DOWNGRADE TO HOLD

•Expect further rental dips in FY12

•Impact on distributable income capped

•Key risks from fair value write-downs

Expect office rentals to dip in FY12

Domestic office rentals peaked in 2H11 and, from our channel checks, we believe that Grade A office rentals has declined a further 3-5% in 1Q12. Given continued macroeconomic uncertainties and an ample office pipeline of 4.2m sqft NLA in FY12-13, we now forecast office rentals to fall 10-15% in FY12.

Downside for distributable income likely limited

That said, we think the downside for CCT’s FY12 distributable income is likely limited. Only 7.9% of CCT’s portfolio gross rental income, primarily at 6BR and One George, is due for renewal in FY12 (29.9% in FY13). Also, despite a forecasted decline in office rentals, we would still likely enter a phase of positive rental reversions in 2H12 as leases signed during the previous trough in 2H09-2H10 are renewed at market levels.

Capital values to face headwinds

However, we believe office capital values could come under pressure with softening rentals expectations, accompanied by cap rates expansion, as major players in the market re-evaluate the office cycle. For CCT’s Grade A portfolio, an average cap rate of 4.0% was used by independent valuers during the latest appraisal in Dec 11, while cap rates in the range of 4.15% to 4.5% were used over Jun 08 – Dec 10 (excluding 6BR, HSBC building). Moreover, we think the recent Twenty Anson acquisition was somewhat aggressive at S$2.1k psf (S$430m) since Capital Tower nearby (also owned by CCT) was valued independently at S$1.6k psf in Dec 11.

Risks from fair value write-downs – DOWNGRADE to HOLD

For CCT’s share price, we see key risks stemming from fair value write-downs as the domestic office sector softens further, though any price downside is likely capped by a currently undemanding valuation (0.7x PB) and a fairly attractive yield (5.7%) for high quality Grade A office exposure. Downgrade to HOLD with a lower fair value estimate of S$1.14 versus S$1.29 previously, to reflect softer cap rate assumptions.

Fairly valued in near term

Limited ro om to drive growth on the back of weak economy. After meeting with the management of CapitaCommercial Trust (CCT) recently, we believe this counter is currently at fair-value with limited upside potential in the short run on the back of slower 2012 economic growth in Singapore. Positive rental reversion, apart from the already signed leases, is also believed to be constrained with MBFC – Phase 2 expected to be completed in 1QFY12. Going forward, we raised our FY11 and FY12 DPU estimates by 3.3% and 1.8% respectively to account for the additional DPU contribution from the new building in 20 Anson Road. Based on our DDM valuation (COE: 8.7%; TGR:2.0%) we maintain NEUTRAL on this counter with an unchanged TP of S$1.38.

Fairly-valued acquisition. The recent purchase of Twenty Anson is expected to add 0.36$¢ to the DPU while the price of S$430m being paid is viewed as fair-valued. Currently, this property is generating a yield of 2.6% with a potential to be increased to 4% when CCT revise the rental rate to the average market rate of S$8.44 psf/month from its current S$6.18 psf/month when 50% and 44% of the property’s NLA is due for renewal in 2013 and 2014 respectively.

Volatile occupancy rate due to AEI. Occupancy rate in Six Battery Road fall to 85.4% in FY11 from 99.7% the year before. Going forward, occupancy is expected to fall with one of its anchor tenant moving out when the lease is due. The occupancy rate at this property is expected to remain volatile until 2013 when the AEI is scheduled to be completed.

Limited room for growth in 2012. Going forward, the positive rental reversion brought about by some of CCT’s properties (e.g. HSBC building) are expected to be offset by the loss in income due to lower occupancy rate in some of its other properties. In addition, with a softer economic forecast in Singapore for 2012, we expect to see strong positive reversion to occur only in 2013. Given limited room for growth in near term on the back of weak economic forecast, we maintain NEUTRAL on this counter at this juncture

CCT acquires Twenty Anson for $430m

IN its first major purchase since the start of its portfolio reconstitution strategy, CapitaCommercial Trust (CCT) yesterday said it had acquired Twenty Anson for $430 million, or $2,121 per square foot (psf) of net lettable area.

To ensure a stabilised net property yield of 4 per cent per annum, CCT will set aside a ‘yield stabilisation sum’ of $17.1 million to be drawn upon over the first 3.5 years. This brings the total purchase consideration, via issued and paid-up share capital of First Office – a special-purpose vehicle (SPV) which owns Twenty Anson – to $446.6 million, taking into account adjustments for First Office’s net liabilities.

The acquisition will be funded using CCT’s existing cash facilities from its divestment of Robinson Point and Starhub Centre in 2010, and bank facilities. No issue of equity or rights units is required.

The acquisition is expected to generate an annualised distribution per unit (DPU) of 0.36 cent.

Comparing the property’s average passing rent of $6.18 psf per month and the current market rate of $8.44 psf per month in the Tanjong Pagar area, there is significant rental upside potential when the leases are renewed, of which 94 per cent are expiring in 2013 and 2014 – when new office supply in the CBD will be well below the historical 19-year average (from 1993 to 2011) of 1.3 million sq ft, noted Lynette Leong, chief executive officer of CCT Management Ltd.

‘Although the high proportion of lease expiries in 2013 and 2014 could expose CCT to tenancy risk for the property, Moody’s believes the well-located and good-quality property, as well as the trust’s strong reputation as an office landlord, would mitigate such a risk,’ said Moody’s in a report.

OCBC said in a report: ‘Given the reasonable price paid, we view this acquisition positively but see little accretive to RNAV at this juncture.’ It maintains a ‘buy’ call on CCT, with an unchanged fair value estimate of $1.29.

AmFraser analyst Lau Wei Chong said the price tag on the building was ‘not cheap, but quite fair’, given that the building is relatively new. ‘Going forward, CCT will probably be beefing up its portfolio of commercial assets. Looking at the situation now, rental rates for older buildings are under pressure, so CCT will also need to renew its portfolio.’

The 20-storey Grade A office tower sits on a site with a remaining lease of about 95 years. It was sold by LaSalle Investment Management and Lum Chang Development Group. Jones Lang LaSalle was the adviser for the deal.

As part of CCT’s reconstitution strategy, the trust has been undertaking asset enhancement works to Six Battery Road, and is developing its Market Street Car Park site into a Grade A office tower, CapitaGreen.

Upon completion, the acquisition of Twenty Anson will increase CCT’s total asset size to $6.9 billion.

CCT’s counter was the top traded property counter yesterday, gaining one cent to close at $1.17.

FY11 NUMBERS IN LINE

•FY11 results in line

•Office rentals to fall further

•Share price shows value

Full year results within expectations.

CapitaCommercial Trust (CCT) reported a distributable income of S$212.8m for FY11, down 3.7% YoY and in line with our full year forecast of S$211.2m. DPU for the full year is 7.52 S-cents. Topline came in at S$361.2m, again tracking closely to our expectations of S$362.7m. This was down 7.8% YoY mostly due to the sale of Robinson Point and StarHub Centre in 2010, the redevelopment of Market St Carpark in 2011.

Bracing for softer rentals ahead.

Overall portfolio occupancy stayed flat at 97.2%, which we note is still higher than the industry average of 91.2%. CCT also recorded marginal fair value gains of S$132m across the portfolio, with the majority of revaluation gains from Raffles City, Capital Tower, Six Battery Rd and One George St. As widely anticipated, we saw an inflection point in office rentals over 4Q11 as Grade A office market rents declined by 0.5%. Looking ahead, we expect office rental levels to decline further in FY12; note however that only 7.9% of leases by portfolio gross rental income for CCT is due for renewal in FY12.

Strong execution from management.

Asset enhancement initiatives (AEI) and the Market St. redevelopment continues to be on track. Demolition works for the Market St building were completed in Dec11. For the AEI at Six Battery Rd, 100% of the upgraded space (93,700 sf) has been precommitted and management will continue enhancements work at that building, timing them according to lease expiries. The occupancy rate at One George St. is currently 93.3%, with new tenants such as The Bank of Fukuoka and Ashmore Investment Management.

Maintain BUY.

We continue to like CCT for its quality portfolio and strong execution by management, with the last traded price at ~27% discount to NAV. Maintain BUY with an lower fair value estimate of S$1.29, versus S$1.41 previously, to reflect lower capitalization rate assumptions.