Rich Valuations

4Q12 remained an active quarter of leasing for CCT. In 2013, all eyes are likely to rest on One George Street with the expiry of yield support and departure of major tenant, Wong Partnership in mid-2013. We view CCT’s current valuations as stretched.

4Q12/FY12 DPUs met our and market expectations, at 26%/101% of our full-year forecast. Factoring in 4Q12, we tweak DPUs but keep our DDM-based target price (discount rate: 7.3%) unchanged. We maintain an Underperform on valuations and uncertainty after income support falls off.

Steady leasing

We expect FY13 DPU to be flat as positive rental reversions and potential interest cost savings (with the expiry of a high-cost interest rate swap) mitigate downside from downtime on back-filling and expiry of income support at One George Street. 4Q12 DPU was up 7% yoy on higher contributions from HSBC Building and 20 Anson.

Management remained active in leasing in 4Q, signing 140,000sf of leases. Demand was still mainly from smaller and mid-sized non-financial tenants. With back-filling, occupancy inched up to 97.2% from 97.1% last quarter. Management is targeting an estimated 171k sf of space (86% pre-committed) for upgrading at Six Battery Road. All eyes this year are likely to rest on One George Street with the expiry of yield support (passing rents of S$8+ psf vs. support rents of S$11.5psf) and impending departure of major tenant Wong Partnership in mid-2013.

Lower cap rates

CCT’s asset portfolio was revalued upwards by S$129m (+3%) as a 25bp cap rate compression on its Grade A offices offset lower forward rental projections. Office assets are now valued at 3.75-4.25% cap rates.

Maintain Underperform

Given the flattish DPU outlook and uncertainty with the fall-off in yield support, we see valuations stretched at 1.1x P/BV and forward yields of 4.8%. Upside could also be capped by its two tranches of convertible bonds due 2015 and 2017 which are already in the money, at S$1.23/ shr and S$1.64/shr, respectively.

Good Quarter But Not Without Concern

FY12 earnings in line with expectations. CapitaCommercial Trust (CCT) reported its FY12 results with a DPU of 8.04S¢ (+6.9% YoY); largely inline with our estimate of 8.02S¢. Revenue and net property income for the period came in at S$375.8m (+4.0% YoY) and S$295.5m (+6.6% YoY) respectively. Distributable income came in at S$228.5m (+7.4% YoY); mainly attributable to revenue contribution from the acquisition of Twenty Anson and higher rental income from HSBC Building. These results are generally respectable as 2012 has proven to be a challenging market for the office sector. However, the increase in income support, particularly for One George Street, remains a concern as it rises to S$4.2m in 4Q12 (vs S$2.2m 4Q11). Going forward, although CCT’s portfolio is expected to benefit from positive rental reversion, as 28.8% of NLA is due for renewal in FY13, the expiry of income support at One George Street in July 2013 proves to be a concern in the short term. With a forecasted FY13 dividend yield of 4.7% at current share price, we have downgraded our rating on CCT to Neutral with a slightly tuned down DDM based (COE: 8.0%; TGR: 1.0%) TP of S$1.70.

Concern on the ending of income support for One George Street. During 4Q12, it was noted that the income support for One George Street amounted to S$4.2m (S$18.1m for FY12) vs S$2.2m for 4Q11 (S$5.0m for FY11). This was mainly attributed to negative rental reversion in this property coupled with the moving out of several tenants over the year (committed occupancy for this building was 92.5% in 4Q12). As the income support is due to expire in July 2013, the relatively low occupancy and negative rental reversion posts to be a key uncertainty in our valuation of CCT. In view of this, we have tuned down our FY13 DPU estimate by c.1.5% to justify for a probable weaker 2H13.

Well positioned to enjoy positive rental reversion in FY13. Going forward, we believe CCT will remain largely stable on the back of additional contribution from Twenty Anson and positive rental reversion from leases that will expire in 2013 (26.2% of gross rental income). Currently, CCT’s average passing rent for the leases to expire in FY13 is at S$7.64 psf/mth. As compared to the market rate of S$9.58 psf/mth, we believe CCT is currently well positioned to capture potential rental upside when its leases expire in FY13.

Downgrade to NEUTRAL with lower TP of S$1.70. As CCT currently trades at a forecasted FY13 dividend yield of 4.7%, coupled with a possible weaker 2H13 on the back of the upcoming lost in income support as highlighted above, we have downgraded our rating on this counter to NEUTRAL with a slightly tuned down DDM-based TP of S$1.70.

AVERAGE PORTFOLIO RENTALS UP

• 3Q12 figures mostly in line
  
• Average portfolio rentals up
  
• FV estimate increased to S$1.70
  

3Q12 distributable income in line

CapitaCommercial Trust (CCT) reported 3Q12 distributable income of S$57.9m – up 11.6% YoY mostly due to contributions from Twenty Anson, higher revenues from portfolio assets and yield protection income from One George Street (OGS). This is mostly in line with expectations and we note 9M12 distributable income now makes up 75% of our FY12 forecast. 3Q12 distributable income translates to a distribution per unit (DPU) of 2.04 S-cents for the quarter, translating to an annualized distribution yield of 5.1% on the last closing price (S$1.58 per unit). 3Q12 topline came in at S$95.5m, increasing 7.0% YoY – again generally within expectations.

Sector fundamentals driving healthy portfolio performance

As indicated in our last two reports, we have expecting an uptick in office fundamentals from 3Q12 till at least 2H13 and believe this was mostly validated by data-points from CCT’s 3Q12 performance: 1) portfolio occupancy edged up QoQ to 97.1% in 3Q12 from 96.2% in 2Q12, and 2) average portfolio rent per square foot increased to S$7.53 – the first increase seen after seven consecutive quarters of decline from 4Q10. We expect this to continue ahead – note that a third of CCT’s office net leasable area is up for renewal in FY13 and that current market rents currently stand at S$9.80 psf.

Maintain BUY

Since we have upgraded CCT to a BUY on 21 Aug 2012, the REIT has appreciated 14% over this time (significantly outperforming the STI which is down marginally -0.1%). At this juncture, we continue to like CCT for its prime assets, relatively stable portfolio drivers and strong execution from management. CCT recently announced a S$34.7m upgrading at Raffles City while OGS’s AEI and CapitalGreen’s construction progression remains on track. Maintain BUY with an increased fair value estimate of S$1.70, versus S$1.62 previously, as we update our model for firmer rental numbers and cap rates.

REFINANCED CONVERTIBLE BONDS DUE 2013

• Refinanced 2013 CB
  
• Rental declines to slow in 3Q12
  
• Higher FV of S$1.62
  

Refinanced convertible bonds due 2013

CCT recently announced that it had refinanced the outstanding balance of its convertible bonds due 2013 with a new S$175m CB issue due 2017. The new 2017 CB has a yield to maturity of 2.5% (versus 3.95% for the 2013 CB), and would yield net proceeds of S$171.9m, of which S$141.1m would be paid for the 2013 bonds (total of S$126m face value) priced at 111.30 and S$20.75m for the settlement of a clean-up call at 109.37 expected on 15 Oct 2012.

CapitaGreen and 6BR AEI progressing as planned

We note that construction works for CapitaGreen is progressing well, with construction status currently at 26% (foundation piling) and main works staying on schedule for completion in 4Q14. The S$92m AEI at Six Battery Road is also on schedule; 200k sq ft of space was targeted for upgrading in FY12, of which 49% was completed in the first half of the year.

Office rentals decline likely to slow in 3Q12

We believe that Grade A office rentals are likely to show a more subdued dip in 3Q12 after three consecutive quarters of declines since 3Q11. Over 2Q12, Grade A office rentals fell 4.7% QoQ to S$10.10 which cumulated in an 8.7% decline over three quarters. Core CBD vacancies, however, showed a reversal from a rising trend in 2Q12 to register a 0.9 ppt dip to 8.4%. A similar picture was seen for islandwide vacancy rates which declined 0.9 ppt to 6.4% (end 2Q12) from 7.3% (end 1Q12). We expect a similar trend for vacancies in 3Q12 which would likely contribute to a muted rate of rental decline.

Maintain BUY

We like that CCT continues to comfortably manage its debt expiry schedule and maintains steady access to capital markets at relatively attractive rates. Maintain BUY with a higher fair value estimate of S$1.62 (versus S$1.53 previously), as we incorporate firmer cap rates assumptions to reflect more benign expectations for the office sector.