Appears fairly priced now

• 2Q14 DPU flat YoY at 2.147 S cents
  
• Moving towards multi-tenanted lease profile
  
• Upside likely limited at current level
  

In-line 2Q14 results

Cache Logistics Trust (CACHE) reported its 2Q14 results last evening, with NPI flat YoY at S$19.6m and distributable income up by 0.5% to S$16.7m. DPU stood at 2.147 S cents, unchanged from 2Q13 but up 0.3% QoQ. For 1H14, DPU cumulated to 4.287 S cents, down by 2.1% YoY due to a 5.0% increase in unit base over the period. We deem the results to be within expectations, as 1H14 distribution formed 49.3% of both our and consensus full-year DPU forecasts.

Still on a stable footing

CACHE’s portfolio remained largely resilient in our view. There was a slight dip in portfolio occupancy to 99.6% from 100% in 1Q, as the master lease at Jinshan Chemical warehouse has expired. However, as we were previously guided, underlying portfolio tenancy was close to fully occupancy, hence limiting the downward pressure. CACHE shared with us its strategy to transform the portfolio into a more multi-tenanted lease profile to reduce the concentration risk and capture the benefits of market cycles going forward. We are more neutral on the move in view of the substantial supply in warehouse space over the next two years and imposition of several cooling measures in the industrial market, including recent revision in JTC subletting policy. Nevertheless, we note that sponsor CWT Limited and C&P Group will remain as major tenants, occupying ~50% of the total NLA at the end of their respective master leases in Apr 2015. Over at C&P Changi Districentre, CACHE also disclosed that it has made good progress on its lease renewal, securing ~63.0% commitment ahead of its master lease expiry in 2015. This should limit any volatility in occupancy and income once the assets are converted into multi-tenancies.

Downgrade to HOLD on valuation grounds

CACHE’s units have enjoyed a good run-up in prices, and as a result, the last transacted price is just a tad lower than our fair value of S$1.25. While we continue to like CACHE’s strong financial position and quality portfolio assets, we believe that the stock is fairly priced at current level (1.27x P/B). As such, we downgrade CACHE from Buy to HOLD on valuation grounds.

Delivered on expectations. Cache’s 2Q14 gross revenue and NPI were within 0.8% and 2.2% of our forecasts, with 1H14 DPU of 4.287c forming 50% of our FY14 estimate. The 2Q distribution of 2.147c will be paid on 26 August. Gross property revenue and distributable income were respectively 1.7% and 0.5% higher YoY.

Strategic shift towards multi-tenanted assets… While only 1% of leases is set to expire in the rest of FY14, management has already begun to plan ahead for FY15, securing 63% of pre-committed leases by NLA for C&P Changi Districentre. This comes as management and major tenants CWT and C&P have jointly agreed to wind down the master tenancies, though they will still occupy c.50% of total NLA at the end of their master leases in April 2015.

…but outlook clouded by new JTC policy, record supply. The new JTC requirement for anchor subtenants to lease ≥70% of GFA for a minimum of 3 years, coupled with the record supply of industrial space coming online in FY14, will put further pressure on an already-soft market. According to Colliers, 2Q14 warehouse rents declined 1.6-2.4%, the third consecutive quarterly decline.

Venturing beyond core markets? Interestingly, we note management highlighted quality deal flow in investible markets such as Australia and China had increased. With a 2013 Moody’s rating of Baa3 Stable and current aggregate leverage of 28.9% as of 2Q14, we think Cache could potentially make opportunistic acquisitions outside its core markets should something attractive come along, while remaining at comfortable gearing levels of c.40%, implyingS$95.9m of debt headroom above FY14F levels.

FV $1.41 unchanged on solid results. We keep our DCF-derived target price unchanged on Cache’s solid performance and FY14F yield of 6.9% despite headwinds in its core market, keeping an eye on both market reactions to leasing policy and developments overseas.

DHL project a key earnings driver

• 1Q14 profit in line; DPU fell y-o-y due to larger share base
• High income visibility for rest of 2014 with only 2% of leases expiring
• Built-to-suit project for DHL, a key driver of inorganic growth; gearing to settle at c.36%
• Maintain BUY rating and S$1.29 TP (DCF metric)

Highlights

1Q14 results in line. Topline and net property income grew 8.2% y-o-y to S$20.7m and S$19.6m, respectively. This was led by contribution from an expanded portfolio (Precise Two warehouse), supported by higher rental income from annual step-ups. Interest cost was 2.7% lower y-o-y due to a lower all-in rate of 3.48%. As a result, distributable income grew 5.5% y-o-y to S$16.7m. However, DPU edged down 4.2% y-o-y to 2.14 Scts due to a larger share base. Operating performance was stable compared to the previous quarter.

High income visibility with minimal expiries in 2014; negotiating renewal of master leases due FY15/16. Cache has renewed the lease for Kim Heng Warehouse for another two years, which means minimal lease expiries (2% of rental income) for the rest of FY14. The bulk of its income will expire in FY15F/16F (mainly the master-leases for IPO properties) but the manager is actively engaging with the master lessees (CWT and C&P Limited) to renew the leases.

Our View

Built-to-suit DHL project to drive growth from FY15F. Supported by a portfolio of warehouses under master leases with annual step-ups that offer high income visibility, the manager has embarked on the Trust’s largest built-to-suit project (BTS) to date for DHL Singapore. Construction of this ramp-up warehouse facility is expected to start in the middle of 2014 and would be completed in phases from 2H15. We have assumed Cache would fund this acquisition with debt and expect gearing to settle at c.36% upon completion (vs 29% currently).

Recommendation

BUY, TP S$1.29. The stock is attractive, offering yields of close to 7.4%-7.7% and a total return of 16% to our TP.

Post-results luncheon feedback

Key issues discussed during the post-1Q14 results investor luncheon we recently hosted for Cache were 1) the BTS project for DHL, 2) the leases due for renewal in FY15, 3) the outlook for the warehouse rental market, and 4) Cache’s financing needs. We came away with our positive view on the stock intact.

What Happened

We recently hosted a post-1Q14 results investor luncheon for Cache.

What We Think

The discussion reaffirms our belief that Cache will benefit from the upcoming BTS project. Upon completion, this property will be used as the Asian headquarters of DHL and will be fully committed by the said tenant within two years of the completion of construction. This project is well-timed given a slower market sentiment on the warehousing industry on the back of a short-term oversupply, particularly from the shadow spaces that will be released into the market in the coming quarters.

Cache’s portfolio has historically been very stable, mainly due to the master leases undertaken by its sponsors. However, looking ahead, with 34% of leases due to expire in FY15, there is a risk that some of these upcoming leases may not be renewed by the sponsor. Having said that, we find comfort in management’s confidence that it will continue to achieve high occupancy even if the leases are not renewed. This confidence is underpinned by the strong geographical positioning of the properties and the costs involved for the tenants to move out, thus significantly limiting the number of choices. In addition, even though the rental market remains soft at the moment, management is confident of getting positive rental reversions for these upcoming leases if they are not renewed as the underlying rental rate is still below the market spot rent despite an annual step-up rental rate of 1.5-2.5% p.a. since 2010. According to URA data, the rental rate for warehouses has jumped by c.50% from S$1.50 psf/mth in 1Q10.

What You Should Do

Although some execution risks may arise if the master leases are not renewed, the potential upside to rental rates could mitigate any probable downside in the event of a dip in occupancy. We maintain our Add rating.

Slow and steady

CACHE’s 1Q14 distributable income expanded 5.5% yoy and its DPU was in line with expectations, accounting for 25% of our and consensus full-year forecasts. While DPU declined 4.2% yoy due to the dilution effect from its placement in Mar 13, we expect this to be mitigated as the trust deploys proceeds into its BTS project. Operationally, CACHE’s properties remain stable, with 100% occupancy and in-built rental escalation of 1.25-2.5%. We

expect growth to come from its recently-announced S$105m BTS project and stabilised NPI yield of c.7%. Maintain our Add rating, with an unchanged DDM-based target price (discount rate: 8%) of S$1.33.

1Q14 results highlight

CACHE’s 1Q14 NPI expanded 8.2% yoy and distributable income rose 5.5% yoy. During the quarter, it renewed the master lease at Kim Heng Warehouse with its existing tenant and announced that it will develop a build-to-suit (BTS) logistics warehouse for DHL.

Stable portfolio with growth from BTS

Operationally, CACHE’s portfolio remains stable, with a 100% occupancy rate, in-built step-up within master leases of 1.25-2.5% p.a., and minimal lease expiries due in 2014. With only 2% of leases (as percentage of leased area) due to be renewed for the rest of the year, we note that potential rental downside in the near term is limited. Respectable growth should come from its BTS project which is set to start contributing in 4Q15, with a stabilized NPI yield of c.7%.

Balance sheet is healthy, with a gearing of 29.1%. We expect its balance sheet to remain healthy at c.34.8% post the BTS project, largely in line with the S-REIT average of 32.5%.

Maintain Add

We maintain our Add recommendation in light of its stable portfolio and growth from the BTS project. CACHE’s FY14/15 dividend yield of 7.4%/7.6% is above the S-REIT average and in line with its industrial peers. While trading at a premium to book value at 1.18x P/NAV, we believe its stability is valued and that the BTS project will be NAV-accretive upon completion.