Short term pain for long term gain
2Q22 results appear relatively stable but was impacted by management base fees now paid out in cash.
- 1H22 DPU fell 4.4% y-o-y to 3.02 UScts as the Manager has elected to receive 100% of its management base fees in cash from 2Q2022. On a like for like basis (adjusting 1H2021 to 3.00 UScts), 1H22 DPU +0.7% y-o-y.
- 2Q22 estimated DPU +0.7% y-o-y to 1.43 UScts, but fell 0.7% q-o-q.
- Gearing remained relatively stable at 37.2% vs 37.5% in 1Q22.
- Average cost of debt declined marginally q-o-q to 2.88% vs 2.93% in 1Q22.
- Hedge ratio has reduced to 77.1% from 84.2%.
- In Jul22, KORE entered into a new loan facility of US$180m to early refinance its borrowings due in Nov23 and Jan24 totalling US$130m. Post refinancing, there will be no refinancing requirement until Nov24.
- On a pro forma basis, all-in average cost of debt will rise to 3.15% from current 2.88% while average cost of debt will rise to 2.80% vs 2.70% currently. Based on a sensitivity analysis, every 50bps increase in LIBOR / SOFR will reduce DPU by 0.062 UScts (c.1%).
Key highlights / observations
- Portfolio occupancy was relatively stable, +0.3ppt q-o-q to 92%. There were marginal positive and negative movements in occupancy: i) The Plaza saw occupancy improving to above 90% (90.6% in 2Q22) after occupancy fell to 88.9% in 1Q22; and ii) One Twenty Five saw occupancy declining by 3.6ppts to 90.4% due to one significant non-renewal. However, management is hopeful of good news on backfilling the space soon.
- Strong 2Q22 reversions at +4.5%, excluding a significant negative reversion from a temporary lease. 1H22 rental reversion was 1.6%, which had moderated from 2.4% in 1Q22. Management explained that there was a temporary lease that was signed at double digit negative reversions. Excluding this lease, 1H22 rental reversion was +3.9% and 2Q22 was +4.5%.
- Leasing momentum picked up though rents moderated. Despite the looming inflation and recession fears, management was encouraged that leasing momentum and activities picked up in 2Q22 and going into 3Q22, though rents moderated. While management is hopeful that recovery will pick up as more return to office (physical occupancy has improved to c.60% from c.50%), it is cautious on the impact on the economy with the aggressive fed rate hikes.
- Current cap rates are able to absorb some of the rising interest rates but may see some impact on cap rates with the aggressive rate hikes.
- Near-term will be impacted but long term sustainable on converting payment of management base fees to cash. We believe that the conversion of payment of management base fees to cash could see some near-term impact given that the decline in DPU is substantial. However, we believe the move is more sustainable in the long-term as investors are getting a “clean” DPU and this will also prevent the dilution of NAV with the issuance of units at steep discount to NAV.
Divestment of 2 of its smallest assets, Powers Ferry and Northridge, at mid-6% exit yield.
KORE has entered into purchase and sale agreements for the proposed divestments of two of its smallest assets within the portfolio – Powers Ferry and Northridge Center I&II – to third-parties at prices above their last valuations of a total of c.US$36m. The divestment is still subject to the satisfaction of certain conditions, but management is confident that the disposals will go through.
Key details of the divestment:
- Last valuation of the assets as at Dec21 was US$36m in total.
- The sale price has yet to be disclosed but exit yield is mid-6%.
- Expected completion in 3Q22
- No capital gains tax will be realized
- We estimate there could be a 2-3% impact on DPU post the divestment following loss in income.
Divestment to optimize and sharpen portfolio and improve efficiency in asset management. We believe the divestment will sharpen its portfolio towards quality assets. In addition, the divestment would improve the efficiency in asset management as the two assets are relatively small, contributing only 2.7% of NPI, and the assets have been underperforming with occupancy at 68% and 82% respectively.
Proceeds to pare down debt in a rising interest rates environment, while it builds buffer for its next acquisition for better quality assets with longer runway when opportunity arises.
Management has plans to utilize the proceeds to pare down debt. Albeit small, we believe this is a positive move as KORE will exercise prudence in capital management in a rising interest rates environment and build its buffer to make its next acquisition for better quality assets with longer runway.
Sharing gains via capital distributions will smooth out earnings and reward loyal and supportive shareholders. While management is still considering if capital distributions will be paid out, we believe sharing some of the gains from divestment will smooth out earnings and investors will see this positively as their long-term support will be rewarded.
Ongoing portfolio optimization may see more assets identified for divestment. As part of its ongoing portfolio optimization strategy, management may consider more divestments of assets such as Iron Point and 1800 West Loop should the opportunity arise.
Maintain BUY; lower TP to US$0.78. We maintain our BUY rating but lower our TP to US$0.78 from US$0.86 previously. We lower our FY22F and FY23F DPU by 7.5% to 7.6% to factor in the change in management base fees to cash. We have yet to price in the divestments.
KORE’s surprising move to change the management base fees to full cash payments and divesting assets may see near-term impact on income and DPU. However, we believe these moves will further optimize its portfolio and capital management in the longer term. The key factor to keep an eye would be how the proceeds will be reinvested.