Minimal dilution impact from CPPU conversion

Frasers Commercial Trust (FCOT) recently announced that 9.37m new ordinary units have been issued following the conversion of 11.1m Series A CPPUs. The conversion enlarges FCOT’s share base by c. 1.4%, which will result in marginal dilution for existing shareholders.

As such, we lowered our FY13-15 DPU estimates by around 1.4% to account for the slightly larger share base. We maintain our Outperform rating and see catalysts from the additional hotel GFA at China Square Central, while lowering our target price to S$1.45 to reflect the slight dilution.

What Happened

FCOT recently announced the issuance of 9.37m new ordinary units following the conversion of 11.1m Series A Convertible Perpetual Preferred Units (CPPUs) at a conversion price of S$1.1845/unit.

What We Think

This conversion exercise of CPPUs into ordinary units was largely within expectations as the stock continues to trade above the conversion price of S$1.1845/unit, while the gearing remains at c.39%.

FCOT has been redeeming its CPPUs since Dec12, costing the trust an average yield of 5.5% annually. Together, the two redemption exercises (Dec 12 and Apr 13) took 95.8% of CPPUs off the market, leaving only 14.3m units.

With the latest conversion exercise, only 1.055m of CPPUs-translating to c.890k ordinary shares -are left on the books. We see limited pressure on the stock if these CPPUs are converted into ordinary units.

What You Should Do

We continue to favour FCOT for the additional hotel GFA planning permission at China Square Central. While management continues to evaluate the potential of the 16,000sqm hotel site, we believe this will provide the next boost to FCOT’s books(c.10-15% to book value) as we expect the hotel to be valued at S$300m-S$350m upon completion. We maintain our Outperform rating and target price of S$1.47,which implies a 6% FY14 dividend yield-largely inline with the office REITs’ average yield of 6.2%.

Growth story intact

• DPU of 1.99 Scts in line (+14% y-o-y)
  
• Capital restructuring completing; expiry of Alexandra Technopark master lease in FY14 presents upside
  
• BUY, TP raised to S$1.69
  

Highlights

DPU growth of 14% to 1.99 Scts in line. Frasers Commercial Trust (FCOT) reported 2Q13 results in line with expectations. Gross revenues and net property income (NPI) dipped slightly by 4% and 7% y-o-y respectively due to the disposal of Keypoint and its Japanese assets, which is compensated to some extent by the acquisition of an additional 50% stake in Caroline Chisholm, coupled with higher rentals achieved across its portfolio in Singapore and Australia. Distributable income to unitholders increased by 17% y-o-y due to savings from the redemption of its CPPU units (funded by the proceeds from the sale of Keypoint), translating to DPU of 1.99 Scts.

Our View

Capital re-structuring completing; DPU CAGR of 19% over next 2 years. Further utilising the proceeds from its Keypoint sale, the manager continues to put it to good use and has redeemed a further 157m CPPU units ( 95.8% of total units) in April’13, resulting in a further savings of S$8.7m, which will provide a further uplift in DPU in the coming quarters. Gearing is expected to head up to 39% (from the current 31.7%).

Reversions positive, expiry of Alexandra Technopark master lease in Aug 14 presents further upside. FCOT continues to enjoy healthy portfolio occupancies of 93.1% and 99.5% for its Singapore and Australian properties, respectively. Rental reversions are positive, ranging from 8-19% for its Singapore properties (55 Market Street and Alexandra Technopark) while Central Park in Perth saw an almost 87% hike in rental rates. In addition, we estimate further upside potential of up to cS$5m, coming from the expiry of its Alexandra Technopark masterlease where the underlying passing gross rent of S$3.27psf is higher than the estimated gross rent of S$2.50 psf paid under the master lease.

Recommendation

Attractive growth over FY13-15F. Supported by its restructuring exercise coupled with underlying growth, we like FCOT’s growth story over FY13-15F, which is visible and achievable. Maintain BUY with a higher TP of S$1.69 as we raise our FY15F earnings from Alexandra Technopark master lease expiry.

Advancing steadily

• Better-than-expected results
  
• Strong operating performance
  
• Expecting further DPU uplift
  

Strong uplift in DPU

Frasers Commercial Trust (FCOT) turned in a strong set of 2QFY13 results. While NPI fell 7.0% YoY to S$23.0m due to loss of income from the divestment of KeyPoint and Japan properties, distributable income grew 16.8% to S$13.1m on lower interest expenses and distribution savings following the redemption of its Series A Convertible Perpetual Preferred Units (CPPUs). Consequently, DPU for the quarter came in at 1.9883 S cents, representing a 14.4% YoY growth. This is slightly above our expectations, as 1HFY13 DPU of 3.5715 S cents already formed 51.4% of our full-year DPU forecast.

Robust demand for its properties

Key rental growth drivers for the quarter came from FCOT’s Australia properties. Notably, Caroline Chisholm Centre registered a 101.0% YoY jump in NPI post acquisition of the remaining 50% interest in the property. In addition, Central Park saw its NPI increase by 6.4% on the back of higher secured rentals. As a result, Australia properties contributed 54.2% of 2Q NPI, up from 37.4% a year ago (prior to divestments). As at 31 Mar, the portfolio occupancy remained strong at 95.3% (1Q: 94.7%), with weighted average lease to expiry at 4.8 years (1Q: 4.9 years). Positive rental reversions ranging from 8-87% for leases commenced during the quarter were also achieved – a strong indication of demand for its properties, in our view.

Maintain BUY with higher S$1.66 FV

Looking ahead, we hold our view that FCOT will continue to perform strongly. While the actual occupancy at China Square Central stood at 73.0%, a high committed occupancy of 92.6% was secured. This is expected to contribute positively to the rental income in the coming quarters. The passing rents for several of its properties are also below the market rates, thus presenting potential for rental upside (especially when Alexandra Technopark master lease expires in Aug 2014). Moreover, the redemption of another 157.1m CPPUs in Apr is likely to provide further uplift in DPU. We now incorporate the better results into our forecasts and tweak our CAPM assumptions. Our fair value is raised to S$1.66 from S$1.52 previously. Maintain BUY.

Reaping What Has Been Sowed

FCOT reported 2QFY13 DPU of 1.99 cents (+14% y-o-y). Together with its 1QFY13 DPU of 1.58 cents, 1HFY13 DPU accounts for 43.4% of our full year forecast. With the main boost in DPU (a result of the buyback of c.96% of CPPU) to come through in 2HFY13, together with its resilient portfolio and bright prospects, we maintain our BUY rating on FCOT with a higher DDM based (COE: 7.1%; TGR: 2.0%) TP of SGD1.65.

Higher DPU mainly due to CPPU redemption. The higher dividend per unit (DPU) was mainly attributed to the redemption of convertible perpetual preferred units (CPPU) which was costing FCOT an average 5.5% annually at the DPU level. Together with the redemption of 45.9% of the total CPPUs originally issued in April, only 4.2% of the original number of CPPUs issued remains outstanding. As the amount of CPPUs available has significantly decreased, we expect FCOT’s DPU to grow by c. 23% and c.11% in FY13 and FY14 respectively.

More positive rental reversion from China Square Central. Its management indicated that the pre-commitment rate in China Square Central reached a stable 92.6% from the actual occupancy of 73%. With this increase, we expect FCOT to benefit from the additional income in the coming quarter. As the asset enhancement initiatives (AEI) remain on schedule and its passing rental rate is at a low of SGD6.60 (vs current market Grade B office rate of SGD7.10 psf/mth), we also expect FCOT to enjoy a c.5-10% positive rental reversion for the leases due to expire (which makes up c.6.1% of total portfolio income) in 2013.

Strong portfolio occupancy. With the pro-active management of its properties, the occupancy rate of FCOT’s portfolio has hit a high of 95.3% (Singapore properties – 93.1%, Australia properties – 99.5%). Together China Square Central’s improved occupancy rate, we expect the overall occupancy rate of this trust to continue growing in the coming quarters.

Maintain BUY with higher TP of SGD1.65. Going forward, we expect FCOT to continue to register stronger DPU as the trust: i) reaps the full year benefit from the acquisition of another 50% of interest in Caroline Chisholm Centre and ii) benefits from CPPU buyback. Given its bright prospects and strong portfolio, we favour FCOT for its attractiveness and maintain our BUY rating on this counter with a higher DDM based (COE: 7.1%; TGR: 2.0%) TP of SGD1.65.

Yield+ growth formula

Positives in 2Q were steady leasing and positive rental reversions. We see attractive yields and a strong DPU CAGR of 14% for FY12-15 after its CPPU redemption and the expiry of its current master lease at Alexandra Technopark in FY15.

2Q/1H13 DPUs broadly met Street and our forecasts at 26/46% of our FY13 number. We raise FY13-15 DPUs by 2-3% to incorporate lower borrowing costs and our DDM-based target price (discount rate: 7.7%) rises accordingly. Maintain Outperform with catalysts expected from further yield-enhancing moves.

Backend-loaded FY13

We expect backend-loaded earnings from further CPPU redemptions and the start of GroupM’s lease at China Square Central in Apr 13. 2Q13 DPU was up 14% yoy and 26% qoq. Yoy, lower CPPU distribution and interest expenses offset a 7% NPI decline after the divestment of properties.

Committed occupancy at China Square Central rose to 92.6% from 86.1% previously, with new tenants at China Square Central. Physical occupancy was a lower 73.0% for 2Q, but should pick up when its major tenant GroupM (13% of NLA at China Square Central) moves in in Apr. While take-up was dominated by smaller tenants (2k-5k sf), management notes healthy enquiries and positive rent reversions of 8-19% for its local assets and a one-off 87% at Central Park.

Asset leverage to rise to 39%

Asset leverage was 31.7% at end-Mar 13 but should climb to 38.6% after the funding of its Apr CPPU redemption through a combination of debt and internal funds.

Maintain Outperform

We reduce borrowing costs on lower debt (factoring in lower debt-funding for FCOT’s Apr CPPU redemption) and cost of borrowing. FCOT offers a strong DPU CAGR of 14% for FY12-15, backed by its completed CPPU redemption, ongoing leasing at China Square Central and the expiry of its current master lease at Alexandra Technopark (where we estimate a potential 13% NPI uplift in FY15 from higher underlying passing rents of S$3.37 psf vs. the master lease’s implied S$2.90 psf).