Restructuring debt

CREIT’s recent acquisitions have led to an upgrade in portfolio quality. Management intends to restructure debt to bring down gearing and interest costs. We raise our TP to S$0.58 and reiterate Buy.

Upgrading quality of property portfolio

CREIT’s recent acquisition of two properties has upgraded its property portfolio. CREIT’s asset lease expiry profile and tenant mix has improved after the S$37.7m acquisitions. To fund them, CREIT raised S$40m from a placement of 86.7m of new units at S$0.478/unit. Of the proceeds, S$24.7m will be used to finance the purchase, with the rest kept for future acquisitions. Following the purchase, CREIT’s gearing ratio falls to 41.5% from 42.6% as only 34% of the acquisition will be funded by debt.

Potential debt restructuring should improve earnings

Management expect CREIT to realise S$90m from the sale of non-core assets by the year end. In August, CREIT paid down its existing debt facility by S$32m bringing its gearing down to 39.5% from 42.6% as of June 2010. Management plans to pay down a further S$30m of the proceeds and use the rest for asset upgrades. The company also intends to restructure its current debt of S$360m which was refinanced at the peak of financial crisis in February 2009 at 5.9% vs current spot rate of 3%, on our estimates. This raises our distributable income by 6.9% for FY10-11F.

Slight dilution expected on acquisitions

The new properties generate a net property income yield of 8.3%, akin to CREIT’s yield prior to the acquisition. Given the expected dilution from the placement, we estimate distributable income per unit (DPU) dilution of 3% in both FY11 and FY12. The new properties will have built-in rental escalation of 2% pa on average during the lease period of seven years vs 2.5% for CREIT pre-acquisitions. Gross floor area at one of the acquisition targets (Chin Bee) may be enhanced by 40%. This should reduce dilution to just 2% in both FY11F and FY12F.

Reiterate Buy with higher target price

Our DCF-based target price is raised to S$0.58/unit (from S$0.53) on the back of our earnings upgrade. We have reduced our cost of equity to 12% (from 13.2%) as bond yields continue to trend down. The stock yield is attractive, in our view at 9.2% in FY10 and 10% in FY11 vs peer average of 7.9% and 8.4%, respectively. It trades at 13% discount to book value vs 0.8% discount for peers, on our analysis.

Earnings dilutive acquisitions

• Acquisition of 2 assets worth S$37.1m; part-funded by placement of 83.6m new units

• Lowered earnings by 2-6% in FY10-11F

• Downgrade to HOLD, TP S$0.51.

Looking towards growth. Cambridge REIT acquired 2 industrial properties for S$37.7m, yielding c8.0%. Income from these properties is backed by long-term leases of over 7 years with periodic step-ups. The acquisition is expected to complete in Sept 2010.

Private placement 83.6m new units to raise S$40m gross proceeds; new 3-year debt facility secured. The acquisition will be funded through (i) S$23.7m from private placement proceeds, (ii) S$13m drawn down from its debt facility at estimated c3.05% cost. The remaining placement proceeds of cS$15m will be used for future acquisitions or fund its planned asset enhancement initiatives. Gearing post acquisition is expected to head down to 41.5% from 42.3% as of 30th Jun 2010.

Dilutive to earnings, DPU adjusted downwards by 2-6%. Expect earnings dilution since placement price implies a yield of 10% against the asset yield of c8%. Our DPU estimates are adjusted downwards to 5.0 – 4.8 Scts in FY10-11F, reflecting the transaction.

Downgrade to HOLD, TP adjusted to S$0.51. We are somewhat surprised at management’s decision to acquire assets that are earnings dilutive. We remain on look out for future initiatives (AEI plans) that would grow earnings to offset the dilution. Given limited upside to our TP of S$0.51, we downgrade the stock to HOLD.

Acquires 2 properties

• Acquires 2 properties for $37.1 million.

• Private placement to raise gross proceeds of $40.0 million

• Maintain hold and fair value of $0.52

Acquisition

Cambridge announced the acquisition of 2 properties at a consideration of $37.1 million. The purchase is at a slight discount to the appraised value of $37.2 million. The property located at 22 Chin Bee Drive has a lease term of 7 years and the initial yield is 9.0%, and there is a rent escalation component of 5% on the 3rd, 5th and 7th year. The property located at 1&2 Changi North St 2 has a lease term of 7 years with an option to renew of another 7 years and the initial yield is 8.01% with annual rent escalation of 1.5%. The total acquisition cost is approximately $37.7 million and will be partly funded with $24.7 million from the private placement proceeds and the remaining $13 million through debt.

Private placement

The private placement consists of 83,683,000 new units which will be placed out to two groups of investor. The first group consists of institutional and other investors and the new units are priced at an issue price $0.478. The second group consists of the Oxley Group and Mitsui & Co Ltd and the new units are prices at $0.503. The private placement is fully underwritten and will raise gross proceeds of $40.0 million and net proceeds of $37.6 million. Part of the net proceeds is used to fund the acquisition while the remaining proceeds will be used for future acquisitions.

Gearing

Gearing is expected to reduce from 42.3% to 41.5% post the acquisition. The REIT will also be repaying $32 million of the existing loan from the divestment proceeds and gearing is expected to further reduce to 39.5%. In relation to the acquisition, Cambridge has secured a $50 million term loan facility and a $20 million revolving credit facility on a 3 year tenor. The term loan facility has an all-in 3.05% interest cost and $13 million will be drawn down to part finance the acquisition.

Advance distribution

Due to the issuance of new units, Cambridge will pay out advance distribution to existing unitholders prior to the issuance of the new units. Management guided the advance payout to be between 0.6 to 0.7 cents. We estimate this to be 0.674 cents and 3Q10 DPU inclusive of the advance distribution to be 1.169 cents.

Divesting non-core assets is positive

At a Glance

• DPU of 1.24 Scts in line

• Restructure portfolio with aim of lowering leverage is positive in the longer term

• Stable 9.9% yields, maintain BUY, TP S$0.54.

Comment on Results

No surprises in 2Q10 results. Topline was slightly lower at S$18.3m (-0.9% yoy) due to divestment of properties; offset somewhat by higher rentals from its periodic rental escalation clauses. Portfolio occupancy remained high at 99.9%, with incomes relatively secured. Net property income improved marginally to S$16.1m (+0.5%) due to lower operating expenses. Despite relatively flat distributable income of S$10.8m, DPU was down 7.8% yoy to 1.24 Scts due to larger unit base.

Portfolio revaluation remained stable. CREIT’s portfolio was revalued at S$831.1m at half time, up S$6.1m (+1%) after netting off its divested properties, translating to 59.9 Scts NAV.

Recommendation

Positive capital recycling strategy. We are positive on management plans to continuously sell its non-core assets, keeping the portfolio relevant. To date, CREIT recorded S$49.7m in asset sales and has contracted to sell another S$40.5m worth in the coming quarters. A majority of the proceeds (up to S$60m) will be used for debt repayments to strengthen balance sheet and lower gearing to <40% by end FY10. The rest will be channeled towards planned asset enhancement initiatives (AEI).

Time to look for growth opportunities? Planned AEI on a couple of its assets could further enhance portfolio yields in the medium term, which are not factored in our numbers yet. Acquisitions however, could be challenging given relatively high-implied yields of c9.0%. With gearing of 42%, any acquisitions would have to be partially funded by new equity, which is expensive.

Buy for stable yields of 9.9%. CREIT remains attractive for its stable FY10-11F DPU yields of 9.9%, 300 bps above the Sreit peers and 740 bps above the Singapore government bond yields.

Executing its articulated strategy in 2010

2 (Outperform) rating maintained

• We maintain our 2 (Outperform) rating and six-month target price of S$0.58, based on parity to our RNG valuation (a finitelife Gordon Growth model). We expect management to continue to show progress in realising its strategy of capital management, divestments, and asset-enhancement opportunities (we expect some imminent announcements in this area) while maintaining a stable quarterly DPU and net-property-income profile.

We expect the valuation discount to narrow steadily

• As long as Cambridge can maintain the momentum of delivering predictable quarterly results while gradually improving its capital position and mitigating its debt-refinancing risk in February 2012, we expect its DPU yield and price-to-NAV differential to narrow relative to its industrial-property peers.

Major risk: lease renewals from FY13

• We believe Cambridge has a favorable short-term lease-renewal profile, with only about 6.9% of leases (by revenue) up for renewal in FY10-12. However, renewals will be a challenge (in our view), with 93.1% of its leases expiring from FY13, although we believe Cambridge has sufficient breathing room to manage these future expiries through pro-active forward leasing or other measures. We also believe its concentration in the CWT (Not rated)/YCH group (24% of gross revenue) does not pose a major concern if the leases are not renewed as the specifications of the properties are of a high quality and their current passing rents are below market rents, according to management.