Fair value for a strong and steady portfolio

• Results in line
  
• Robust occupancy, long leases provide income stability
  
• Downgrade to HOLD on valuations
  

Results in line with expectations. Kreit reported an 80.4% y-oy rise (+1.5% qoq) in its 4Q top-line to $40.8m while NPI grew 84.7% y-o-y and 2.2% q-o-q to $32.8m. The higher jump in NPI was driven by the additional contribution from OFC. Taking into consideration the higher interest income from MBFC Phase 1 and 8 Chifley Square, distribution income improved 45.1% y-o-y to $51.9m translating to a DPU of 1.97cts. NAV rose to S$1.30/unit on the back of revaluation gain of c.S$140m. Cap rates for its Singapore and Australia portfolio are at 4.0% and 6.6%-7.0%, respectively.

Robust occupancy, forward leasing and long leases mitigate downside leasing risks. All local office assets (except Ocean Financial Centre at 95.9%) are 100% occupied. The Reit’s proactive leasing efforts in forward locking its leases have also reduce FY13 lease expiry and rent reviews to 4.4% and 3.0% respectively, which should help to mitigate leasing risk. Meanwhile, Australia properties continue to enjoy high occupancy of 97.4%-100%. Including the recent acquisition of the Old Treasury Building office, weighted average lease expiry tenure is c.7.0 years implying strong income visibility. As for ORQ, the underlying monthly rents of a c.S$9 psf are still below the income support level of c.S$10 psf. We understand that the group is still in the midst of rent review for some of their tenants. Post the review, rents should move up nicely. Going forward, earnings will be driven by (i) the additional contribution of Old Treasury Building, (S&P will likely completes in 1H); (ii) completion of the OFC retail and car park podium and 8 Chifley Square in the 2H13; and (iii) tax savings from the conversion of MBFC Phase 1 to LLP structure.

Downgrade to HOLD on valuations. We continue to like Keppel Reit for its stable and resilient cashflow, the share price is now trading close to our TP. We have downgraded our call to HOLD on valuations. While the next catalyst could come from acquisitions, we think an accretive acquisition could be modest as current physical prime office yields are trading at sub 4%. We see re-rating catalysts from stronger rentals reversions.

Building on a Good Year

Results did not surprise. Keppel REIT (KREIT) reported a 4Q12 distributable income of SGD51.9m (+45% YoY, flat QoQ), while full-year distributable income surged by 79% YoY to SGD201.9m. These were due mainly to contributions from Ocean Financial Centre (OFC). Full-year DPU was 7.77 cents, in line with expectations. KREIT’s portfolio occupancy is a healthy 98.5%. Maintain HOLD on valuation.

Portfolio near full-occupancy. With the exception of OFC which has a committed occupancy of 95.9%, the rest of KREIT’s Singapore properties are effectively at full-occupancy. Management continued to cite demand as coming from energy and resources companies, legal firms and corporate services providers. In the fourth quarter itself, nearly 80% of the leases were signed with new tenants, with the remaining 20% coming from existing ones seeking expansion.

FY13 growth drivers. Underpinning DPU growth in FY13 will be rent reviews to be carried out at One Raffles Quay (ORQ), where we expect positive rental reversion as under-rented leases are marked-to-market. In addition, the retail and car park podium at OFC and 8 Chifley Square are on track for completion in 3Q13. Management is also comfortable with KREIT’s current gearing level of 42.9%, considering that the interest coverage ratio is a high 4.8x.

Likely pause in Australian acquisitions. KREIT will be shortly completing the purchase of the Old Treasury Building in Perth, Australia, and management is happy to maintain status quo with four Australian assets, unless a very compelling value proposition comes along. In fact, management alluded that it could possibly consider divesting one or more of its Australian properties at the right price to help fund future acquisitions. In addition, management stated that it has yet to review the possible acquisition of MBFC Tower 3. We reiterate that a likely triggering event would be when the occupancy improves to above 90%, up from the last reported 76%.

Maintain HOLD. We raise our DDM-derived target price to SGD1.25 as we adjust our cost of equity and terminal growth rate assumptions, and maintain our HOLD recommendation base on valuation grounds.

Fine end to FY12

KREIT continued to provide a positive read-through of the office market in 4Q, with management guiding positively for ORQ. Headline yields are compelling but we see this as merely compensating for its higher asset leverage and income support.

4Q/FY12 DPUs were spot-on at 25/100% of our FY12 forecast, but came in slightly above street expectations. We raise our FY13-14 DPUs on stronger ORQ performance and adjustments to income support at OFC. Our DDM-based target price (discount rate: 7.7%) rises accordingly but we maintain our Neutral call. We see rerating catalysts from accretive acquisitions.

Steady quarter

4Q12 DPU was up 40% yoy on acquisitions and positive take-ups, partially inflated by a distorted base in 4Q11 due to a mismatch in the timing of OFC contributions and unit-base expansion. Qoq, DPU edged up 0.6%. Results provided a positive read-through of a stabilising office market. Portfolio occupancy rose to 98.5% from 98.2% on higher take-ups at OFC, where signing rents ranged S$9-11psf. At ORQ, where the market is concerned about the drop-off of income support (ORQ saw the last of its GST rebates in 3Q), management guided that the impact should be mitigated by the strong rental reversions (due to low expiring rents) on its rental reviews at the asset and FY12 acquisitions.

On acquisitions

Thanks to revaluation gains, asset leverage dipped to 42.9% from 44.1% as at end-3Q, albeit still the highest among S-REITs. Although this could warrant some equity fund-raising for sizeable acquisitions, management highlighted the possibility of asset divestment to reduce the quantum of possible cash calls. We understand that management has yet to indicate interest for a potential purchase of MBFC Tower 3.

Maintain Neutral

KREIT currently trades at 1.1x P/BV and forward yields at 5.7%. Headline yields are compelling, but we see this as merely compensating for its higher asset leverage. This should warrant equity-raising for further purchases, which could, in turn, limit accretion.

Occupancy keeper

• Results in line; 9M DPU is 76% of our FY12 forecast
  
• Healthy take-up, stable rents backed by high occupancy rates and low expiry leases
  
• Kreit Asia renamed as Keppel REIT
  
• Maintain BUY, DCF-backed TP unchanged at S$1.28
  

Highlights

Results in line. On a y-o-y basis, K-REIT’s gross revenues and NPI more than doubled to S$40.2m and S$32.1m respectively, led by an enlarged portfolio. On a q-o-q basis, revenue grew by a more stable 2.3-2.6% backed by improving occupancy rates at all properties, tax savings at MBFC Phase 1 and the additional contribution from a GST rebate from One Raffles Quay (ORQ). Distributable income was S$51.7m or 1.96cts DPU (+85% y-o-y, +1% q-o-q). To mark its next chapter of growth, K-Reit Asia will be renamed as Keppel Reit.

Our View

Stable rents backed by strong occupancy. Demonstrating its strong leasing capabilities, portfolio occupancy inched upwards to 98.2%. Take-up came from existing tenants, as well as new tenants from the shipping, insurance, fund management and legal sectors, with space requirement from as small as 2,000 sf to 50,000 sf. The high occupancy also translates to better holding power in terms of rents. Monthly asking rents at Prudential Towers and OFC held firm at c.S$9 psf and the low teens respectively with standard incentives provided to the tenants.

Limited downside risk, earnings growth from enlarged portfolio. Looking ahead, we see limited downside risk to revenue. Lease expiry for 2012 is now close to nil with only 14% of its net lettable area to be renewed or reviewed next year. The reit is already actively looking at renewing 2013 leases and interest from tenants is relatively encouraging. Meanwhile, additional contribution from its recently acquired Perth asset, the progressive completion of 8 Chifley Square and the full contribution from Ocean Financial Centre should continue to lift revenue.

Recommendation

Maintain BUY at S$1.28 TP. We continue to like the reit for its strong earnings visibility supported by long-weighted lease expiry of 7.2 years. While gearing has increased to 44.1%, we note that its other financial metrics remained healthy including management confidence in refinancing its S$598m due end of the year. FY13/14F yields at 6.6-6.7%, one of the highest among REITs. Maintain Buy at an unchanged DCF-backed TP of S$1.28.

More of the Same Despite New Name

Quarterly earnings remained steady. KREIT (officially renamed as Keppel REIT wef from 15 Oct) posted a 3Q12 distributable income of SGD51.7m – a 94% YoY increase mainly due to contributions from Ocean Financial Centre (OFC). This was largely in line with expectations. With a 3Q12 DPU increasing 1% QoQ to 1.96 cents, 9M12 DPU now stands at 5.8 cents. We adjust our forecasts to include the recent acquisition of a 50% stake in the Old Treasury Building in Perth. Upgrading KREIT to HOLD, with a fair value of SGD1.09.

OFC occupancy only improves marginally. KREIT’s Singapore portfolio occupancy remained healthy at 98.2%, but the occupancy rate at OFC improved just marginally from 92.3% in 2Q12 to 95% in 3Q12. All leases expiring in 2012 have already been renewed and only 0.3% of the leases (by NLA) will be due for review in 4Q12.

Further diversification into Australia. KREIT recently announced that it will be acquiring a 50% stake in the Old Treasury Building in Perth for an estimated consideration of AUD165m (SGD211.2m). The development is only expected to be completed in 2015, but in the meanwhile, KREIT will enjoy an effective return of 7% based on its progressive capital contribution. The Government of Western Australia has already pre-committed to 98% of the net lettable area on a 25+25 year lease, which increases KREIT’s portfolio WALE to 7.5 years.

Fund-raising still a possibility. Post-acquisition of the Old Treasury Building, KREIT’s gearing is expected to creep up to 45% – right on the cusp of what is generally perceived as an acceptable level for S-REITs. We note that the current commitment level at MBFC Tower 3 has edged up to ~76%. At this rate, the occupancy level could exceed 90% by this time next year, suggesting that the property may be ready for acquisition then. Based on the current gearing level, KREIT would very likely have to undertake an equity fund-raising to fund the acquisition.

Fairly-valued. Due to the long WALE and certain rental supports, KREIT’s DPUs are expected to remain resilient up to FY15F, but the prospect of equity fund-raising remains a near-term overhang. We upgrade KREIT to HOLD, with a DDM-derived target price of SGD1.09.