S&P affirms FCOT's 'BB' long-term corporate credit rating, revises outlook to positive

Standard & Poor's on Wednesday affirmed Frasers Commercial Trust (FCOT)'s 'BB' long-term corporate credit rating and revised the outlook from stable to positive.

S&P notes that the "positive outlook reflects its expectation that FCOT's financial risk profile could strengthen in the next 12 to 18 months, assuming the trust uses the proceeds from the proposed sale of KeyPoint to pay down its debt."

FCOT's manager, Frasers Centrepoint Asset Management (Commercial) Ltd, said it will be reviewing the possible uses of the sale proceeds of KeyPoint.

• FCOT has abandoned plan to redevelop Keypoint and instead sell it to a JV between Fragrance and Aspial.

• The property has remaining tenure of 62 years, and the site presently zoned for commercial use, and can potentially yield GFA of 426,421 sf. FCOT had on Aug 15th ’11 obtained approval for a residential cum-commercial development, with maximum gross plot ratio of 5x, or GFA of 391,208 sf.

• The deal between FCOT and Fragrance / Aspial is subject to various conditions, including Singapore Land Authority‘s extending the previous inprinciple approval, or extending terms of lease to a fresh 99 year lease.

• The price is $360 mln before expenses, which works out to $1161 psf, based on current NLA of 309,963 sf. FCOT will realize profit of $72.8 mln from the disposal.

• We would not count on FCOT making a special distribution to its unit holders, as FCOT said it would want to reduce debt, which amounted to $740.3 mln giving a gross gearing of 35.8% at end Mar ’12.

• Note that FCOT’s market price had initially reacted positively to news (in mid August) of the redevelopment plans. Price then was about 80 cents.

• As for Fragrance, which is in the midst of a group restructuring, we would hardly be surprised if management should decide to spend on sprucing up the property and sell it while the demand for office space is strong, as is the case today – witness Oxley‘s namesake development at Robinson Road, or EON Shenton.

• Besides, Hong Fok‘s 360-unit Concourse Skyline in the vicinity still has 130 units unsold (ie 64% takeup), despite getting close to completion next year. It was launched in Sept ’08 at $1600-2000 psf.

• We do not cover the 3 companies.

Unlocking value in Keypoint

• Sells Keypoint for S$360m or S$1161psf of NLA

• Locks in S$75m gain, lifts book NAV to S$1.44

• Maintain BUY, TP raised to S$1.24

Proposed sale of Keypoint FCOT has announced it has entered into an agreement to sell Keypoint for S$360m or S$1161psf of NLA. The purchaser is a company jointly owned by Fragrance Group Ltd and World Class Land Pte Ltd, a subsidiary of Aspial Corporation Limited. The proposed sale price represents a NPI yield of 3.11% and the buyer is mostly likely going to redevelop the building into a residential/ commercial building. The trust has also received inprinciple approval to refresh the 62-year land lease to 99 years.

Price slightly ahead of our expectations. This is slightly ahead of our earlier expectation of S$322-351m. The sale price is also 26.3% above the latest valuation of S$285m as at Sept 2011. The sale was expected and conducted as part of FCOT’s portfolio evaluation strategy. While we are pleased that Keypoint’s occupancy, as well as rental performance for the asset has been improving, we believe the divestment will strengthen its portfolio profile taking into consideration that Keypoint has a shorter leasehold tenure. At the same time, the proceeds will provide the group greater financial flexibility to pursue acquisitions, repay debt or redeem its upcoming CPPU due for redemption in August 2012.

Locks in $75m gain. FCOT is expected to recognise a gain of S$75m from the sale and we estimate it will boost book NAV by 11 Scts to S$1.44. Assuming the proceeds are used to fully pare down debt, gearing will decline significantly to an estimated 27% from its current 40%. Meanwhile, the trust will see decent interest savings as its current all-in-interest rate is 3.9% vs NPI yield of 3.11%. Keypoint contributed about 11% to net property income in 1H12.

Maintain BUY, TP raised to S$1.24. In terms of earnings impact, while FY12 DPU will dip marginally, FY13 DPU is expected to increase by 7%to 6.9 Scts due to significant interest savings. Meanwhile, DCF valuation is raised by 9% to $1.24 with the additional cashflows from the divestment. Maintain BUY with a revised DCF-backed TP of $1.24. We continue to like FCOT for its pro-active steps to reshape its portfolio and strengthen its balance sheet. Rerating catalysts will come from its ability to enhance China Square Central and to improve occupancy, as well as to refinance its S$500m SGD loan due in November this year at a more attractive interest rate.

Another good set of results

• In line with expectations, 1H DPU forms 53% of our FY12 forecast.

• Drop in occupancy likely transient; expect healthy, positive rental reversions to continue.

• Maintain BUY at an unchanged TP of S$1.76

Highlights

In line with expectations. On a y-o-y basis, 2Q12 revenue and NPI rose 27.4% and 30.4% respectively, on the back of a strong portfolio performance, partial completion of the AEI works at Causeway Point and contributions from Bedok Point. However, revenue rose by a more sustainable 5% on a q-o-q basis. Consequently, 2Q DPU came in at 2.5ct representing a 20.8% y-oy and 13.6% q-o-q increase, even though the trust retained S$659,000 for future distribution. 1H DPU forms 53% of our FY12 forecast. The group renewed 77177sf of retail space at 11% higher than the preceding rental rate.

Our View

Healthy operational metrics. While occupancy fell 4 ppt to 93.5%, we believe it is transient, and attributable to the tenant changeover for Northpoint’s foodcourt, as well as thecommencement of the AEI work at levels 5 and 7 at Causeway

Point. Upon the opening of the food court, portfolio occupancy should move closer to c95%. Meanwhile, our recent site visit to Causeway Point reaffirmed our positive view of the AEI works. On levels 1 and 2, the freed up space from the downsizing of the anchor tenant space has been rented out to new tenants, thus enhancing the mall tenant mix and increasing its attractiveness. Meanwhile footfall was also healthy, therefore, we think the trust should be able to drive rental reversions for the remaining c48,000sf of leases expiring this year.

Balance sheet remains robust. Gearing is at a healthy 30.9% with no major refinancing (only S$75m in FY12). Average cost of borrowings dropped marginally by 3.06% to 3.04%

Recommendation

Maintain BUY. We continue to like FCT for its pure suburban exposure and strong balance sheet. FCT is currently offering a FY12/13 prospective yield of 5.7% – 6.1% and our unchanged DCF-backed TP of $1.76 offers a total return of close to 20%.

Management scores again

FCOT’s sale of KeyPoint for3.1% yield and an estimated S$73m gain is a major positive, in our opinion, opening doors to options, all of which could be accretive for unit-holders. We continue to expect stock outperformance, as management continues to deliver.

We keep DPU estimates unchanged pending EGM approval of the deal (expected in Jul) though we believe unit-holders are likely to approve. Maintain Outperform and DDM target price (discount rate: 9.4%).

What Happened

FCOT will be selling KeyPoint for net proceeds of S$357.8m (S$1.2k psf, S$73m above book value of S$285m) for a tight yield of 3.1%. The buyer is a company jointly owned by Fragrance Group and World Class Land Ltd. Proceeds will be used to lower asset leverage. As expected, management won’t be paying out capital gains.

What We Think

The sale is not a major surprise given previous news reports of management’s intention and based on past conversations with management. Management had, in fact, somewhat “dragged its feet” on this long-awaited S$ refinancing. Assuming all the proceeds are used to lower debt, we estimate that asset leverage will drop near 28%. Qoq fluctuations from a loss of income from KeyPoint should be minimised by its recently-acquired 50% stake in Caroline Chisholm Centre, and also adequately compensated by interest cost savings upon any debt repayment (estimated S$ cost of borrowing of 3.8-4.0% vs. divestment yields of 3.1%), assuming no major time lag.

Management should be able to gear up eventually at low costs of borrowing to :1) redeem its 5.5% CPPU; 2) buy back shares at current yields of 7-8% (both immediately accretive); and/or 3) buy Valley Point and/or Alexandra Point from its sponsor (less accretive but expanding its asset base). All combinations should work out positively for unit-holders.

What You Should Do

The deal is a major positive, further bolstering our confidence in management. Maintain Outperform.