Growth delivered, as expected. CCT’s FY14 results came in within expectations, as full-yearDPU rose by 3.9% YoY to 8.46 cents, led mainly by stronger contributions at Capital Tower and Six Battery Road. While we expect more growth ahead with CapitaGreen (CG) coming online, we believe CCT is fairly-valued and its FY15F DPU yield of 4.6%is relatively uncompelling. Maintain HOLD and TP of S$1.76.

Capitalising well on tight market. CCT’s portfolio occupancy was robust at 96.8% as at 4Q14. Excluding the recently completed CG, its office properties operate at occupancies in excess of 97%. Capital Tower and Six Battery Road saw their revenues increase by 8.8% and 12.8% YoY respectively, offsetting the 5.8% decline at One George Street due to the cessation of its yield protection in July 2013.

CapitaGreen leasing demand beat expectations. As at Dec 2014, CG achieved a commitment rate of 69.3%, exceeding management’s target of 50%. To minimize potential impact when the wave of new Grade A office supply hits the market in 2016, most tenants at CG have been signed on leases longer than three years, with 91% (by gross rental income) of the committed leases expiring only in 2019 and beyond. Management expects CG to contribute meaningfully to Distributable Income only in FY16, as tenants progressively move into the property.

Not if, but when. CCT has a call option to acquire the remaining 60% stake in CG from its JV partners, CapitaLand and Mitsubishi Estate. The option is valid for three years starting from Dec 2014 with the completion of the property and will be priced at market valuation. CCT has debt headroom of S$1.3b assuming 40% gearing, which will cover the cost of the potential acquisition. We reckon that CCT will trigger the option only when the property’s occupancy rate exceeds 95% to minimize the need for income support.

Fairly valued, maintain HOLD. We like CCT’s sound capital management, with a low gearing of 29.3% and 83% of its borrowings are on fixed rates which minimizes uncertainty when interest rates rise. However, valuations are no longer compelling with FY15F DPU yield expected to be merely 4.6%. Our DDMderived TP remains unchanged at S$1.76.

Poised To Benefit From Rental Uplift

CapitaCommercial Trust’s (CCT) Q314 results were in line. CCT achieved 40% pre-commitment for CapitaGreen, with Cargill taking up additional space. CCT needs another 70,500 sqf before reaching the targeted 50% pre-commitments by year-end. Anchor tenant, GIC Pte Ltd, which contributes 5% to gross rental income, will renew its leases at Capital Tower in 2015. The management expects significant rental reversions. Assume coverage with BUY and TP of SGD1.80 (from SGD1.44), resulting in a 15.8% total return upside.

• Results in line with expectations. CCT saw a 2.9%/4.5% YoY increase in 3Q14/9M14 DPU to 2.10/6.32 cents, accounting for 26.0%/76.8% of our forecasts. Balance sheet remained strong, with a low gearing of 30.2% and 80% of borrowings on fixed rates. CCT has debt headroom of SGD1.2bn, assuming a gearing of 40%. Portfolio occupancy rate remained unchanged at 99.4%, while monthly average office portfolio gross rent continued its uptrend, increasing to SGD8.42 psf from SGD8.23 in 2Q14.
  
• CapitaGreen achieves 40% pre-commitment (2Q14: 23%). CCT secured leases for an additional 114,500 sqf at CapitaGreen, clocking in a total of 279,500 sqf leasing commitment. The new leases include additional space take-up by Cargill, and new tenants from the Banking, Insurance and Financial Services, Real Estate and Food & Beverage sectors. CCT is in advanced negotiation for another 75,000 sqf, on target to achieve its 50% leasing target by end of the year. We expect the new tenants to be signing up at rentals north of SGD10-11 psf/month vs “lossleader‟ Cargill, who contracted for 51,000 sqf in 1Q14 at a likely rental of SGD9-10 psf/month.
  
• Our view. Being one of two major prime office developments (the other is the 527,000-sqf South Beach Development) in the CBD due to complete this year and next, we expect CapitaGreen to be fully occupied by end-2015, with higher rentals of SGD11-12 psf/month progressively signed in 4Q14-2015. CCT is poised to benefit from higher office spot rents as it has one of the most favourable lease expiry profiles among office REITs: ~44% of office leases, by monthly gross rental income, are expiring in 2015-2016. Assume BUY with a DDM-derived TP of SGD1.80 (COE = 6.8%; TG = 2%) (from SGD1.44), implying a 15.8% total return upside.

Credit rating upgraded by S&P

• Upgraded to A- by S&P
  
• 40% gearing -> S$1.3b debt headroom
  
• Likely to buy remaining 60% of CapGreen ahead
  

Long-term corporate credit rating upgraded to A- (stable)

Earlier this week, Standard and Poor‟s Rating Service (S&P) announced that it had upgraded CCT‟s long-term corporate credit rating from “BBB+‟ to “A-” with a stable outlook. The rating agency had reassessed CCT‟s appetite for expansion and believes that the trust would likely “remain disciplined in using debt to fund new investments.” In addition, the trust‟s risk profile has been reinforced by its stable business performance, consistent cash flows, high occupancies and an expanded asset portfolio with CapitaGreen‟s anticipated completion by end-2014. We note that CCT currently enjoys one of the highest credit ratings in the S-REITs sector – only below that assigned to CapitaMall Trust (A2) by Moody‟s.

Significant debt headroom of S$1.3b to 40% gearing

CCT‟s gearing stood at a healthy 28.8% as at end 2Q14 – down 1.2 ppt QoQ from 30.0% as at end 1Q14 – which is the lowest amongst its peer group of office S-REITs (average gearing of 36.0%). Recall that MAS regulations stipulate S-REITs without a credit rating are required to cap their gearing below 35% while those with a rating are allowed to go as high as 60%. CCT has significant capital headroom for acquisitions ahead; by our estimates, the trust has a debt headroom of S$1.3b before it hits a 40% gearing level.

Likely to exercise call option on remaining 60% of CapGreen

Looking ahead to FY15, we believe that management will likely exercise its call option to purchase the remaining 60% of CapitaGreen that it does not already own (50% owned by CapitaLand and 10% by Mitsubishi Asia). Assuming a valuation of S$2.5k to S$2.8k psf NLA for CapitaGreen, this will cost S$1.0b – S$1.2b which CCT can wholly fund using debt and yet land under a 40% gearing ratio post-transaction. Maintain HOLD with unchanged fair value estimate of S$1.67.

In a sweet spot, for now

• DPU grows 3.7% despite dilution from 2014 CBs
  
• Higher income from Capital Tower and 6 Battery Road offset loss of income support at One George Street
  
• CapitaGreen: income contribution pushed back as Manager prefers to wait for 2015
  
• Maintain HOLD, TP S$1.67
  

Highlights

Strong set of 2Q14 results. CapitaCommercial Trust (CCT) reported gross revenue of S$65.8m (+3.2% y-o-y). The increase in rental income came mainly from an improvement in occupancies at its major buildings (namely Capital Tower, 6 Battery Road) which more than offset the loss of income support from One George Street. Net property income grew at a smaller 2.0% y-o-y to S$52.0m, mainly due to higher property taxes and operating costs. Distributable income to unitholders came in at S$64.1m (DPU of 2.18 Scts), which was 3.7% higher y-o-y, boosted by release of QCT distribution income (S$2.35m, nil a year before).

Stable valuations. Portfolio valuations were written upward slightly, supported by higher rents achieved across the portfolio. Due to a change in valuers, cap rates expanded slightly by c.10bps for its Grade A buildings, but remain at the 3.75%-4.25% range. NAV remain stable at S$1.67 per unit.

Our View

Portfolio occupancy remained robust at 99.4% During the quarter, the Trust renewed/leased 83.5k sqft of office space and 14k sqft of retail space, with 31% of leases coming from new tenants in the financial services, retail products/services and energy/commodities/maritime & logistics industries. Strong demand for office space also resulted in significantly higher committed rents at 6 Battery Road (S$12.50-14.00 psf pm vs S$11.84) and One George Street (S$10.40-11.00 psf pm vs S$9.55) relative to both expiring rents, as well as comparable market rents.

CapitaGreen 23% pre-leased. CapitaGreen has achieved precommitments for 23% of NLA. We understand that the average rents for these initial leases are still below market rates of S$10.60 psf pm but the latest leases signed are starting to inch higher. Given that this is still some way off from target rents of S$12-14 psf pm, the Manager has indicated that it is content to hold off some leasing activity until 2015, and has guided for positive DPU contribution only in 2016. While we like this wait-and-see strategy, we remain cautious about the strength of new demand, given that we haven’t seen much new demand for floor plates that would have traditionally been a catalyst for sharp increases in rent levels.

Recommendation

Maintain HOLD, TP S$1.67. We have raised our estimates slightly to account for higher portfolio occupancies and rents achieved. While we believe that CCT will continue to be a main beneficiary of the supply crunch in the CBD over 2014-2015, with CapitaGreen only contributing meaningfully from 2016 onwards, immediate term growth is likely to be flattish, diluted by conversions of the CBs. The stock offers dividend yields of 5.0-5.1%, which is fair.

CapitaGreen’s completion on track

• 2Q14 figures within expectations
  
• CapitaGreen 23% pre-committed
  
• Call option within 3 years of completion
  

2Q14 results within expectations

CapitaCommercial Trust (CCT) reported 2Q14 distributable income of S$64.1m – 7.6% higher YoY. This cumulates to an YTD distributable income of S$124.0m, which is within expectations and makes up 51.0% of our FY14 forecast. 2Q13 DPU is 2.18 S-cents, which is 5.3% higher than the 2.07 S-cents paid in 2Q13 and translates to a 5.1% distribution yield as at the last closing price of S$1.67. The growth in distributable income over the quarter was mainly due to stronger contributions from assets, lower interest expenses and the release of retained tax-exempt income distribution (S$2.4m). In terms of the topline, 2Q14 gross revenues increased 3.2% YoY with all properties, except One George Street, clocking higher income over the quarter.

Stable portfolio performance

Portfolio occupancy remained stable at 99.4% as of end 2Q14 versus the previous quarter. As a result of continued rental reversions, CCT’s average committed office portfolio rentals increased marginally QoQ from S$8.22 to S$8.23/sq ft. Over the quarter, the trust signed leases for 97.5k sq ft of space, of which 31% are new leases, and the portfolio WALE (weighted average lease term to expiry) as at end Jun-14 stands at 7.8 years. CCT continues to enjoy a healthy balance sheet, with gearing improving to 28.8% as at end 2Q14 from 30.0% the previous quarter, and an average cost of debt of 2.4%.

CapitaGreen achieved “top-out” and now ~23% pre-committed

CapitaGreen’s structural work has reached the top floor and remains on track to complete by the end of this year. The trust has secured aggregate lease commitments for ~23% (165k sq ft) of total NLA, and expects CapitaGreen to contribute revenue to MSO Trust from 2H15 onwards, and to distributable income from FY16. We also note that CCT has a call option to acquire, from its JV partners, the remaining 60% stake in CapitaGreen at market valuation within three years of completion. Maintain HOLD with an unchanged fair value estimate of S$1.67.