DPU GETS ANOTHER THRUST

• Expecting further DPU uplift
  
• Gearing to notch higher
  
• Current valuations still undemanding
  

Second round of CPPU redemption

Frasers Commercial Trust (FCOT) announced that it has successfully exercised the right of redemption for 157.1m Series A Convertible Perpetual Preferred Units (CPPUs). This constitutes 91.6% of the number of CPPUs outstanding. No CPPU has been successfully converted into new units, thus leaving a remaining 14.3m CPPUs in issue. The redemption will take place on 1 Apr, and will be funded via bank borrowings and cash. In addition, the distribution to entitled CPPU holders amounts to S$2.3m, or 1.3562 S cents per CPPU.

Positive impact on DPU

The decision by FCOT to redeem the remaining CPPUs was not expected as we feel that FCOT could have done so in the previous exercise. Nevertheless, we welcome the move as it would lead to an improvement in FCOT’s DPU, given that the CPPU distribution rate is relatively high at 5.5% vs. its average borrowing cost of 3.3%. Furthermore, this would remove any uncertainty pertaining to a possible dilution in unit base from a conversion of the CPPUs (currently in the money). The only trade-off, in our view, would be a higher aggregate leverage, which we believe would rise from 29.2% as at 31 Dec 2012 to ~40% assuming the CPPU redemption is fully funded by debt. This may imply limited debt headroom/higher risk of equity fund raising. However, our sense after talking to FCOT is that there is possibly no immediate acquisition target in sight, while its cash balances are more than sufficient to finance its asset enhancement initiatives for the Precinct Master Plan and China Square Central (both on track for completion).

Maintain BUY with higher fair value

We now project a full CPPU redemption in our model, as it may no longer be economical for FCOT to retain the remaining CPPUs. This raises our fair value from S$1.48 to S$1.52. We continue to like FCOT for its active management, growth potential and undemanding valuations (0.87x P/B vs. average 0.96x P/B for its office peers). Maintain BUY.

EXPECT FURTHER DPU ACCRETION

• In-line 1QFY13 results
  
• Fundamentals strengthened
  
• Expects DPU uplift
  

Consistent 1QFY13 showing

Frasers Commercial Trust (FCOT) released its 1QFY13 results last Friday. NPI fell by 6.9% YoY to S$22.9m due mainly to the disposal of KeyPoint and three properties in Japan. However, higher contribution from additional 50% interest in Caroline Chisholm Centre and lower interest costs helped to offset the loss of income from the divestments. As a result, distributable income and DPU grew by 6.9% and 4.6% YoY to S$10.3m and 1.5832 S cents respectively. The results were congruent with our expectations, as NPI and DPU met 25.2% and 22.2% of our respective full-year projections.

Healthy portfolio performance

Australia properties surpassed Singapore properties as the biggest income driver in 1Q, contributing 53.7% to NPI (Singapore: 45.1%). Portfolio occupancy remained stable at 94.6% compared to 4QFY12 occupancy of 94.9%. ~95k sqft of space was contracted, reflecting healthy tenancy activities within the office space. For the rest of FY13, we note that 13.7% of its leases (by gross rental income) are due for renewal, with China Square Central (CSC) forming the bulk of lease expiry (8% of total income). As the average passing rent at CSC (S$6.20 psf pm) is lower than the spot market rents, we believe positive rental reversions may be achieved upon renewal.

Further improvements expected; maintain BUY

Management updated that the Precinct Master Plan initiatives and asset enhancement works for CSC office tower are on track for completion and are expected to rejuvenate the area and make CSC an even more attractive office accommodation. FCOT now boasts a healthy gearing of 29.2% and improved financing costs of 3.3% (3.5% in 4QFY12) following the partial prepayment and refinancing of its debts. Together with the successful 47.6% redemption of CPPUs on 2 Jan, we maintain our view that FCOT’s DPU will get further uplift going forward. We keep our forecasts unchanged but bump up our fair value to S$1.48 from S$1.31 on lower cost of equity of 7.0% (7.8% previously) as we factor in an anticipated increase in investor risk appetite and the current low interest rate environment. Maintain BUY.

What next after CPPU redemption?

After a series of yield-enhancing activities and portfolio restructuring in FY12, FCOT is in an enviable position asDPUgrowth is built-in through FY15 andasset leverageof 31% providesit withthe financial flexibility to do more.

We adjust FY13-15 DPUs by between -5% and +2% for the changes to NPI margins, timing of CPPU redemption in FY13, and upside from Alexandra Technopark in FY15. We maintain Outperform with a higher DDM-based target price (discount rate: 7.7%). We see catalysts from more yield-enhancing actions.

FY13 growth locked in; in-built growth till FY15

2012 marked a turning point for FCOT when management successfully restructured its asset portfolio and engaged in yield-enhancing activities. With the recent completion of a 48% CPPU redemption, management has locked in a nice 12% DPU uplift for FY13. Ongoing back-filling and positive rental reversions on its under-rented local office assets should extend DPU growth into FY14. Meanwhile, underlying NPI on Alexandra Technopark has already surpassed that provided by its master lease, which could provide another layer of uplift come FY15 when the master lease lapses.

Ammunition to do more

Asset leverage at 31% after its recent CPPU redemption leaves FCOT with the financial flexibility to do more. We expect FCOT to relook at hotel redevelopment plans over the next year, where it could sell the site and redeploy proceeds into accretive CPPU redemption. Management is also on the lookout for acquisitions, failing which it still retains the financial flexibility to redeem all its remaining CPPUs for ~10% DPU accretion while keeping asset leverage at levels of 40%.

Maintain Outperform

With DPU growth of 6-12% over FY13-15, FCOT‟s growth visibility is one of the strongest among S-REITs. This is further backed by undemanding valuations (0.9x P/BV and forward yields of 6-7%). We maintain Outperform and see upside from a gearing-up for acquisitions, CPPU redemption, and asset enhancements.

WELL-POSITIONED FOR GROWTH

• Positive move to exit Japan market
  
• Lower funding cost burden
  
• Good growth potential
  

Transformational year

We are very positive on Frasers Commercial Trust’s (FCOT) transformation over the past one year. At the close of 4QFY12, FCOT announced the exit of the Japan market with the divestment of its Japan properties. This was earlier than we expected, even though we had been anticipating the move. We like the transaction because 1) the Japan properties had been recording weak performance, 2) divestment would enhance the portfolio occupancy and weighted average lease to expiry, and 3) gearing ratio is expected to drop from 36.8% to 28.6% (including partial prepayment of its AUD and SGD loans), with no debt maturing until FY15. This will significantly strengthen its financial position and flexibility, and aid FCOT in seeking the release of 55 Market Street and Caroline Chisholm Centre (CCC) from its securitized pool.

Successful redemption of CPPUs

More recently, FCOT had also exercised its right of redemption in respect of 170.7m Series A CPPUs, representing 50% of the number of CPPUs in issue. This is in line with our view that FCOT may redeem half of the CPPUs using the net proceeds (S$537.8m) of KeyPoint divestment. Based on the latest announcement on 5 Dec, FCOT had successfully redeemed 162.6m CPPUs, or ~47.6% of total outstanding CPPUs, in cash. With this positive development, we expect FCOT to post an improvement in the distributable income, since the funding costs (distribution rate) of the CPPUs are relatively high at 5.5%.

Maintain BUY

Apart from having a significantly strengthened financial position and lower funding cost burden, we expect FCOT to gain from interest savings following the refinancing of its S$500m term loan facility. In fact, average borrowing rate fell from 4.0% in 3Q to 3.5%. In addition, the increased stake in CCC and expected improved performance at China Square Central will likely continue contributing positively to its rental income. Hence, we are staying optimistic on its growth potential in FY13. Maintain BUY with an unchanged fair value of S$1.31 on FCOT.

A BRAND NEW START

• In-line 4Q performance
  
• Exit of Japan market
  
• Well-positioned for growth
  

Strong 4QFY12 results

Frasers Commercial Trust (FCOT) reported its 4QFY12 results last Thursday. NPI grew by 8.7% YoY to S$26.5m, while distributable income jumped 17.3% to S$11.3m. The strong growth came on the back of higher rental contribution from Central Park and an increased stake in Caroline Chisholm Centre. DPU for the quarter stood at 1.75 S cents (+15.1% YoY) and is consistent with our 4Q estimate of 1.76 S cents (consensus: 1.86 S cents). For FY12, DPU amounted to 6.69 Scents (+16.3%), translating to a 5.6% yield. Starting from FY13, FCOT will commence quarterly distributions. Hence, unitholders will receive its final semi-annual distribution for 2HFY12.

Divestment of Japan properties

FCOT also announced the completion of divestment of its Japan properties, after months of market anticipation. Total consideration was a nominal JPY4 as the holding vehicles for the properties were at an aggregate net liability of S$4.9m. Nevertheless, we view the transaction positively because 1) the Japan properties have been recording weak performance, 2) the divestment would improve portfolio occupancy to 94.9% from reported 93.8%, and 3) weighted average lease to expiry would be extended to 5.0 years from 4.7 years. More importantly, gearing ratio is expected to drop from 36.8% to 28.6% (including partial prepayment of its AUD and SGD loans), with no debt maturing until FY15. This will significantly strengthen its financial position and flexibility, and aid FCOT in seeking the release of two properties from its securitized pool.

Maintain BUY

Regarding the space vacated by MMC at China Square Central (CSC), FCOT also updated that 76% of the space has been re-leased, including 49,000 sqft by GroupM starting Apr 2013. Going forward, FCOT intends to embark on Phase 2 of refurbishment works at CSC by end-2012, which should further enhance its positioning. We are positive on FCOT’s transformation, strong execution and growth potential in FY13. We re-jig our forecasts to incorporate the developments, but our fair value is unchanged at S$1.31. BUY.