FCOT posts DPU of 1.38 cents for Q3

FRASERS Commercial Trust (FCOT), whose five-into-one unit consolidation was completed in February this year, yesterday posted a distribution per unit (DPU) of 1.38 cents for the third quarter ended June 30.

This is 10 per cent higher than a year ago, when the DPU, after adjustment for the unit consolidation effect for comparison, was 1.25 cents.

Distribution per Series A convertible perpetual preferred unit (CPPU) was 1.37 cents, unchanged year on year.

FCOT’s Q3 results were driven largely by higher contributions from a local property, KeyPoint, and two Australian properties, Central Park and Caroline Chisholm Centre.

The strengthening of the Australian dollar against the Singapore dollar played a part in boosting contributions from the Australian properties. Together with rising occupancies and higher rental rates, net property income in Q3 rose 10 per cent over the year to $24.9 million.

Total distributable income rose 8 per cent to $13.4 million from a year ago. This comprised $8.7 million in distribution to unitholders – which increased 13 per cent – and $4.7 million in distribution to CPPU holders – which stayed flat.

For the nine months ended June 30, DPU was 4.23 cents, up 4 per cent year on year from 4.05 cents (which was adjusted for the consolidation effect). Distribution per CPPU was unchanged at 4.11 cents.

In January, FCOT sold Cosmo Plaza, an office building in Japan.

Later in May, it divested its investment in the Australian Wholesale Property Fund, using the net proceeds to repay part of an existing Australian dollar loan, creating interest savings.

‘The full effect of the partial repayment of the AUD loan would be seen in the coming quarters,’ said Low Chee Wah, CEO of FCOT’s manager. He added that the disposal of non-core assets has helped to strengthen FCOT’s balance sheet and distributable income. ‘The trust is benefiting from the fruits of the initiative which will place FCOT in a better position for future growth,’ he added.

FCOT closed unchanged on the stock market yesterday at 87 cents.

Near-term catalysts in sight

• Near-term catalysts from early refinancing; initiate with Outperform. FCOT is a commercial REIT investing primarily in offices in the region. We use DDM (discount rate 9.4%) to value FCOT at S$0.99. Since taking over in 2008, FCOT’s management has stabilised its capital structure and assets and divested non-core holdings. With a stabilised portfolio and capital structure and a strong sponsor in F&N, we see no reason for its depressed 40% discount to book and forward yields of 7-8%. We see catalysts from early re-financing and improvements in occupancy and rentals.

• DPU upside just from refinancing. FCOT’s entire debt will be maturing in 2012. With a high cost of debt of 4.3% vs. 3% for most REITs in their recent refinancing, we anticipate an 11% DPU uplift even with a minimal rate reduction of 50bp.

• Further kicker from expiry of master lease. The master lease for its largest local asset, China Square Central (net rents of S$4+ psf), will be expiring in 2012. With significant leases due for expiry in 2012 and F&N’s expertise in retail management, direct management of the asset could allow FCOT to ride the rental upside. Possible AEI and hotel development to unlock value could also be low hanging fruits for FCOT.

• We do not see an overhang from CPPUs, with limited dilution of 4% on full conversion. Redemption of the CPPUs at par could even allow accretion if overall funding costs for FCOT come in below the CPPU rate of 5.5%.

Valuation and recommendation

DDM-derived valuation. We use DDM to value FCOT, the methodology we use to value all the REITs under our coverage. We use a discount rate of 9.4%, derived from a risk-free rate of 3.8%, an equity risk premium of 4.3% and a beta of 1.3x. We also assume a terminal growth rate of 2%.

Initiate coverage with Outperform and target price of S$0.99. We initiate coverage with a target price of S$0.99, which represents a total return of 30% from a forward yield of 7% and price upside of 23%. Since taking over the reins in 2008, FCOT’s management has stabilised FCOT’s capital structure and assets and divested noncore holdings. With a stable portfolio and capital structure and a strong sponsor in F&N, we see no reason for its depressed 40% discount to book and forward yields of 7.1% (vs. office S-REITs’ averages of 0.8x P/BV and 6.1% DPU yield). We do not see an overhang from CPPUs (with limited dilution on full conversion) and even anticipate accretion from potential redemption at par on favourable funding rates. We thus initiate with an Outperform, anticipating catalysts from early re-financing at favourable costs of borrowing and improvements in occupancy and rentals.

Divestment of the Australian Wholesale Property Fund (AWPF)

Divestment of all units in AWPF: Frasers Commercial Trust (FCOT) announced on 12 May that it has completed the sale of all 39,758,513 ordinary units in Australian Wholesale Property Fund (AWPF) to National Nominees Ltd for an aggregate consideration of AUD22.2m (equivalent to S$29.11m). Including transaction costs, the net proceeds worked out to about AUD22.04m (S$28.9m). Prior to completion of the divestment, FCOT had a 39% indirect interest in AWPF and as at 31 March, the carrying value of the investment amounted to AUD24.94, (S$32.52m). The divestment is in line with the manager’s objective to reshape the portfolio of FCOT as the investment in AWPF is considered non-core. Taking into consideration that AWPF has not paid any distributions since Mar 2008, the Manager is of the view that the divestment is in the interest of unitholders as the net proceeds from the divestment will be utilised to reduce debt liabilities.

Positive on Divestment. Despite the divestment loss of S$3.62m, we view this transaction positively. AWPF was inherited from FCOT’s predecessor, Allco Commercial REIT (acquired prior to the financial crisis). Its book value on FCOT’s balance sheet has also dropped from a high of $75.1m in 4Q07 to a low of S$26.1m in 3Q09. We do not see much upside potential for the solely New South Wales assets, and have always reiterated that the capital could be recycled for better income maximizing purposes such as debt pare-down or yield accretive refurbishments. According to our estimates, this successful divestment will lower FCOT’s aggregate leverage from 37.8% as of 31 Mar to 37%. It will also provide FCOT with additional debt headroom of S$101.8m before surpassing the 40% gearing mark. The impact on FY11 DPU is, however, marginal with this divestment.

Looming Dent on Japan Assets. Our primary concern now rests with its Japan exposure1 . As of 31 Mar, FCOT’s Japan assets account for 9.6% of its gross revenue and 7.92% of its overall NPI. We noted that 100% of the leases for Azabu building in Tokyo and 65.5% for Galleria Otemae in Osaka will expire by FY12. We remain wary of the prospects in Japan, as office rentals are unlikely to see further uplift following Japan’s recent natural disasters. Furthermore, some occupiers have postponed or are reassessing their office strategies, which will likely delay the market recovery. DTZ has also forecasted Grade A office rents for Tokyo to decline further, only showing growth in 2013. Maintain BUY with a reduced fair value of S$0.87 (prev: S$0.89).

Focusing on Core Assets

FCOT announced that they will be divesting the units in Australian Wholesale Property Fund (AWPF) for AUD22.2m (S$29.11m). Recall AWPF was inherited from the previous ALLCO portfolio, which comprises a 39% indirect interest in an Australian registered investment scheme. Basically this fund has been a drag on earnings and valuations post the financial crisis. The fund had stopped paying dividend since March 2008 and valuation has dropped from a high of AUD$59.2 m (S$75.1m) in 2007 to AUD$24.9 (S$32.52m) as at end-2Q11.

We view this move positively as firstly, the group would immediately get rid of this drag on earnings. We do not see that this Australian fund will have much upside in the medium term. Secondly, we believe utilising the proceeds from the divestment to partially pare down an existing AUD150m term loan will lower gearing and there will likely be some interest savings which should lift bottomline marginally. Based on our numbers, post divestment gearing will drop slightly from 39.2% to 37.8% and DPU in FY 2011/12 will increase slightly by <1%. We continue to like FCOT with the manager taking proactive steps to reshape their portfolio by divesting non-performing assets including Cosmo Plaza earlier this year. We believe there are still opportunities for the group to enhance their DPU through asset enhancements and more capital management exercises.

Maintain BUY with an unchanged TP of $1.05.

2Q11 annualised DPU yield of 8%; Maintain BUY

2Q11 Annualised DPU Yield of 8%. Frasers Commercial Trust (FCOT) posted it 2Q11 results on Thursday, which was in line with our expectation and street estimates. 2Q11 gross revenue was flattish YoY but rose 2.2% QoQ to S$29.6m. This was due to higher revenue contribution achieved from Central Park and KeyPoint as a result of an increase in occupancy rates, which was offset by the loss of revenue contribution from Cosmo Plaza following its divestment on 18 Jan 2011. This also increased its NPI by 1% YoY and 3.9% QoQ, as Cosmo Plaza has been generating negative NPI since 4Q10. We are also witnessing an improvement in NPI margin, which rose from 78.9% in FY10 to 80.5% in the quarter. Distributable income is up 2.4% YoY and 27.6% QoQ. 2Q11 DPU is 1.61 S-cents, representing an annualised yield of 8%. Gearing also edged down 2% from 1Q11 to 37.8%.

Portfolio Performance. Overall portfolio occupancy grew by 5.9 pp to 97.7% from last quarter. This was boosted by the rise in occupancy for both Singapore and Australia portfolio plus the divestment of Cosmo Plaza. In particular, Australia portfolio has achieved 100% occupancy rates led by new leases by Jones Lang LaSalle and Hamersley Iron. In Singapore, portfolio occupancy rates grew from 97% to 97.4% driven by the commencement of new leases for both 55 Market Street (55MS) and KeyPoint which include Gabriel Law Corporation, Corporate Serviced Offices and L’Oréal. However, 55MS is still experiencing negative rental reversions, with FY11 average passing rent at S$10.50 psf pm while new leases are signed at S$6-S$6.50 psf pm. According to our estimates, 55MS is likely to rise out of negative territory only after 2013. Keypoint is also undergoing negative reversions, albeit at a lesser magnitude with average passing rent and spot rent at S$5.40 psf pm and S$5.10 psf pm respectively; but management expects a turnaround by end of the year.

Looming Dent on Japan Assets. FCOT’s Japan assets account for 9.6% of its gross revenue. We noted that 100% of the leases for the Azabu building in Tokyo and 65.5% for Galleria Otemae in Osaka are expiring by FY12. We remain wary of the prospects in Japan, as office rentals are unlikely to see further uplift after the earthquake episode. Furthermore, some occupiers have postponed or are reassessing their office strategies, which will likely delay the market recovery. In fact DTZ has forecasted Grade A office rents for Tokyo to decline further, only showing growth in 2013. Maintain BUY with a reduced fair value of S$0.89.