental revenue was up 25% yoy to S$283m, driven by acquisitions completed during the year (S$340m) and higher overall occupancy rates (97% as at end-FY03/07, up from 95% a year ago).

On course to meet portfolio target. Areit has a portfolio target of S$5bn by 2010 (current S$3.3bn). Some S$148m worth of acquisitions sealed last year are pending completion (build-to-suit projects that are expected to be completed by 1H08). The potential acquisition pipeline includes S$400m-500m from parent Ascendas, S$600m-700m from JTC asset divestments and a development capacity of S$269m.

Strong demand for suburban office space, as more businesses move their noncore operations away from the CBD on account of surging prime office rents. As a result, rental renewal rates at Areits Business and Science Parks and Hi-Tech Industrial properties rose 13% and 19% respectively during the year. About 74% of Business and Science Parks leases and 65% of Hi-Tech Industrial leases are short term and imply the potential for robust rental reversions going forward.

Decision on regional expansion by year-end. Besides outright acquisitions of overseas assets, Areit could participate in parent Ascendas investments in the region by taking stakes in funds that Ascendas has set up in these countries.

FY10 DPU introduced at 14.6cts, based on a portfolio size of S$4.8bn by end-FY10 (average growth of S$500m a year) and an assumed average cap rate of 7% for potential acquisitions. In addition, our FY08-09 DPU forecasts have been raised by 3.2% and 1.6% respectively after tweaking margin assumptions for the different property segments.

DDM-based target price lifted to S$2.90 from S$2.82, on account of our revised DPU forecasts (cost of equity 6.2%). Our new target price implies an FY08 yield of 4.9% (spread of 200bp over the 10-year government bond), which we believe is reasonable. While the size of Areit makes acquisition-led growth incrementally difficult, above-average projected yields of 6% for the next three years make Areit a good defensive stock. We anticipate newsflow on Areits overseas expansion over the next 12 months to provide catalysts for the stock. Maintain Outperform.

Focus on asset size guidance

DPU growth likely to slow. Ascendas REIT (AREIT) will report its 4Q07 results on 18th April after market closes. We are expecting AREIT to report 4Q07 DPU of 3.45 cents, giving full year DPU of 12.90 cents. While FY DPU growth is about 10.3%, this is less than half of the 21.9% growth in FY06. This slowdown is best seen on a sequential basis, with DPU growth of about 7.8%. The growth deceleration reflects the slower rate of acquisition compared to previous years and at much lower yields from the assets bought.

Keep an eye on guidance for acquisition in FY08. As AREIT’s earnings growth has been on the back of acquisition of domestic assets, the key issue is whether the slower pace of acquisition is a one-off or a structural slowdown. Over the last few years, AREIT’s asset size has grown fairly large. It grew by about S$420m in FY04, by S$1000m in FY05 and by S$656m in FY06. For FY07, AREIT is likely to report that it has achieved about S$500m of acquisitions. For the FY07 results, the key would be to focus on management’s guidance (if any) of expected acquisition in FY08.

Market competition is intensifying. The market is definitely getting more competitive. Presently, there are three industrial REIT players in the market, i.e. AREIT, Mapletree Logistics Trust and Cambridge Industrial Trust. A fourth player, MacarthurCook Industrial REIT, is currently being offered and JTC REIT could be listed in 2008. Growth strategies vary very little among the industrial REIT players. They all adopt the same acquisition led growth strategy. Hence we do not anticipate competitive pressures to buy assets and grow earnings to get any easier.

Maintain HOLD. The key worry is AREIT’s high price-to-book ratio of about 1.7 times. This implies that the market continues to believe that rapid growth is still possible. With the industrial REIT space getting very crowded, we see a high probability of disappointment. Hence AREIT has to either moderate expectation or alternatively propose a new approach to growth. There are a few possibilities, one is to venture overseas and another is to try to buy out a rival REIT that is trading at a much higher yield. We value AREIT at S$2.31 based on an asset size of S$4.0bn (S$2.9bn as at 3Q07). We maintain our HOLD rating.

Continuing to Perform

3Q07 Results. 3Q07 net income available for distribution increased 6.8% YoY to S$41.0m. 3Q07 DPU of 3.2 cts increased 6.3% YoY and 1.3% QoQ. Annualized DPU based on 9 months to 31 Dec 06 works out to be 12.6 cts, up 8% YoY. Gross revenue was up 16% YoY mainly due to additional rental income from the following completed acquisitions: Steel Industries, Hamilton Sundstrand, Thales, Aztech, Noel Corporate, 138 Depot Road and 150 Ubi, Sembawang Kimtrans, Logistics 21 and LabOne. As of 31st Dec 06, gearing worked out to be 39.5% with a debt of S$1,126m and interest cover ratio of 5.7x. NAV per unit of 136 cents translates to a current P/B of 1.95x. The ex-date of the distribution of 3.2 cts per unit is on 24 Jan 07 and will be paid out on 28th Feb 2007.

As of 31st Dec 06, weighted average lease term to expiry was 6.3 years based on 68 properties. Portfolio occupancy increased to 96.1% with multi-tenanted buildings occupancy (54% of portfolio) at 93.1%. Concentration risk from top 10 tenants dropped from 35.7% at 31st Dec 05 to 33.8% at 31st Dec 06, representing a well-diversified portfolio.

Investment highlights. AREIT has recently completed the purchase of two properties, Super Industrial Building and 26 Senoko Way, for S$49.0m, funded by bank debt. Asset enhancement is ongoing for Alpha building, and has been completed for Telepark. Courts Megastore has been completed on schedule in Dec 06 with lower than expected development cost. In summary, S$211m worth of acquisitions has been completed year-to-date and S$214m worth of investments as shown in Fig. 1 is in progress for completion.

Singapore Industrial Property. According to URA, prices of multiple-user factory space rose 1.1% QoQ in 3Q06 with rentals of multiple-user factory space remaining unchanged. Prime industrial space increased QoQ at a range of 1.2% to 3.8%. The best performer goes to high-tech space which increased 7.6% QoQ for the ground floor and 4.9% QoQ for upper floor, backed by the improving manufacturing sector, research & development firms and government injection of S$1.5 billion into the biomedical sciences. Results have been within our expectation and we believe that demand for high-tech space will continue to remain high and drive rental rate up.

Valuation. 12 acquisitions and developments were announced in financial year to date amounting to S$425m, exceeding our initial assumption of S$400m. We revise our projection for acquisitions upwards to S$500m worth of acquisitions for FY07 as well as FY08. Interest rate decrease over the last quarter has also allowed us to decrease our required rate of return (WACC) to 6.8%.

Using DDM with a growth rate of 2.5%, we increase our fair value to S$2.74, representing a FY07F yield of 4.66% and a healthy spread of 1.6%. FY07F P/NAV using our fair value is 1.94x but we believe that this will decrease after AREIT revalues its properties for FY07. We maintain Hold on AREIT.