Citi Research analyst Brandon Lee is keeping his “buy” call on Lendlease Global Commercial REIT (LREIT) even after the REIT’s unit price has become the worst-performing S-REIT within the brokerage’s coverage at -3% year-to-date (ytd).
To Lee, the lower unit price may be attributed to concerns over the suburban retail cap rate expansion after the sale of Jurong Point to Hong Kong-listed Link REIT.
“Jurong Point’s transacted yield of 4.8% in December 2022 was 20 basis points (bps) higher than its December 2022 valuation yield of 4.6%, which resulted in investors expecting suburban retail cap rate expansion over the next six to 12 months, especially for LREIT’s nearby Jem (whose implied net property income or NPI yield on [its] FY2022 valuation was [around] 4.2% for its retail component based on our estimates),” Lee writes in his Jan 19 report.
However, he adds that valuers’ appraised value for Jurong Point as at December 2022 was flat y-o-y, which is similar to the valuation exercise conducted by Frasers Centrepoint Trust (FCT) in September 2022. The same valuers were used for both Jurong Point and Jem.
“More importantly, we see more attractive short/long-term and well-rounded prospects for Jem,” says Lee. The mall is underpinned by Jurong Lake District’s development into Singapore’s biggest business district outside the city centre, with an existing vibrant area that comprises a mix of office, retail and institutional buildings around Jurong East MRT interchange station. The interchange, which Jem is connected to, is also set to be enhanced by completion of a new Jurong Region Line station and an integrated transport hub in 2028, as well as more sites released by the government.
To this end, Lee sees LREIT’s current unit price, which implies a cap rate expansion of around 90 bps as “overly negative”. LREIT’s current unit price also implies an asset devaluation of 17% and an eight percentage point rise in gearing to 47%. This means around $0.4 billion to $0.5 billion of capital is required to lower LREIT’s gearing to 35% and 30% respectively, the analyst says.
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“However, we think the likelihood of equity fund raising (EFR) to improve gearing is low, given resilient suburban retail cap rates,” he writes.
“Additionally, investors remain concerned over LREIT’s trailing adjusted interest coverage ratio (AICR) of 2.3x, which is below comfortable level of 2.5-3.0x, though we estimate a slightly better FY2023 AICR of 2.4x after factoring in full-year contribution of Jem (completed in April 2022) and higher debt cost,” he adds. “We think 2.4x is reasonable as gearing is unlikely to cross 45%, but estimate $0.4 billion of capital would be needed to increase AICR to 3.0x.”
Further to his report, Lee sees that the potential sale of LREIT’s Sky Complex, which will lower the REIT’s gearing to around 31%, could also soothe more conservative investors.
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To factor in the higher debt cost and updated lease expiry profiles, Lee has cut his distribution per unit (DPU) estimates for the FY2023, FY2024 and FY2025 by 8.1%, 10.6% and 7.0% respectively. Along with the higher estimated risk-free rate of 3.5% compared to the current 2.13%, Lee’s target price for LREIT has been reduced to 78 cents, down from 93 cents before.
As at 10.33am, units in LREIT are trading 1 cent higher or 1.41% up at 72 cents.
