SHOWING SOLID VALUE HERE

• Market expectations overly pessimistic
  
• Limited office renewal in 2H12
  
• Upgrade to BUY with higher S$1.53 FV
  

The Grade A office bellwether

CapitaCommercial Trust (CCT) is a commercial REIT focused on investing in quality income-producing commercial properties. Its current portfolio consists of 10 quality office commercial assets in the Central Area of Singapore, with a total NLA of approximately three million sq ft and ~550 tenants. One of the first REITs to list on the local bourse in May 04, it is a Grade A office bellwether with total assets of S$6.8b (as of end 2Q12) and market cap of S$3.9b. CCT’s sponsor is CapitaLand.

Better than expected 2Q12 results

2Q12 distributable income of S$58.5m was 7.5% higher YoY and translated to a DPU of 2.06 S-cents per share. Judging from consensus estimates, we believe this to be above market expectations which had anticipated weaker rental reversion performances in the year to date. Key drivers for CCT’s 2Q12 numbers were the revenue contribution from Twenty Anson, higher revenues from Raffles City and HSBC Building, and higher yield protection income for One George Street.

Upgrade to BUY with higher fair value estimate of S$1.53

In our view, the 4.7% dip in Grade A office rentals in 2Q12 was rather benign relative to more pessimistic market expectations. In 2Q12, we also saw the core CDB vacancy rate show a reversal from a rising trend to register a 0.9% dip to 8.4%, mostly due to limited supply completion and a stronger than expected office absorption during the quarter. We see this dynamic of limited office completion and stabilizing vacancy rates continuing till 2H13 (when Asia Square T2 and The Metropolis T1&2 are slated for completion). Moreover, with limited office leases in its portfolio up for renewal (4.1%) in 2H12, we judge CCT’s operating fundamentals to be reasonably sound ahead. All considered, we believe there is solid value at current valuations (0.87x PB with a forward yield of 5.6%) for CCT’s portfolio of prime office assets and operating track record. Upgrade to BUY with a higher fair value of S$1.53, versus S$1.31 previously, as we incorporate stronger cap values for CCT’s portfolio.

Looking for more catalysts

• In line performance, meeting 54% of our FY2012F DPU

• Rents and occupancy continue to be firm

• Downgrade to HOLD on valuation grounds, TP raised slightly to S$1.40

In line performance. Gross revenue and NPI for 2Q12 grew by 5-8% y-o-y largely due the additional contribution from the acquisition of Twenty Anson, as well as higher rental income from HSBC Building and Raffles City Singapore (RCS). Lower property tax, interest cost, as well as interest income from Twenty Anson also helped lift DPU by 7.3% to 2.06 Scts after retaining S$1.3m tax income from Quill Capita Trust (QCT). This brings 1H DPU to 3.96 Scts or 54% of our FY2012 forecast. The trust took in a small revaluation surplus of S$65.8m (+1.07%).

An active leasing quarter. Despite softer leasing activities, portfolio occupancy held steady at 96.21%. In total, the group secured about 180,500 sf, of new leases (50%) and renewals (50%). Monthly signing rents at One George Street was stable at S$9.50 psf and 6 Battery Road at >S$10 psf. The S$92m upgrading works at 6 Battery Road is on track with c.200,000 sf to be upgraded in 2012. Of which, 100,000 sf has been completed and 70% pre-leased. Meanwhile, CCT will be embarking on an asset enhancement initiative (AEI) exercise for Golden Shoe Car Park in 3Q12. The S$0.6m AEI exercise will generate incremental income of S$83,000 or 14% ROI upon completion.

Downgrade to HOLD on valuation grounds. While we like CCT for its strong balance sheet and pro-active leasing strategies, the stock is trading close to our target price, thus we downgrade our call to HOLD. We have nudged up our FY12/13F DPU by c.4 % and TP by 3% to S$1.40 as we lowered the risk free rate while also taking into account higher contribution from the hotel component at Raffles City Singapore, as well as higher takings from Golden Shoe Car Park. Upside risks will hinge on potential acquisitions or better than expected portfolio performance.

Boost From Property Tax Savings

1H12 earnings stronger than expected. CCT’s 2Q12 net property income rose by a better-than-expected 7.8% YoY to SGD75.2m, while the distributable income increased by 7.5% YoY to SGD58.5m, mainly attributable to lower property tax and the addition of Twenty Anson. DPUs for 2Q12 and 1H12 grew by 7% and 5% to 2.06 cents and 3.96 cents respectively. We think this is a creditable showing despite the challenging leasing market. We upgrade our recommendation to HOLD.

Retrospective tax savings. Property tax in 2Q12 was SGD1.7m (or 23.6%) lower than a year before, due to vacancy refund and successful appeal of annual value assessment. For 1H12, the tax savings amounted to SGD4.2m, or about 0.15 cents/unit. Management said that they will continue to work with the tax authorities to ensure the annual value assessment remains fair.

Positive leasing activity in 1H12. In 1H12, CCT signed new office and retail leases and renewals of ~180,500 sq ft, with demand still mainly from financial services companies, although demand is still restricted to small and mid-sized office space. New tenants and existing ones seeking additional space for expansion accounted for approximately half of those spaces. Compared with 1Q12, the average office portfolio rent slid marginally from SGD7.45 to SGD7.39 psf. With another 5.7% of its office NLA up for renewal for the rest of this year, the impact from any potential negative rental reversion is likely to be limited.

Balance sheet’s sound as a pound. On the back of a marginal 1% growth in its portfolio valuation, CCT’s gearing edged down to 30.1% this quarter from 30.5%. There are no refinancing needs for the rest of this year, and the debt maturing in FY13 is a very manageable SGD197m. CCT’s average cost of debt stayed low at 3.1%.

Upgrade to HOLD. We raise our forward DPU forecasts by an average of 4% per annum, mainly due to lower property tax estimates, as well as a slight upward revision in our rental assumptions. We have also raised our terminal growth rate assumption to 1.5%, resulting in a new DDM-derived target price of SGD1.24. We expect the forward average DPU yields to remain fairly stable at 5.7% based on the current share price, but CCT is fairly valued now, in our view. Upgrade to HOLD.

Weak market sentiment going forward

1Q12 DPU in line with expectations. CapitaCommercial Trust (CCT) reported 1Q12 DPU of 1.90S¢ (+3.3% YoY), equivalent to 24.3% of our FY12 DPU estimate. Revenue and net property income came in at S$87.4m and S$69.9m respectively. Although gross revenue fall by 3.9% YoY NPI came in flat as operating expenses dropped by 17.1%. In the subsequent quarters, we expect CCT to register a slight growth in DPU, mainly from additional contribution from the recently acquired building at Twenty Anson Road. Although leasing activities have remained active during 1Q12, we expect the pressure on office rental rates to continue to remain high due to 1) weakening absorption rate for office space amid global economic uncertainty, 2) rising available office space from the secondary market and 3) negative reversion to continue as 1Q12 Grade A and island wide Grade B office rent fell by 3.6% and 1.3% respectively QoQ. We maintain our NEUTRAL call on CCT with an unchanged DDM based (COE: 8.7%; TGR:2.0%) TP of S$1.38.

More space from secondary market expected. During the 1Q12, office stock reached 52.8m sf on the back of 1.3m sf from MBFC Tower 3 completion. Although net absorption for this period grew positively to 587,000 sf (as compared to 93,313 in 4Q11), going forward, we expect sizeable amount of stock from the secondary market to be released as major financial companies move their offices out of the existing buildings to new facilities when their leases are due.

Weak market sentiment for offices. As indicated by CBRE, occupancy rate island-wide during the 1Q12 came in at 92.7%, a drop of 57bps QoQ (-162 bps YoY). Concurrently, Core CBD occupancy rate was noted to have fallen to 90.7% from 91.2% in the previous quarter. During 1Q12, both Grade A and island wide Grade B office rents also declined to S$10.60 psf/mth (-3.6% QoQ) and S$7.25 psf/mth (-1.3% QoQ) respectively. Going forward, we have projected a 10% negative rental decline in 2012.

Limited room for growth in 2012. Due to the expected weak market sentiment for offices together with negative rental reversion and the loss in income due to lower occupancy rate in some of CCT’s properties, we believe there are limited room for growth in near term. At this juncture, we continue to maintain our NEUTRAL rating on CCT and TP of S$1.38.

CapitaCommercial Trust's Q1 DPU gain 3.3%

CapitaCommercial Trust (CCT) announced on Friday its first quarter distribution unit (DPU) was at 1.90 Singapore cents, an increase by 3.3 per cent from the DPU (1.84 Singapore cents) a year ago.

The distributable income was at S$53.9 million for its first quarter which ended 31 March 2012, 3.4 per cent higher than last year's standing.

CCT's 1Q net property income registered no change in percentage year-on-year, while its gross revenue fell by 3.9%, to $87.43 million.

Following the company's refinancing strategy this year, CCT's average cost of debt has decreased to 3.1 per cent in 1Q 2012 from 3.6 per cent in 4Q 2011

CCT's Singapore portfolio occupancy rate was at 96.0 per cent, higher than the market occupancy rate of 90.7 per cent.

Its Grade A occupancy was at 94.4 per cent despite the market's decline to 87.1 per cent.

The outlook for CCT is optimistic as they have recently acquired Twenty Anson, a new and well-located prime office building which will be poised to contribute income to 2Q 2012.

Another 17 tenants from diversified business sectors have also been added to CCT's stable.

"CCT's gearing at 30.5 per cent is still at the low end of our target range, giving us good headroom for future investment opportunities," said Ms Lynette Leong, Chief Executive Officer of CapitaCommercial Trust Management Limited which manages CCT.

No distribution is said to be given for Q1.