Steady leasing

The key positives in KREIT’s 2Q13 results were the higher leasing at OFC, successful backfilling at Prudential Tower and the proactive refinancing of loans due in FY14. KREIT’s headline yields are high but we see this balanced by its high asset leverage and income support.

KREIT’s 2Q13/1HFY13 DPUs broadly met consensus and our expectations, forming 25%/50% of our FY13 forecast. We tweak our FY13-15 DPUs and our DDM-based target price (discount rate: 8.3%) higher to factor in its recent acquisition. Maintain Neutral.

Flattish DPU growth outlook

Although we expect a DPU uptick in FY14 from KREIT’s Australian acquisitions, long-term growth is likely to be muted due to the expiry of income support. 2Q13’s DPU was up by only 1.5% yoy due to the higher earnings contributions from OFC and KREIT’s Australian acquisitions being offset by the loss of income support at ORQ and its larger unit base post-placement. Qoq, 2Q13 DPU was flat. The key positives in 2Q13 came from a slight increase in OFC occupancy to 97.9% from 96.6%. Prudential Tower remained 100% occupied as management successfully backfilled several departing tenants. However, rental income was negatively hit by the fit-out periods.

Capital management

Management completed the early refinancing of c.60% of its borrowings due in FY14, which raised the weighted average term to expiry from 3.2 years to 3.6 years. Management noted that the interest costs for bank loans have been stable. Asset leverage was a high 44.2% at end-2Q13 and may rise above 45% if the recent Melbourne acquisition is funded entirely by debt. However, management stated that the acquisition would probably be partially funded via equity and expressed confidence in asset values.

Maintain Neutral rating

We factor in KREIT’s recent Melbourne acquisition, assuming 50:50 debt-equity funding. KREIT’s high headline yields remain its key attraction but we see this balanced by its high asset leverage and income.

Keppel Corporation: Sells 6.7% of Keppel REIT at S$1.555/unit

Keppel Corporation (KEP) announced that its wholly owned subsidiary, Keppel Real Estate Investment Pte Ltd, has entered into a sale and purchase agreement with Goldman Sachs (the placement agent) for the sale of 180m units of Keppel REIT (6.7% of total issued units of KREIT) for S$1.555/unit. The aggregate cash consideration of S$279.9m took into account KREIT’s last transacted price of S$1.605/unit as at 20 May 2013 and the 30-day VWAP of S$1.5129. This is at a premium to the book value and NTA/share of S$1.31 and S$1.28, respectively, as at 31 Mar 2013. Upon completion of the sale (expected 27 May), KEP’s interest in KREIT remains substantial (from 58.2% to 51.5%). Recall that KEP earlier rewarded shareholders with dividend in specie of KREIT units; announced on 24 Jan 2013 when KREIT’s share price was S$1.37. Maintain BUY on KEP with S$12.68 fair value estimate.

Continues to deliver

• Results within expectations
  
• Resilient portfolio underpinned by long leases and strong income visibility
  
• Maintain HOLD, TP raised slightly to S$1.43
  

Highlights

Results in line with projections. Keppel REIT reported a 13% y-o-y increase in property income to S$41.4m in 1Q13 while NPI rose a better 21% to S$34.4m. The higher jump in the latter is due to the better performance at OFC as well as increased contributions from 77 King St. Portfolio occupancy rose to 98.8%. Distributable income was 7.6% better y-o-y at S$52.2m (DPU 1.97Scts), eroded marginally by higher borrowing costs. Effective interest rate was 2.17% vs 2.03% a year ago.

Our View

Stable portfolio supported by long leases, medium term growth from completion of non-speculative developments.

Looking ahead, all of its Singapore assets continued to enjoy robust occupancy and there is only a remaining 3.5% of NLA to be renewed and another 3% to undergo rent review this year. With a smaller anticipated supply of new space in the CBD this year, we believe occupancy should remain relatively high and newer buildings should experience lesser pressure on rent rates compared to older buildings. This should mitigate any leasing risk. The expected completion of the OFC retail and carpark podium by 3Q13 should also boost bottomline. Meanwhile, in Australia, earnings should be driven by additional contribution from Old Treasury Building in Perth in the medium term and completion of 8 Chifley Square in 2H13. The latter is 56% pre-committed to date. Recent refinancing exercise also extended the trust’s debt maturity profile to 3.2 years.

Recommendation

Maintain Hold. We continue to like Keppel Reit for its stable and resilient cashflow that is underpinned by a long WALE, which currently stands at 5.7 years. However, share price has outperformed and the stock is trading just 1% below our TP of S$1.43. Hence, maintain HOLD call. At the current level, the trust offers a potential total return of 7%.

16 Apr 2013

Singapore Result Snapshot

Keppel REIT

Bloomberg: KREIT SP | Reuters: KASA.SI Refer to important disclosures at the end of this report

Another Steady Quarter

DPU flat QoQ. KREIT reported a 1Q13 distributable income of SGD52.2m (+1% QoQ; +8% YoY), resulting in a 1.97 cts/unit DPU which was similar to 4Q12’s and in line with expectations. We believe that the potential for further equity fund-raising remains, either to pare down its gearing or to fund the acquisition of KepLand’s one-third stake in MBFC Tower 3 sometime in the future. Maintain HOLD.

Assets reporting healthy occupancy rates. KREIT’s portfolio occupancy edged up from 98.5% as at end-2012 to 98.8% as at 1Q13, mainly as OFC’s occupancy rate crept up from 95.9% to 96.6% in the same period. With only 3.5% of leases expiring for the rest of 2013 and another 4.4% in 2014, we expect vacancy risks to be largely mitigated. In fact, KREIT’s weighted average lease expiry (WALE) of 6.9 years remains one of the longest among the S-REITs.

No mention of MBFC Tower 3. In KepLand’s latest update, MBFC Tower 3’s occupancy rate crept up from 79% as at end-2012 to ~84% as at end-Feb. We believe that demand from more non-financial tenants in the coming months could take Tower 3’s occupancy rate above 90% possibly in 2H13 and when that happens, we believe the asset is more amenable to be acquired by KREIT.

More fund-raising still possible. KREIT undertook an opportunistic private placement in Feb to raise gross proceeds of SGD53.2m (40m new units at SGD1.33/unit), which would be largely used for debt repayment and working capital purposes. However, its gearing remains high at 43.3% post-placement, suggesting that more equity will have to be raised to fund the potential acquisition of Tower 3, which we value at SGD1.1b. In our opinion, this could happen in the coming months to take advantage of the stock’s current 1.1x P.B valuation.

Short-term weakness quite possible. We raise our target price slightly to SGD1.27 as we fine-tuned our model, but maintain our HOLD recommendation on the back of limited upside. In addition, KepCorp will be distributing a portion of its stake in KREIT to its own shareholders as dividend-in-specie. The shareholders will receive their KREIT units on 8 May and we expect some sell-down from those shareholders who do not wish to have KREIT in their portfolios.

Opportunistic placement

KREIT’s capital raising is no surprise as we expected its recent purchase of Old Treasury Building to be 50:50 debt-equity funded. The dilution should be muted at about 1%, given the good pricing and small share issuance.

Adjusting for the timing of the placement vs. our earlier assumption of a more backend loaded placement for Old Treasury Building, we trim our FY13-15 DPU estimates but maintain our DDM-based target price. We reiterate our Neutral call as we see higher headline yields compensating for higher asset leverage and income support.

What Happened

KREIT has announced a small private placement of new units and a sale of existing units by Keppel Corp. The private placement of 40m new units (1.5% of previous unit base) raises S$53.2m while the latter pares down 75m of KepCorp’s units (2.8% of previous unit base). The price for both the placement shares and KepCorp’s sale was S$1.33 per unit, representing a discount of 0.6% to the adjusted VWAP and a 2.3% premium over NAV per share. KREIT intends to use most of the placement proceeds to pare down borrowings.

What We Think

KREIT’s capital raising is not a surprise. We flagged the possibility of capital raising by more REITs in our 7 Feb note “REIT – Equity-raising back in vogue”. Our numbers have also factored in a 50:50 debt-equity funded S$211m acquisition of Old Treasury Building though we expected it to be more backend loaded. The S$53m placement proceeds should cover 50% of the initial payment (50% of purchase price) due in Mar 2013 and keep asset leverage well within 45% even as more payments are drawn down.

The move was probably opportunistic, driven by its share price performance YTD, tight placement pricing and sale-and-purchase agreement with the banker involved. After this placement and recent distribution-in-specie of KREIT’s shares by KepCorp, KREIT’s free float should improve to about 42%, with KepCorp retaining an estimated direct stake of about 15%.

What You Should Do

The dilutive impact is muted at about 0.9% in FY13. We reiterate our Neutral call as we see higher headline yields compensating for higher asset leverage and income support.