Stability From Singapore And Recovery From Sydney
On a same-store-basis, KREIT improved portfolio occupancy by 1.5ppt yoy to 97.0% in 2Q23 by backfilling vacant space ahead of new supply hitting in 4Q23. P/NAV at 0.62x is almost at the low of 0.61x on 23 Mar 20 during the onset of the COVID-19 pandemic. Thus, potential downside from Keppel Corp shareholders selling KREIT units they received in specie could be limited. KREIT provides 2024 distribution yield of 6.9% (CICT: 6.2%, Suntec: 6.6%). Maintain BUY. Target price: of S$1.06.
WHAT’S NEW
• Well-positioned in Singapore with vacant spaces backfilled. Keppel REIT (KREIT) maintained high portfolio occupancy of 94.9% in 2Q23 (improved 0.7ppt qoq and 1.5ppt yoy to 97.0% if we exclude newly-completed Blue & William in Sydney). In Singapore, KREIT has backfilled vacant spaces ahead of new supply from completion of IOI Central Boulevard Towers in 4Q23. Ocean Financial Centre (OFC) (+8.2ppt yoy) and One Raffles Quay (ORQ) were fully occupied at 100% in 2Q23. Committed occupancy improved +0.9ppt yoy to 98.3% for Marina Bay Financial Centre (MBFC) and +2.9ppt yoy to 98.2% for Keppel Bay Tower.
• Maintaining positive rental reversion in 2H23. KREIT achieved positive rental reversion of 8.1% in 1H23. Average signing rent for Singapore office leases has increased from S$11.54psf pm in 2022 to S$12.35psf pm in 1H23. Management guided positive rental reversion at mid- to high-single-digits for its Singapore office portfolio in 2023 despite a high average expiring rent at S$11.55psf/month for 2H23.
• Sydneysider returning to work in offices. Several large corporations, including banks, have instructed employees to return and work from their offices. Commuter traffic at train stations within the CBD, such as Circular Quay, Town Hall and Wynyard, already hit 70% of pre-pandemic levels in May 23, the highest since the COVID-19 pandemic started in Feb 20. According to CBRE, rental growth for Sydney was 8.1% yoy in 2Q23, outpacing Melbourne at 1.3% yoy. Vacancy rate for Sydney was more stable at 11.5% (+0.2ppt qoq) compared to 15.0% for Melbourne (+0.9ppt qoq).
• Rising occupancies for Sydney properties. 8 Chifley Square in Sydney has signed a new government tenant for 100,000sf, which improved occupancy by 5.4ppt to 87.4% in 2Q23. KREIT is also in advanced negotiations with a co-working operator to backfill vacant space at 8 Chifley Square, which has the potential to lift occupancy above 90%.
• Blue & William started contributing in Apr 23. Blue & William, a freehold Grade A office building with NLA of 152,128sf in close proximity to North Sydney Train Station, achieved practical completion on 3 Apr 23. It has secured its second tenant from the banking sector and committed occupancy has improved to 37.7%. KREIT is in talks with a few prospective tenants for the remaining office space. The developer Lendlease has provided rental guarantee on unlet space for three years from the date of practical completion, which ensures the property is able to provide NPI yield of 4.5%.
• Prudent capital management. Aggregate leverage increased 0.5ppt qoq to 39.2% as of Jun 23. All-in interest rate was stable at 2.84% in 2Q23. It has hedged 76% of borrowings to a fixed rate. S$800m or 22% of its total borrowings are due for refinancing in 2024. We conservatively estimate that average cost of debt would increase by 0.65ppt to 3.5% in 2024.
STOCK IMPACT
• Stability from Singapore and recovery from Sydney. KREIT is well-positioned as it has backfilled vacant office spaces ahead of competition from new supply from IOI Central Boulevard Towers. Its properties in Sydney, 8 Chifley Square, Pinnacle Office Park and Blue & William benefit from companies tightening on hybrid work arrangements.
• Overhang from distribution in specie. Keppel Corp has announced a proposed special dividend in specie of 352.4m units in KREIT representing 9.4% of KREIT’s total issued and paid-up units. Keppel Corp shareholders will receive one KREIT unit for every five Keppel Corp shares. Keppel Corp’s stake in KREIT will drop from 46.5% to 37.1% post the distribution in specie. The proposed distribution in specie has to be approved by Keppel Corp’s shareholders during the EGM on 18 Oct 23. Thereafter, KREIT units will be credited to Keppel Corp shareholders’ accounts on 7 Nov 23.
• P/NAV near historical low. KREIT is trading at P/NAV of 0.62x (38% discount to NAV per unit of S$1.34), which is almost touching the low of 0.61x 0n 23 Mar 20 at the onset of the COVID-19 pandemic. The potential downside from Keppel Corp shareholders selling the KREIT units they received in specie could be limited due to KREIT’s current depressed valuation. Fundamentally, Keppel Corp’s distribution in specie of KREIT units has no impact of KREIT’s DPU.
• Rewarding unitholders with capital distributions. Management set aside S$100m from accumulated capital gains to be distributed over the next five years to mark KREIT’s 20th anniversary in 2026. Distributions would be made semi-annually from 2H22 to 1H27 (S$10m every six months).
EARNINGS REVISION
• We maintain our existing 2023 DPU forecast.
VALUATION/RECOMMENDATION
• Maintain BUY. Our target price of S$1.06 is based on DDM (cost of equity: 6.75%, terminal growth: 1.5%).
SHARE PRICE CATALYST
• Resilient rents and capital values for office properties in Singapore.
• Contribution from Blue & William in Sydney kicking in from Apr 23.