Analysts at RHB Bank Singapore, UOB Kay Hian, DBS Group Research, CGS-CIMB Research, Citi Research and Maybank Securities are keeping their “buy” and “add” calls on Keppel REIT (KREIT) after the REIT’s results for the 9MFY2023 ended Sept 30 stood in line with most if not all of their estimates.
For the 9MFY2023, the REIT’s distributable income from operations stood 10.1% lower y-o-y at $148.6 million. The decline was attributed to higher borrowing costs and higher property expenses as a result of higher property tax and utility costs. That said, the drop in distributable income was partly mitigated by higher property income and rental support.
Following the positive results, the analysts from RHB, UOB Kay Hian, DBS, CGS-CIMB and Citi have all kept their target prices of $1.08, $1.06, $1.15, $1.14 and 99 cents respectively, while Maybank’s Krishna Guha lowered his target price to $1 from $1.05 previously.
According to Guha, the lowered target price factors in a higher risk-free rate and lower margins, resulting in an around 1% lower distribution per unit (DPU). That said, he remains positive on the REIT due to its 7% yield and “reasonable valuation” of 0.7x FY2023 P/B.
However, some of the near- and medium-term headwinds include the REIT’s sponsor’s proposed in specie distribution of KREIT units, potentially lower asset values and the evolving hybrid work pattern.
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Upside factors noted by the analyst include an earlier-than-expected pick-up in leasing demand for office space driving improvement in occupancy, better-than-anticipated rental reversions and accretive acquisitions or redevelopment projects.
On the other hand, downside risks include a prolonged slowdown in economic activity which could reduce demand for office space, resulting in lower occupancy and rental rates, the termination of long-term leases contributing to a weaker portfolio tenant retention rate and a sharper-than-expected rise in interest rates, which could increase cost of debt and negatively impact earnings, with higher cost of capital lowering valuations.
RHB analyst Vijay Natarajan says that he was “positively surprised” by the occupancy uplift across most of the REIT’s overseas assets, with stronger rental reversions in 3QFY2023 against 1HFY2023.
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He writes: “While borrowing costs are expected to rise by 50 to 60 basis points (bps) next year post-refinancing, the effects are likely to be offset by continued operational improvements”. On finance costs, the analyst notes that the next major loan re-financing will come in 2QFY2024, as $800 million will expire next year. This should increase borrowing costs to mid-3% levels, he adds.
“We expect the year-end portfolio valuation to remain largely unchanged with Singapore assets anticipated to see a slight increase, offsetting potential weakness in overseas markets and foreign exchange (forex) effects,” he writes.
In his Oct 18 report, the analyst sees that the REIT’s manager is likely to resume its share buybacks after a “slight pause” in 3Q2023, which KREIT attributed to letting the market digest the impact from higher float due to the dividend-in-specie distribution of its shares by its sponsor.
With its gearing of 39.5% as at Sept 30, the REIT’s manager has said that it remains “open to tactical divestments of its overseas assets at the right opportunity”.
“Keppel REIT is oversold, in our view, amid broader market pessimism on the office asset class. It is trading at an attractive 40% discount to book value with 7% yield,” says Natarajan.
UOB Kay Hian’s Jonathan Koh, is similarly pleased with the REIT’s occupancy rates and its outlook.
He writes: “In Singapore, committed occupancies for Ocean Financial Centre (OFC), One Raffles Quay (ORQ), Marina Bay Financial Centre (MBFC) and Keppel Bay Tower were high at 100.0%, 99.7%, 98.6% and 98.2% respectively.”
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Koh observes that KREIT is well-positioned as it has backfilled vacant office spaces ahead of competition from new supply at its Singapore IOI Central Boulevard Towers in 4QFY2023, and its properties in Sydney, 8 Chifley Square, Pinnacle Office Park and Blue & William, all benefit from companies tightening on hybrid work arrangements.
Notably, he also writes that KREIT is trading at a price to net asset value ratio (P/NAV) of 0.64x, which is at a 36% discount to the net asset value (NAV) of $1.31 and is close to reaching the same level of 0.61x on March 23, 2020, 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 on KREIT’s DPU,” opines Koh.
Share price catalysts understood by the analyst include resilient rents and capital values for office properties in Singapore as well as contribution from Blue & William in Sydney, which will kick in from April.
The team of analysts at DBS also sees that KREIT’s current share price is attractive, although it could be weighed down by a cautious stance on the continuation of rising interest rates in the near term.
“However, we believe at these levels, it is an attractive entry point for a medium term outlook and to position for a turn in interest rate hike cycle,” writes the DBS team.
Meanwhile, CGS-CIMB analyst Lock Mun Yee notes that potential catalysts for KREIT include the redeployment of divestment proceeds to new accretive acquisitions and recovery to pre-Covid demand for office space whilst downside risks include the longer-than-expected frictional vacancy from tenant movements due to a slower-than-anticipated backfilling of office space, and reduced appetite for the REIT’s office space due to a hybrid work environment.
“At a 7.1% FY2023 dividend yield, we believe much of the downside risk has been factored into its current share price,” says Lock.
Finally, Citi analyst Brandon Lee likes KREIT’s “superior portfolio” although he notes that the lower proportion of new leases at 44% which is 24 percentage points (ppt) lower q-o-q suggests weak incremental demand for office space, which could possibly also be due to the REIT’s tight portfolio vacancy.
He notes that KREIT has received enquiries on tenant downsizing, but is happy to take back its space in view of the strong market.
“We see slight positive share price impact on strong leasing metrics in Singapore,” he says.
Units in Keppel REIT closed 0.5 cents lower or 0.60% down at 84 cents on Oct 18.
