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Analysts see Keppel REIT benefitting from office rental upcycle though higher interest costs may be a drag

Felicia Tan
Felicia Tan • 6 min read
Analysts see Keppel REIT benefitting from office rental upcycle though higher interest costs may be a drag
The analysts' target prices range from 85 cents to $1.15. Photo: Keppel
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Analysts are mostly positive on Keppel REIT’s prospects after the REIT reported a distribution per unit (DPU) of 2.95 cents for the 2HFY2022 ended Dec 31, 2022, 2.4% higher y-o-y.

For the FY2022, the REIT’s DPU grew by 1.7% y-o-y to 5.92 cents.

The REIT’s distributable income for the 2HFY2022 and FY2022 included an anniversary distribution out of capital gains. The REIT, in October 2022, said it will distribute a total of $100 million in over the next four years leading up to its 20th anniversary in 2026.

Of the analysts, the team at OCBC Investment Research (OIR) is the only one to rate Keppel REIT “sell” with a lower fair value estimate to 85 cents from 87 cents previously.

In its report dated Jan 30, the team sees several positives including healthy rental reversions and the REIT’s benefitting from the office rental upcycle in Singapore. The REIT’s 2HFY2022 results also came in line with the OCBC team’s expectations. Its FY2022 DPU was also “very close” to the team’s forecast of 5.90 cents.

That said, the downside risks from the softening macroeconomic environment as well as the rising borrowing costs are expected to weigh on Keppel REIT’s growth, writes the team. The team’s aggregate leverage ratio stood unchanged q-o-q at 38.4% as at Dec 31, 2022. The REIT manager has indicated that it sees the possibility of its all-in cost of borrowing increasing from 2.29% towards the 3% mark as at end-FY2023.

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A tighter-than-expected supply of office spaces, leading to higher rental reversions, was seen by the OCBC team as one of the potential catalysts. Other catalysts include the stronger-than-expected demand for office space as well as faster-than-expected Fed rate hike pivots.

On the other hand, a faster-than-expected slowdown in macroeconomic conditions, which may dampen business sentiment, is a potential risk. A protracted high interest rate environment as well as currency exposure from holdings in Australia, South Korea and Japan are other downside risks, in the team’s view.

‘Buy’ calls from CGS-CIMB, Citi, DBS and RHB

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Meanwhile, analysts from CGS-CIMB Research, Citi Research, DBS Group Research and RHB Group Research have kept their “add” or “buy” calls after Keppel REIT’s results for the 2HFY2022 and FY2022.

CGS-CIMB analysts Lock Mun Yee and Natalie Ong note the REIT’s strong operating performance in its Singapore portfolio, as well as its strong rental reversion for Singapore offices.

While they have kept their target price unchanged at $1.14, the analysts have lowered their DPU estimates for the FY2023 to FY2024 by 1.5% to 2.1% to factor in higher funding cost assumptions.

Keppel REIT’s DPU for the 2HFY2022 and FY2022 stood roughly in line with Lock and Ong’s full-year forecast.

“Potential catalysts include the redeployment of divestment proceeds to new accretive acquisitions or share buy-backs, while downside risks include longer-than-expected frictional vacancy from tenant movements due to a slower-than-expected backfilling of office space,” they write.

Citi analyst Brandon Lee has kept his target price at $1.10, adding that he sees “muted share price” following the REIT’s “in-line” results.

“Keppel REIT’s 4QFY2022 results painted a still-healthy Singapore office sector despite the uncertain macroeconomic climate, evidenced by strong rent reversions (which will slow to mid-high-single-digit level in FY2023, albeit still decent), healthy occupancy and resilient capital values,” Lee writes in his Jan 27 report.

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“While the softer leasing market is a concern, we think Keppel REIT’s prime office portfolio should be able to withstand the headwinds, helped by competitive expiring rents and limited supply through 3QFY2023,” he adds.

Furthermore, the analyst continues to see value in the REIT with its current P/B of 0.7x and an FY2023 yield of 6.3%. The yield is supported by the REIT’s anniversary distributions.

DBS analysts Rachel Tan and Derek Tan are remaining upbeat on Keppel REIT’s prospects, saying that its best-in-class office portfolio, anchored by Grade A offices in Singapore’s CBD, is “well positioned” to benefit from a potential recovery in a tight net supply market.

Following the merger between the former CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT), Keppel REIT is now the only purely office real estate investment trust (REIT), a valuable trait that investors have yet to appreciate, the analysts add.

Keeping their target price unchanged at $1.15, the highest among their peers, the analysts deem Keppel REIT’s valuations “attractive” at a price-to-net asset value (P/NAV) of 0.7x, close to -1 standard deviations (s.d.) of the REIT’s historical range.

In addition, the analysts are upbeat on Keppel REIT’s active moves in churning its assets to optimise and grow its portfolio. “We believe [this] will drive inorganic growth,” they write.

They add: “Keppel REIT trades at a lower velocity compared to its other large-cap Singapore REITs (S-REITs), which we believe can be addressed if the sponsor considers paring down its stake to a more optimal 30%-35% level, similar to other large-cap S-REITs”.

That said, the analysts acknowledge that key risks to their “positive view” include a prolonged economic downturn and potential new waves of Covid-19 that may impact office rents and vacancies.

RHB analyst Vijay Natarajan has lowered his target price to $1.10 from $1.14 after the REIT’s results stood slightly below his estimates. Keppel REIT’s earnings for the FY2022 came in at 96% of Natarajan’s full-year forecasts.

The analyst has also lowered his DPU estimates for the FY2023 to FY2024 by 4% to 5% due to higher interest costs. The lowered estimates also took into consideration the latest occupancy, rental and recent acquisition assumptions.

“As Keppel REIT’s environmental, social and governance (ESG) score of 3.2 is two notches above the country median, we applied a 4% premium to our intrinsic dividend discount model (DDM) value to derive our target price,” he writes.

Despite the lower target price and DPU estimates, the analyst remains upbeat on Singapore’s office market, which is “expected to stay resilient on low supply and flight-to-quality trends”.

“We believe the REIT could also look at asset divestments to lower gearing and recycle capital,” he adds, noting that Keppel REIT’s valuations are “reasonably attractive, at 0.7x book value with an FY2023 yield of 6.2%”.

On Keppel REIT’s entry into the Japan market following the acquisition of the freehold Ginza 2-chome in October 2022, the analyst believes that the asset was overpaid at a consideration of 8.8 billion yen ($84 million).

“The building is only 36% occupied currently, and has an estimated net property income (NPI) yield of 1.2% (3.1% when fully occupied), which we regard as very low,” says Natarajan.

“Debt cost is expected to be around 1.5%, which means the acquisition is not expected to be immediately yield-accretive. When the building is fully occupied, however, the deal will be mildly-accretive with full debt funding,” he adds.

Units in Keppel REIT closed 0.5 cent higher or 0.52% up at 97 cents on Feb 1.

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