Continues to deliver

• Results in line, marginal value writedowns

• Improved office demand and rental outlook

• Maintain Hold. Slight adjustment to DPUs which lifted TP to $1.33

Results as expected. CCT reported Q2 distribution income of $55.7m (DPU 1.97cts), up 15.2% y-o-y and 2.1% q-o-q. Net property income rose 1.3% on a mere 0.3% rise in revenue, contributed by marginally higher portfolio occupancy of 95.6%, better rents, lower operating expenses and reduced interest expense. In 1H10, the group has achieved DPU of 3.9cts or 55% of our full year forecast. The group took a marginal 0.5% writedown in its portfolio value to $5.49b, mainly from 6 Battery Rd, Bugis Village and Market St carpark. At this juncture, cap rates remain unchanged from Dec 09 levels.

Leasing demand gains momentum. New and existing tenants are renewing and expanding premises and management appears more upbeat about the rental outlook. The group renewed 442,000sf of leases in 1H10 including notable names such as Credit Agricole, Northern Trust, Accenture. Renewal of a remaining 6.6% of leases this year and a further 20% next year should benefit from the stronger rental market. With the sale of Starhub Centre for $380m, the group’s net gearing level is expected to improve from 32.8% to an estimated 20.8%, hence, providing the financial muscle for new acquisitions.

Maintain Hold. We expect 2H10 to be slightly weaker than 1H10 to reflect income loss from the divestment of Robinson Point and Starhub Centre. We have tweaked our FY10 and FY11 numbers slightly up to 7.2cts and 6.6cts respectively to adjust for non-tax deductible items. CCT is currently trading at yields of 5.4% and 4.9% for FY10 and 11 respectively. Maintain Hold with a slightly higher TP of $1.33. Catalysts, in our view, for the stock remains its ability to pursue yield accretive acquisitions to replenish its portfolio or potential redevelopment of some of its older properties.

1H DPU of 3.9 S cents; CCT more positive on office Sector

1H DPU of 3.9 S cents. CapitaCommercial Trust (CCT)’s 2Q10 gross revenue of S$100.2m edged up 0.2% YoY but slipped 1.6% QoQ. Similarly, net property income gained 1.3% YoY but fell 4.3% QoQ to S$74.2m. The QoQ declines may be due to lower contributions from Robinson Point, sold on 19 Apr. Tax claims on capital equipment and lower interest expenses due to reduced leverage (32.3% versus 41.9% a year ago) resulted in a 15.9% YoY increase in distributable income to S$55.7m. CCT has declared a 1.97 S cents DPU for 2Q10. Unitholders will receive a total of 3.9 S cents for 1H10, translating to an annualized DPU yield of 5.8%. CCT will trade ex-distribution on 28 Jul.

CCT more positive on office sector. CCT signed 277,000 square feet of new leases and renewals during the quarter; demand stemmed from banking, financial and professional services. About half of new leases signed were driven by the expansion plans of existing tenants. Portfolio occupancy improved to 95.6% from 95.1% three months ago, with Grade A office occupancy hitting the 100% mark compared to 99.1% three months ago. The manager’s tone was fairly positive, citing strong pre-commitment for new space, the QoQ up-tick in market rents over 2Q10, and the pick up in leasing momentum at its assets. CCT said that “given Singapore’s strong economic growth, the prospects for further rental growth for Grade A and prime office space appear positive for the rest of 2010.” Negative rent reversions still remain a key risk, in our view.

Scouting for acquisitions. Last week, CCT said it will sell non-Grade A office building StarHub Centre to Frasers Centrepoint Ltd, the property arm of Fraser & Neave [FNN, NOT RATED] for S$380m. This is its second asset sale in the year. Sale proceeds will be used for growth opportunities and/ or to reduce debt. With “ample resources” in the form of sales proceeds and debt headroom up to its long-term 45% target, CCT said it was looking for “well-located Grade A” office assets in Singapore. The re-development of Market Street Car Park, shelved during the crisis, could be an alternative use of the funds (contingent on CCT’s ability to re-obtain Outline Planning Permission from the URA to convert the allowed use of the asset). With a change in analyst coverage, we will be reviewing our assumptions and earnings estimates. As such, our previous HOLD rating and S$1.26 fair value for CCT is UNDER REVIEW.

Distributable income up 16% for CapitaCommercial

Money from StarHub Centre sale to be kept for acquisitions or to repay debt

CAPITACOMMERCIAL Trust (CCT) unitholders will not receive any special payout as a result of the trust’s recently announced $380 million sale of StarHub Centre. Instead, CCT will keep the sale proceeds as dry powder for acquisitions or to repay debt.

CCT will generally be looking at Grade A office assets in Singapore, which tend to be ‘quite sizeable’, Lynette Leong, CEO of CapitaCommercial Trust Management Ltd, said during the trust’s second quarter results briefing yesterday.

The trust has $85 million of debt due to expire this year and a further $841 million in 2011. As at June 30, its cash and cash equivalents totalled $464 million.

CCT posted distributable income of $55.67 million for Q2 ended June 30, up 15.9 per cent from a year back. The improvement was due mainly to lower interest expenses on the back of lower borrowings.

Net property income edged up 1.3 per cent year on year to $74.23 million and gross revenue rose 0.2 per cent to $100.2 million.

CCT booked a $19.6 million gain on the sale of investment property from divesting Robinson Point, which was completed on April 19. It also booked a $12.94 million premium on the repurchase and cancellation of $175 million of convertible bonds due 2013 in Q2 this year.

An independent valuation of the trust’s portfolio of investment properties was conducted as at June 30, which showed a marginal 0.5 per cent or $25.7 million drop in its market value since the previous valuation at end-2009. However, these three items do not affect distributable income.

CCT’s distributable income for the first half of this year was $110.02 million, up 17.8 per cent from a year earlier, on a 2.3 per cent rise in gross revenue to $202.04 million.

Net asset value per unit – after adjusting for H1 distributable income to unitholders – came to $1.36 as at June 30, down one cent from the end-2009 figure.

Distribution per unit for Q2 2010 works out to 1.97 cents. The trust, which pays distributions semi-annually, will make a DPU payout of 3.9 cents for H1. The books closure date is July 30 and unitholders can expect to receive their distribution on or around Aug 27.

DMG & Partners Securities said that the Q2 DPU was ‘about 8 per cent above our and the street’s forecast . . . (but) we maintain our FY2010 DPU forecast of 7.2 cents, in view (of the likelihood) that the sale of Robinson Point and StarHub Centre may reduce overall distributable income in H2 2010’.

‘Management reiterated that they will use proceeds from the asset divestment to retire some of its short-term debt, thereby boosting its credit metrics. CCT trades at 5.4 per cent FY10 yield, and will trade ex-2Q10 distribution on July 30. Maintain ‘neutral’,’ DMG said in a report yesterday.

CCT’s gearing ratio – borrowings over total deposited properties – stood at 32.8 per cent as at June 30, down from 33.2 per cent as at Dec 31, 2009.

In Q2 this year, CCT signed new leases and renewals of 277,000 square feet, taking the total for the first half to 422,000 sq ft. Tenants include Accenture at Raffles City Tower; Credit Agricole Corporate and Investment Bank at Capital Tower; financial research outfit EDHEC Risk Institute-Asia and law firm Watson, Farley and Williams at Six Battery Road; and Northern Trust at One George Street.

Ms Leong said that CCT was seeing growing expansion needs among its tenants. She also remains upbeat on the recovery of Singapore’s office market, after Prime and Grade A average office rental values bottomed out in Q1 this year.

‘We are positive that the continued growth in office demand in tandem with Singapore’s economic development will further strengthen absorption rates and augur well for the office market,’ she said.

StarHub Centre ties its lot to the trump card next door

LAST week, CapitaCommercial Trust (CCT) sold its StarHub Centre at Cuppage Road, a 10-storey predominantly office building, to Frasers Centrepoint Ltd for $380 million, a whopping 42.5 per cent above the most recent valuation of the asset as at June 30, 2010.

In January, the trust’s manager had already revealed that it had obtained outline planning permission (OPP) from the Urban Redevelopment Authority to change the use of the property to residential (capped at 80 per cent of gross floor area) and commercial use from its current zoning of purely commercial use. The StarHub Centre site has a balance lease term of about 85 years.

The sale took place after an expression of interest exercise followed by a private tender.

Besides Frasers Centrepoint, other parties that took part in the bidding process are said to have included GuocoLand.

What was probably the deal clincher for Frasers Centrepoint is that it did not make major conditions or seek provisions which would give it the right to rescind the purchase of the property. CCT’s manager in its release last Friday said StarHub Centre’s sale was not subject to any additional planning or redevelopment approval of any kind following the OPP.

Also, the transaction was not subject to approval for a top-up of the site’s lease, although it revealed that on July 13, Singapore Land Authority gave in-principle lease upgrade approval to top up the site’s lease to 99 years. Frasers Centrepoint also did not require that CCT fulfil the conditions of the in-principle lease upgrade approval.

More options

Frasers Centrepoint could afford not to demand such conditions because of its trump card – majority ownership of the next-door Centrepoint Shopping Centre. The latter fronts the Orchard Road shopping belt and gives Frasers Centrepoint more options than any other bidder that had vied with it for StarHub Centre, which is tucked behind Orchard Road and faces the Central Expressway.

With or without a lease upgrade for StarHub Centre and a redevelopment to a mostly-residential scheme, Frasers Centrepoint can tap more synergies from owning the two properties.

Currently, there is already a second-storey link between the two properties. If SLA proceeds to top up StarHub Centre’s lease to 99 years and URA gives the formal nod for the redevelopment of the property into a mainly residential scheme (60 to 80 per cent of gross floor area or GFA) with some commercial space, Frasers Centrepoint can do retail for the balance commercial component (which has to be 20 to 40 per cent of GFA according to the OPP) and integrate it better with Centrepoint Shopping Centre in front.

The residential component could be in the form of apartments – perhaps smallish units that can be sold at relatively high per square foot prices to help fund the retail portion of the redevelopment.

Who knows, the group could even seek and get permission from the authorities and build serviced apartments for the residential component since it has a serviced residences arm.

Frasers Centrepoint can also endure the risks in the event that the authorities don’t give the final approval for a lease top-up or if the lease upgrading premium Frasers Centrepoint has to pay the state does not make the lease extension an economically viable option. It may not even be too perturbed if URA does not give further planning approvals for the residential-commercial scheme stated in the OPP. If such a scenario materialises, Frasers Centrepoint may still find it worthwhile to redevelop StarHub Centre into a new full-retail project as an extension to Centrepoint Shopping Centre, which fronts Orchard Road.

Deal waiting to happen

Any other developer would be stuck if a lease upgrade is not granted since it would be difficult to redevelop and build a residential component and hope to sell apartments with 80-plus years’ remaining lease. Redeveloping StarHub Centre on the balance lease term into a full-commercial project may not be workable either. As a shopping centre, it is unlikely to do well because of its location, hidden behind the main shopping belt.

Building offices may also not be an attractive venture as office rents in the location are below those in the financial district. As a DMG & Partners Research report notes, ‘at the peak of the office market StarHub Centre had an average passing rent of below $5 psf a month, significantly lower than most schemes in the Raffles Places and Tanjong Pagar vicinity’.

That was probably why CCT came to the conclusion that StarHub Centre had reached its optimal stage of life cycle as an office building.

CCT’s manager was not keen on exposing the trust to the risks in the residential market by undertaking, either solo or on a joint-venture basis, a redevelopment of StarHub Centre into a predominantly residential project.

Even if the trust had sold the asset to its parent, CapitaLand, the latter would not have had as many options as Frasers Centrepoint does. Put simply, CCT’s sale of StarHub Centre to Frasers Centrepoint was a deal just waiting to happen.

Divesting Starhub Centre for S$380m

Second divestment this year. CCT announced the sale of Starhub Ctr, a non-grade A office off Orchard Rd for S$380m (S$1,140psf GFA) to Frasers Centrepoint through a private tender following an expression of interest. FCL, which owns the adjacent Centrepoint SC has a strategic benefit and intends to redevelop the building into a high-end mixed residential & retail. With CCT’s focus on the office sector, mgmt has decided not to participate in the redevt and expose CCT to residential devt & market risk. Starhub Ctr contributes 4% to NPI & 5% to portfolio value.

Sale price of S$380m marginally ahead of S$368m forecast and is 42.5% above its latest valuation of S$266.7m resulting in a net surplus of 109.m (3.9cts/shr) and a 2.9% boost to book NAV to S$1.41. Mgmt plans to use the net proceeds of S$375.8m for acquisitions and/or to repay debt. Depending on how the proceeds are utilized, impact to FY11/12 DPU & DDM ranges fr -4.3% (if proceeds are retained as cash) to marginally positive +1.6% (if debt is retired). With an implied exit yield of 3.2%, redeployment of proceeds into higher yielding assets would be accretive.

Strategically positive but capital redeployment crucial. We see this as a strategically positive move to crystallize value fr its portfolio & could focus attention on its underlying NAV. However, we think capital deployment is crucial to offset the earnings dilution. With its enhanced financial flexibility, CCT is well positioned for acquisitions with c.S$1.78bn in debt funded capacity (incld sales proceeds of S$579m YTD) if it gears up to 45%. Its spare balance sheet capacity also enables it to undertake the redevt of Market St Car Park, a valuable opportunity in our view given falling construction costs & DC rates. Maintain Buy with valuations undemanding at 5.6% FY10e yield and 11% disc to RNAV.