Growth potential at great price!

At a Glance

• Healthy portfolio performance with occupancy reaching a high of 98%

• Re-rating catalysts from imminent refinancing and potential divestment of Keypoint

• Excellent value; stock at 0.6x P/BV and >7.5% yield. Maintain BUY and TP raised slightly to S$1.08

Comment on Results

Slightly below our expectation, in line with market. On a y-o-y basis, 4Q11 revenue and NPI rose 4-5% to S$30.4m and S$24.3m respectively. Net CPPU dividends, distribution income rose by a marginal 1% to S$9.6m, translating to 1.52 Scts DPU. Net revaluation gain of S$35.6m largely from better performance of its SG and Australia portfolio lifted portfolio value to S$1.9bn or book NAV of S$1.34/unit. Full year DPU of 5.75 Scts makes up 94% of our FY11 estimates largely due to lower non tax deductible items adjustment like amortization cost.

Portfolio performance remained fairly consistent. SMEs or new-to-market companies remain on a lookout for spaces <2,000 sf, which bode well for FCOT SG properties. Portfolio occupancy remained strong at 98% and the group continued to experience positive rental reversion for most of its properties. With about 24.3% of leases (on a see through basis for CSC) in terms of revenue expiring in FY12, there will be organic growth given that expiry rents are below current market level.

Expect a stronger balance sheet. Gearing is now at a healthy 36.6%. Given its lumpy debt profile, FCOT is likely to term out its debt profile by refinancing its S$132m AUD loan first, followed by its S$500m SG loan. We expect the trust to reap interest savings of 50-100 bps.

Recommendation

Maintain BUY.
The possible divestment of Keypoint will unlock FCOT’s latent value, in our view, empowering the REIT to deploy the capital for better yielding opportunities. FCOT trades at an attractive 0.6x P/BV, offers FY12-13F yields of 7.7% – 8.1%. Maintain BUY with a slightly higher DCF-based TP of S$1.08 as we rolled our numbers forward into FY12.

FCOT’s Q4 DPU dips 1.9%

Quarter’s DPU of 1.52 cts compares with adjusted 1.55 cts a year ago; full year DPU up 2.7%

FRASERS Commercial Trust (FCOT) yesterday posted a distribution per unit (DPU) of 1.52 cents for the fourth quarter ended Sept 30.

This is 1.9 per cent lower compared with the previous year when the DPU, after adjusting for a unit consolidation exercise, was 1.55 cents.

For the full year, FCOT’s DPU was 5.75 cents – 2.7 per cent more than last year’s adjusted DPU of 5.6 cents.

Distribution per Series A convertible perpetual preferred unit (CPPU) for both Q4 and the full year remained unchanged year on year, at 1.39 cents and 5.5 cents respectively.

In Q4, FCOT’s total distributable income increased by one per cent to $14.4 million, following a 4.8 per cent rise in net property income to $24.3 million.

Gross revenue climbed 3.8 per cent to $30.4 million on higher contributions from Central Park, Caroline Chisholm Centre and KeyPoint. At KeyPoint, the occupancy rate grew to 88.4 per cent from 81.1 per cent a year ago.

Gross revenue would have been higher if not for lower contributions from the sale of Cosmo Plaza in January, and from lower rental rates at 55 Market Street.

For the full year, FCOT’s total distributable income rose 3.5 per cent to $55.2 million, and its net property income was 3.2 per cent higher at $96 million. Gross revenue increased 1.4 per cent to $119.6 million.

‘The trust has achieved growth in its distributable income to unitholders despite the negative rental reversion in some of its leases,’ said Low Chee Wah, CEO of FCOT’s manager.

Over the financial year, the average occupancy rate for FCOT’s portfolio shot up to 98 per cent from 90.8 per cent a year ago.

Its gearing at Sept 30 stood at 36.6 per cent, down from 39.6 per cent last year.

‘The manager will embark on an exercise to carry out an early re-financing of the trust’s existing debts which are due towards the end of next year to take advantage of the prevailing low interest rate environment,’ said Mr Low.

‘In addition, the manager will continue to review and re-shape the portfolio and to improve the quality of the assets so as to drive better portfolio and financial performance for our unitholders.’

FCOT gained half a cent on the stock market yesterday to close at 79 cents.

Gravitating towards an exciting year!

• Steady portfolio performance with enhancements/repositioning and capital management to boost DPU

• Resilient earnings tied by long/master leases

• Attractive valuations; maintain BUY, S$1.05 TP

Multi-pronged growth strategies to drive DPU. In a recent NDR with FCOT, investors view management’s efforts to reshape its portfolio and strengthen its balance sheet as proactive steps to steer the reit in the right direction. Performance portfolio has improved remarkably compared to the last crisis with occupancy standing at a high of 98% and signing rents moving up nicely. Meanwhile, its balance sheet has improved with gearing at 37% and the imminent refinancing that is likely to lower all-in interest cost by 50-100 bps. The recent approval for an outline planning permission (OPP) to redevelop KeyPoint as well as possible asset enhancement plans at China Square Central (CSC) upon expiry of the master lease in Mar 2012 should further help to optimize portfolio yield.

Stable earnings supported by “sticky” tenant base and long leases. Excluding CSC’s master lease (expiring in Mar 2012), almost half of its revenue is tied to master/long leases of up to 25 years. This would ensure resilient and stable earnings, while allowing the trust to enjoy positive rental reversion. At the same time, we note that rents for its SG portfolio are competitive, hence it is able to cater to a “niche market” ie cost conscious small-to mid-size companies or relocating tenants from soon-to be demolished older buildings. In addition, our scenario study shows that FY12/13F DPU will only fall by a marginal 2-5% should reversion rents fall by 5-10% or to 2009 levels for its SG portfolio, hence minimizing downside risk should there be an economic slowdown.

Attractive valuations at 7.4-7.8% yield. At 0.61x P/BV NAV, FCOT’s implied property yield is significantly higher than the current book cap rates. Therefore, we see potential for the gap to narrow as the group executes its multi-pronged strategies. FY11/12F yields of 7.4-7.8% are also much higher than its peers at 5.6%-6.6%. Maintain BUY at an unchanged DCF-backed TP of S$1.05.

Key to unlock value

• Approval granted to redevelop KeyPoint into a commercial and residential development

• Possible divestment could reap profit of up to c$68m

• Maintain Buy and S$1.05 TP

Keypoint secures approval for residential/commercial development. FCOT announced that the URA has granted an outline planning permission (OPP) for the redevelopment of KeyPoint subject to key terms and conditions including a minimum 60% of GFA allocated for residential use and a commercial portion of not more than 40% but not less than 20% of GFA. The application for the OPP was carried out as part of FCOT’s regular asset management review to identify assets that could potentially be enhanced and optimised.

More options on the cards, possible profit of up to S$68m if a sale materialises. While we acknowledge that any plans for the property is rather preliminary, we see this development as positive as OPP provides flexibility in restructuring and sharpening its portfolio and asset planning including the possible hotel development component at China Square Central. We believe that an option for potential divestment of the property, apart from selling the residential redevelopment component, could unlock value for the trust. Our report highlights two scenarios assuming sale of the property for redevelopment into residential/commercial based on configurations of 60/40 and 80/20. Our estimates show that the trust could potentially unlock up to S$39-68m of our forecast under these two scenarios. This is 14-24% higher than the latest valuation of S$283m for Keypoint.

Maintain Buy, TP unchanged at S$1.05. We continue to like FCOT for its undemanding valuation of 0.6x P/Bk with FY11-12F yields of 7.6-8.1%, 180-240 bps above peers’ average of 5.7%-5.8%. More importantly, we think that the manager has been stepping up to reshape the portfolio in the last 6 to 12 months including the divestment of nonperforming assets. Going forward, we see opportunities for the group to enhance its DPU including the imminent refinancing exercise, which would lead to interest savings.

Poised for the turn

• In line; maintain Outperform. 3Q11 DPU of 1.38cts meets our forecast and Street expectation at 24% of our FY11 figure. 9M11 DPU forms 74% of our estimate. DPU was up 10% yoy on stronger NPI contributions from almost all its self-managed assets mainly on better occupancy. Occupancy at KeyPoint had improved for the ninth consecutive quarter. An improving underlying portfolio at China Square Central meanwhile should position FCOT for upside when it takes over direct management in Mar 12. No change to our DPU estimates or DDM-based target price of S$0.99 (discount rate: 9.4%). With an improving portfolio, stable capital structure and a strong sponsor in F&N, we see no reason for its 35% discount to book amid forward yields of 7%. We see catalysts from early refinancing, the unlocking of value from AEI at China Square Central and improvements in occupancy and rentals.

• 3Q11 net property income up 10% yoy and 4% qoq. NPI was up 10% yoy on stronger contributions from Central Park, Caroline Chisholm Centre and Keypoint. Qoq, NPI was up 4% as there were improvements at its Australian assets. Occupancy at KeyPoint also continued to improve for the ninth consecutive quarter to 86% since the in-house team took over property leasing in 2Q09. Passing rents were stable at about S$5 psf with limited exposure to higher rollover rents locked in at the 2008 peak.

• Improvements at China Square Central. China Square Central’s underlying occupancy improved 20bp, with recent leases renewed at S$6.30-8.00 psf vs. expiring rents of S$6.30 psf and passing rents of below S$6 psf. Continued improvements in occupancy and rentals on the back of more proactive management by FCOT and an upcoming Telok Ayer MRT station could position FCOT for upside when it takes over direct management following the expiry of the master lease in Mar 12.

• Potential upside from refinancing. Asset leverage had been pared down to about 37% after the divestments of AWPF and Cosmo Plaza. This entire amount (S$745m) will mature in 2012. With a high cost of debt of 4.3% and prolonged low interest rates, FCOT could save in terms of interest following the refinancing of this debt. We estimate that a 50bp interest-rate reduction could lift its DPU by 11%.