Steady ship in the inaugural year

• 4Q14 DPU of 1.39 Scts exceeded forecast by 6.1%
  
• Positive rental reversions; NAV up 4.4%
  
• Maintain HOLD, TP revised to S$1.03
  

Highlights

DPU of 1.39 Scts exceeded IPO forecast by 6.1%.

• Revenue and net property income of S$51.1m and S$38.0m were 2.6% and 5.6% higher against forecast. Portfolio rental reversions remained strong – Paragon achieved rental uplifts of 10.5% YTD, while Clementi Mall secured 5.5% higher rents YTD. However, we note that tenant sales for Paragon and Clementi mall were down 4.5% and 3.3% y-o-y, respectively, while foot traffic remained stable. The property portfolio was revalued up by c.3.4% to S$3.05bn, lifting NAV per share by 4.4% to S$0.93. Gearing headed lower to 26.0% as a result.
  

Investment Thesis

Stable Earnings Outlook

• With rentals already at market rates and retailers outlook still fairly weak due to the decline in tourist arrivals and poor retail sales, further rental hikes at both Paragon and Clementi Mall going forward appear modest. Limited acquisition prospects in the near term
  
• Seletar Mall (its ROFR asset from its sponsor, SPH) is expected to complete in Dec’14 and is the next main growth catalyst for the SPH REIT. However, we believe an acquistion timeline for this mall to come only in 2016 onwards after stabalization. Till thn, we see limited scope for acquistions.
  

Valuation

HOLD. Target Price S$1.03. Our revised target price of S$1.03 is based on DCF after accounting for lower units/debt levels. At current price, the stock appears fairly valued at a forward yield of 5.4%. We maintain our HOLD call given its premium valuations vs peers.

Risks

Interest rate risk

• SPH REIT will be negatively impacted when its loans are refinanced in an environment of rising interest rates. This risk is mitigated through having a staggered debt maturity profile with nil refinancing till 2016. Reported average interest cost of 2.33% is slightly lower than IPO forecast of 2.35%.

Post-results feedback

The key issues discussed during the investor luncheon we hosted following SPH REIT’s 3QFY14 results were: 1) the potential AEIs at Paragon, which could add c.10,000 sq ft of NLA, 2) rental outlook for both the retail mall and medical suites at Paragon, and 3) the potential acquisition of Seletar Mall. We remain confident that SPH REIT will continue to expand, while offering sustainable returns to investors. Maintain Add and target price of S$1.09.

What Happened

We recently hosted an investor luncheon for SPH REIT following its 3QFY14 results announcement.

What We Think

Management highlighted three potential AEIs for Paragon that would add c.10,000 sq ft of NLA. The first AEI (slated for completion in 1QFY16) involves replacing the existing chillers with smaller, more efficient units and relocating them outdoors. This would add c.5,000 sq ft of NLA to level five of the mall. Management did not share any details on the other two AEIs as those projects are awaiting the approval of the board of directors and authorities. However, management guided that upon completion, one of the projects would add 5,000 sq ft of NLA and the other would improve Paragon’s efficiency.

Shopper traffic at both Paragon and Clementi Mall dipped slightly in 3QFY14 due to different reasons. For Paragon, the dip (-1% yoy) caused by the weak Chinese visitor numbers. Management also noted that future rental growth is expected to moderate to c.3% p.a., given the passing rent of S$21.70 per sq ft/month. The rental rates for the medical suites (passing rent of S$11.06 in 3QFY14) are expected to rise at a slower pace than those for the retail segment. As for Clementi Mall, the slower shopper traffic was due to the rising competition in the Western region of Singapore. However, Clementi Mall’s shopper traffic YTD was still higher yoy. Given the passing rent of S$15.90 per sq ft/month, management was confident of maintaining rental income to the supported level of S$18 per sq ft/month, as it reshuffles its portfolio to include stronger tenants, before the end of its income support in FY18. Seletar Mall, which is slated for completion at end-CY14, is likely to be injected into the REIT 1-2 years after the date it first commences operations.

What You Should Do

Maintain Add as SPH REIT continues to deliver stable earnings, while enjoying growth opportunities in the long run.

Right dose of class and stability

SPH REIT is a retail REIT with two quality and well-located assets in Singapore (Paragon and Clementi Mall). We believe that the portfolio offers a unique combination of prime Orchard Road and suburban retail, and an alternative play on rising medical tourism in Singapore.

Using DDM-based (discount rate of 7.7%), we arrive at a target price of S$1.06, translating to implied CY14 yields of 5.4% for unitholders. We deem this fair against listed peers such as CMT, FCT and MCT, which trade at CY14 yields of c.5.6-5.7%.

Dose of class and stability

SPH REIT is a retail REIT with two quality and well-located assets in Singapore valued at a total of S$3.2bn. They are: 1) Paragon, a premier upscale mall and medical suites/office property in the heart of Orchard Road, and 2) Clementi Mall, a mid-market suburban mall located in the centre of Clementi town. We believe that the portfolio offers a unique combination of prime Orchard Road and stable suburban retail, and an alternative play on rising medical tourism in Singapore.

Paragon is the main draw

The main attraction for SPH REIT is Paragon. We like Paragon‟s 1) clear luxury positioning, 2) strategic location near Mount Elizabeth Hospital, 3) unbeatable track record of 100% occupancy and annual rental growth over the past 10 years, and 4) synergies between the mall and the medical tower. We expect Paragon to benefit from the government‟s positioning of Singapore as a top luxury lifestyle destination and from the nation‟s expanding medical tourism. We see growth from positive rental reversions (as its current passing rent of S$21psf is at the lower end of its peers‟ S$21-24psf, based on our estimates), rental step-ups, healthy occupancy cost of 15.7% (estimated by Urbis), and potential rise in medical suite rents. Meanwhile, Clementi Mall offers stable suburban retail exposure, further enhanced by a five-year income support.

Further growth potential through acquisition

With an asset leverage of 26.9%, SPH REIT has a debt headroom of c.S$415m to 40% asset leverage for acquisitions. Key pipeline asset includes The Seletar Mall, which is slated for completion by end-2014. Given its good mix of stability and room for growth, we initiate coverage on SPH REIT with an Add rating and TP of S$1.06.

Maintaining its thrust ahead

• DPU exceeded prospectus forecast
  
• Rental reversion remained strong
  
• Keeping view for steady performance
  

2QFY14 results within expectations

SPH REIT turned in a sturdy set of 2QFY14 results last evening. NPI came in 8.6% higher than the pro forma figure in previous year at S$38.8m, while distributable income grew 9.4% YoY to S$34.9m. The positive variance was due to higher rental income from both Paragon and Clementi Mall, and lower utilities expenses. As a result, DPU for the quarter rose by a similar 8.6% YoY to 1.39 S cents, ahead of its prospectus forecast of 1.33 S cents by 4.5%. Together with 1Q distribution, 1HFY14 DPU amounted to 3.25 S cents (+5.5% YoY), 3.2% above prospectus forecast. This met 50.8% of our FY14F DPU, which we deem to be consistent with our expectations.

Robust operational performance

SPH REIT’s portfolio continued to exhibit resilience during the quarter. Both retail malls saw improvements in NPI YoY and remained fully leased. For 1HFY14, SPH REIT also achieved positive rental reversion of 10.8% for its portfolio, driven by rental uplift of 13.6% at Paragon and 5.1% at Clementi Mall. In addition, shopper traffic has held steady at Paragon, while that at Clementi Mall increased 2.7% YoY. The only slight disappointments for an otherwise robust performance were the 1) slight decline in recent tenant sales at Paragon in tandem with the softening of the luxury market; and 2) continued tight labour market which may hamper expansion plans by retailers. However, management shared that the situation is still far from worrying and that the strong lease commitment by its tenants is a strong testament to its quality portfolio properties.

Maintain HOLD on valuation grounds

Looking ahead, SPH REIT is keeping its view that it will continue to deliver steady performance. We understand that the development of its ROFR property, The Seletar Mall, is on track for completion in Dec 2014. Its balance sheet remains strong, with gearing at 26.9% and cost of debt at 2.33%. This gives SPH REIT ample debt headroom for growth. We are keeping our forecasts and S$0.99 fair value unchanged, as the results were in line with expectations. Maintain HOLD.

A class act

• Portfolio of landmark assets with resilient cashflows
  
• Backed by reputable sponsor, SPH with a visible acquisition pipeline
  
• Initiate with HOLD, TP S$0.97
  

Portfolio of landmark assets. SPH REIT offers investors a unique exposure to the retail and healthcare services industry in Singapore, backed by a portfolio of landmark high quality commercial assets. We believe that the REIT will provide a stable yield platform with growth potential from organic and inorganic means.

Strong resilient cashflow. Paragon, which enjoys a high degree of tenant retention, provides a strong resilient cashflow stream while Clementi Mall provides room for organic growth as it moves into its first rental reversion cycle in FY14. The latter, which enjoys very strong pedestrian footfalls and a lower-than-industry occupancy cost, is anticipated to renew its leases positively.

Backed by a reputable and strong Sponsor. The Sponsor of SPH REIT is Singapore Press Holdings, a leading media organisation. In addition, it has more than a decade-long track record in the property sector since acquiring Paragon in 1997. It has also provided a ROFR that includes The Seletar Mall, currently under construction, to the REIT. This has provided SPH REIT with a visible inorganic growth driver.

Initiate with HOLD, TP S$0.97. We initiate SPH REIT with a HOLD call, TP S$0.97 based on DCF. While FY13-14F Yields of 5.4-5.6% are attractive given its stability, the REIT is trading at a premium to other retail-focused SREITs, which currently offer yields in the range of 6.1%-6.5%. Upside risks to our forecasts will hinge on better than anticipated performance of Clementi Mall or acquisitions which we have not factored in.