Positives priced in

• 3Q10 in line; maintain Underperform and target price of S$1.26. 3Q10 DPU of 1.69 Scts met our expectation and consensus, forming 25% of our full-year forecast. 9M10 DPU of 4.65 Scts represents 70% of our forecast, in line considering backend-loaded contributions expected from Australian assets acquired in the year. K-REIT also released a forecast of its consolidated statement from its recent acquisitions and divestments. We fine-tune our FY10-12 DPU estimates by -1% to +1% but keep our DDM-based target price of S$1.26 (discount rate 7.2%) intact. Maintain Underperform with limited accretion from its recent asset swap, and unattractive FY10 DPU yields of 4.8% vs. Suntec REIT’s 6.5% and CCT’s 5.2%. Derating catalysts could include lower-than-expected rental reversions.

• 3Q10 NPI grew 42% yoy. 3Q10 net property income of S$17.5m was up 42% yoy on contributions from additional stakes in Prudential Tower and 275 George Street. A 37% yoy decline in DPU was attributable to an enlargement in its share base after its Nov 09 rights issue though total distributable income grew 26% on the back of the NPI increase. Qoq, 3Q10 DPU was up 3% on lower borrowing costs.

• Occupancy rose to 99.2%. Portfolio occupancy improved 1.3% pts qoq to 99.2%, largely due to new tenants secured at Bugis Junction Towers. Leasing demand was driven by a mix of new tenants and expansion by existing tenants. Though average portfolio rent was not disclosed, we believe this could have been flat or marginally lower qoq. The 100% completion of FY10 rent reviews should, however, help to curb any near-term decline in average portfolio rents.

• Release of forecast statement. Accompanying the results, K-REIT released a FY11 forecast of the consolidated statement from its recent acquisitions (Marina Bay Financial Centre Phase 1 and 77 King Street) and divestment of Keppel Towers and GE Tower. K-REIT’s FY11 DPU estimate of 6.68 Scts for its enlarged portfolio is lower than our assumed 7.23 Scts due to lower rental and occupancy assumptions for its local portfolio. We have kept our FY11 DPU estimate largely unchanged.

Results in line

• 3Q10 distribution income up marginally 3.2% qoq, in line

• Revenue is likely to see limited near term upside

• Maintain Hold with TP S$1.20

In-line set of results. Kreit reported a marginal 6.3% qoq decline in topline to $21.8m in 3Q10, mainly due to a correction to the straight-line accounting of rental income reported in 2Q10 from the 50% stake in 275 George Street, while NPI dipped a smaller 4.8% to $17.5m on lower property expenses. However, the adjustment had no impact on the distributable income, which rose by a modest 3.2% to $22.7m (DPU: 1.69cts). The increase in distributable income was largely due to lower borrowing costs of 3.4% (vs 3.54% in Q2). Occupancy rate increased by a slight 1.3ppt qoq to 99.2% with an additional 29100sf of new take up.

Limited upside in the near term. Its portfolio is running at almost full capacity, and there is limited rental reversion upside as most of the leases up for renewal would be inked at the peak in 2007. However, downside risks are now capped as demand improved. As highlighted in our previous report, we view the purchase of MBFC1 and sale of KTGE as a longer term positive for the Reit. The acquisition will upgrade its portfolio quality and extend the average portfolio lease expiry profile from the present 5.7 years to 7.8 years, although near term income boost would be relatively small. In their 2011 forecast, the group has indicated a net 5.3% rise in distribution income and 4% better DPU impact from the purchase of MBFC1 and sale of KTGE. Post acquisition, Kreit’s gearing would rise to 39.1%.

Maintain Hold. Although we see limited revenue upside in the near term, the improving office rental and capital value cycle is likely to benefit the group’s underlying rental and asset value in the medium term. This will underpin Kreit’s income. Maintain Hold and DCF-backed TP of $1.20.

K-Reit sees 2011 DPU rising by up to 10.2%

Its Q3 net property income rises 42% to $17.5 million

K-REIT Asia is expecting a series of property transactions to boost its distribution per unit (DPU) for FY2011 by as much as 10.2 per cent.

The commercial real estate investment trust released the projections yesterday together with results for the third quarter ended Sept 30.

K-Reit forecasts that with the acquisition of an office block at 77 King Street in Australia, the proposed purchase of a one-third stake in Phase One of the Marina Bay Financial Centre (MBFC), and the proposed sale of Keppel Towers and GE Tower, its DPU for FY2011 would be 6.68 cents.

This would be higher than the 6.06 cents which could be generated by its existing portfolio, comprising Keppel Towers, GE Tower, Bugis Junction Towers, an interest in Prudential Tower, an interest in One Raffles Quay, and a stake in 275 George Street in Australia.

Based on the forecasts, the three deals would actually cause net property income and total return after tax to be lower in FY2011. But after net tax adjustments, income available for distribution would rise, leading to the higher projected DPU.

The projections shed some light on the impact of a proposed asset swap between K-Reit and its parent. K-Reit said last week that it is buying the MBFC stake from Keppel Land for $1.427 billion, and selling Keppel Towers and GE Tower to it for $573 million.

K-Reit will be holding an extraordinary general meeting in December to seek unitholders’ approval for these two deals.

Recent acquisitions have helped to raise K-Reit’s earnings. In Q3, its net property income was $17.5 million, 42 per cent higher than a year ago due mainly to contributions from an additional six strata floors it bought at Prudential Tower in November last year, and a 50 per cent stake it acquired in 275 George Street in March.

Distributable income to unitholders rose 26 per cent to $22.7 million.

DPU in Q3 was 1.69 cents, 25 per cent more than the 1.35 cents a year ago, which has been adjusted for the effect of a rights issue completed in November last year. Without the adjustment, DPU last year was actually higher at 2.69 cents.

K-Reit closed unchanged at $1.37 yesterday.

Win-win for Keppel Land and K-Reit?

FOR economics students weaned on the principle of profit maximisation, the term ‘win-win’ which buyers and sellers use so often to describe deals might sound like an incongruity.

Looking at how the market reacted to the proposed asset swap between Keppel Land and K-Reit Asia, there must be many such sceptics around. Although both parties said that the deal would enhance value for their shareholders and unitholders, investors chose to buy into the property developer and sell their stakes in the Reit.

Keppel Land rose to an intraday high of $4.23 yesterday before closing at $4.16, five cents higher than on Monday. At least four research houses – CIMB, Standard Chartered, DBS Vickers and DMG & Partners – raised the target price for the stock.

In contrast, K-Reit lost two cents to end trading at $1.35. CIMB downgraded the counter to ‘underperform’ from ‘neutral’.

The market clearly thought there was just one winner in the deal. Is the judgement fair? The way to answer this is to see if Keppel Land got too good a price for its one-third stake in Phase One of Marina Bay Financial Centre (MBFC), or underpaid K-Reit for Keppel Towers and GE Tower.

In one leg of the swap, Keppel Land will sell its MBFC stake to K-Reit for $1.4268 billion or $2,450 per sq ft of net lettable area. This is just a slight 0.4 per cent more than the open market valuation of $1.4205 billion. So far, so good.

What’s worth noting is that the sale price is higher than many analysts’ projections. Standard Chartered said that the consensus estimate was $2,300 psf; DMG & Partners valued MBFC Phase One at $2,100 psf in its model. To the research community at least, the stake sale leans in Keppel Land’s favour.

Also, compared with other office spaces sold recently downtown, the MBFC stake secured a higher price. For instance, four floors at Samsung Hub changed hands for $2,125 psf in August. It is true that MBFC is newer, has many established tenants and is in a glitzier district, but the amount of premium these factors command is debatable.

Most importantly, some market watchers do not see K-Reit benefiting much from buying the MBFC stake, at least in the short term. It will have to take on a huge debt of $821 million, which raises its aggregate leverage to 39.1 per cent. It is also not clear at this point if the transaction would be yield accretive. One research house, CIMB, expects a 6-7 per cent drop in K-Reit’s distribution per unit for FY2011-12.

In short, while Keppel Land is selling its MBFC stake to K-Reit in line with market valuation, there are some who expected a lower price, or think that K-Reit would be burdened.

In the second part of the swap, K-Reit will sell Keppel Towers and GE Tower to Keppel Land for $573 million. This is just 0.5 per cent less than the valuation of $576 million, assuming the buildings are put to residential use. Again, nothing to raise eyebrows here.

The bigger question which many observers have is whether K-Reit could have gotten a higher price if it put the two towers up for bidding. With liquidity still surging in Asia, there could be other property developers or funds willing to pay above valuation.

Some would recall that when CapitaCommercial Trust sold StarHub Centre through an expression of interest exercise and a private tender in July, it managed to secure a price that was 42.5 per cent higher than the asset’s latest valuation.

Near Keppel Towers and GE Tower, Singapore Technologies Building is up for sale with a price tag of at least $1,500 psf of net lettable area. Hypothetically, if Keppel Towers and GE Tower were sold at just $1,350 psf, they would already fetch $581 million.

In this case, while Keppel Land is paying K-Reit according to market valuation, some wonder if K-Reit could have gotten more if there was competition for the assets.

At a briefing on Monday, management from Keppel Land and K-Reit reiterated several times that the prices were in line with market valuations, and that both companies stand to gain from the bundled deal. They should illustrate more clearly what the benefits are – particularly for K-Reit unitholders – in order to get investors to buy into the ‘win-win’ theory.

Why Wait For Circular?

• The transactions between the 2 companies:

– K-Reit buys the 1/3 stake in Marina Bay Financial Centre Towers 1 (NLA of 57,671 sqm) &2 (95,867 sqm) as well as the Marina Bay Link Mall (8,776 sqm; MBFC Acquisition ) for $1426.8 mln / $2450 psf.

(K-Reit’s portfolio rises from $2.5 bln to $3.4 bln, 90% of which will be in the prime Raffles Place and Marina Bay precinct. Weighted average lease to expiry increases from 5.7 years as at end Jun ’10, to 7.8 years. Percentage of NLA committed under long term leases of 5 years or more increases from 36% to 64%.)

– K-Land provides $29 mln rental support for the fitting-out periods when rent and maintenance charges will not be received, till Dec 2014.

– K-Land buys GE Tower / Keppel Tower (NLA of 430,112 sf; KTGE divestment) for $573 mln / $1332 psf. K-Reit recognizes $26.3 mln profit. K-Land will redevelop this into a residential project with 5.6x gross plot ratio.

– K-Reit will borrow $821 mln, utilize $41.5 mln proceeds from last year’s rights issue and sale proceeds from the KTGE divestment to finance the acquisitions. There will be no need to issue new units as with the acquisition of One Raffles Quay (ORQ).

COMMENTS

1. The MBFC Acquisition is no surprise, being expected by investors, especially since the towers were fully committed.

2. But what is disappointing is that the 2 companies chose to be reticent about what really matters most to investors, ie is the acquisition yield accretive ? (Investors would just have to wait for the circular to be released.)

3. Fact is, K-Reit is selling the 2 “old” assets at a yield of 3.23% (Net attributable profit of $18.5 mln / $573 mln sale price). Reticence suggests yield from MBFC Towers 1&2 may be lower. (According to the statement, pro-forma Distributable Income / DPU for 2009 drop to $44.072 mln from $70.519 mln; and to 3.27 cents from $5.28 cents respectively.)

4. One could “surmise” that there will be little yield accretion, thanks largely to the record low interest rate environment, which allows K-Reit to borrow cheap (average borrowing cost to drop to 3.05% from 3.54% ) and push gearing once again to the hilt of just under 40% from 15.2% before the latest transactions. (We have been wondering which among the property-related companies will be able to benefit from record low rates after rushing to lower their gearing in the aftermath of the Financial Crisis – just look at K-Reit for instance.)

5. K-Land merits a BUY, being a clear beneficiary of the latest inter-group transactions, having made it clear its intention to redevelop the 2 CBD-fringe office buildings into residences, itself a positive for office rentals. (Technically, K-Land looks good too.)

6. As for K-Reit, the unnecessary uncertainty as the circular is being “finalized” suggests HOLD remains appropriate for now. We maintain preference for CapitaCommercial Trust, which should soon decide on the redevelopment of the Market Street CarPark.

(K-Land owns 612,588,450 K-Reit units, or 45.64% of the total issued. Keppel Corp’s total deemed interests, including K-Land’s, totals 1,020,022,898 units or 75.99%.)