Citi Research analyst Brandon Lee has downgraded CapitaLand Integrated Commercial Trust C38U (CICT) to “neutral” from “buy” as he sees limited near-term distribution per unit (DPU) upside for ION.
CICT’s manager, on Sept 3, announced its intention to acquire 50% of ION Orchard at an agreed property value of $1.85 billion. The 50% stake will come from CICT's sponsor, CapitaLand Investment (CLI). The DPU accretion is expected to be 0.9% on a pro forma basis, had CICT held and operated ION Orchard from Jan 1 to June 30 this year.
While the rest of Lee's peers view the deal positively, the analyst says he sees limited near-term upside for ION.
“After analysing ION Orchard’s historical financials (FY2016 – FY2023), we see three upside catalysts to DPU: tax transparency, which could add [more than] 1% to full-year DPU, though we think there is no certainty CICT could obtain it and timing could be protracted,” he writes in his Sept 9 report.
The limited near-term upside is also due to the mall’s current passing rent of $31 per sq ft per month, which is about 8% below its pre-Covid-19 levels in 2019, normalising to pre-Covid-19 levels. That said, this estimate has already been priced in by FY2025 to FY2026, says Lee.
Finally, the limited upside may stem from debt cost savings, given CICT’s pre-existing loan of $0.8 billion expiring in March 2026 at 4.86% versus an “achievable” rate of 3.5% to 4.0%, which Lee has factored in.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Furthermore, the impact from ION’s occupancy improvement of 1 to 2 percentage points to CICT’s four-year average retail occupancy of 98% is “marginal” while gross turnover (GTO) rent could “plateau” or “slow” down given the trend of the slowdown in tenant sales. To be sure, CICT’s GTO rent already makes up 14% of revenue versus its pre-Covid-19 level of 7%.
“While we think the acquisition yield of 4.9% - 5% (our estimates) is undemanding versus [its] competitors’ 4.0% - 4.8%, we believe ION’s 2023 valuation cap rate of 4.35% (compressed from 4.9% in 2016, with no expansion in any year despite higher interest rates past few years) is fair,” says Lee. This is compared to the mall’s less-prime competitors nearby such as Paragon and Wisma Atria with valuation cap rates of 4.5% and 4.75%.
ION’s acquisition price of +8% versus is 2023 has also likely priced in most of the potential normalisation in rent to pre-Covid, Lee adds.
CICT’s DPU is also likely to be impacted by the impending office downcycle, Lee continues. At present, Singapore offices contribute a “significant” portion to CICT’s assets under management (AUM) and net property income (NPI) at 43% and 32% respectively
“[This is] especially given 2H2024/FY2025 expiring rents of $12.15/$11.91 per sq ft are above our estimated spot of $11.30/$11.00 per sq ft (-5/-3% y-o-y) & near 2Q2024 spot of $11.95 per sq ft (we find peakish),” he adds. The REIT’s office allocation will drop by 3 percentage points after the acquisition of ION.
At this point, CICT’s valuations, at its current FY2024/FY2025 yield spread are “slightly stretched” in Lee’s view. This is compared to the mean of 2.8% when the Singapore 10-year bond yields were at 2.5% to 2.75% and mean of 3.4% during the last interest rate cut cycle in 2019 to 2020. The yields are currently at 2.6% and with a minimum mean of 2.3% and maximum mean of 6.0%. CICT’s current P/B of 1.03 times is nearing its mean of 1.07 times.
Despite the downgrade, Lee has upped his target price estimate to $2.21 from $2.20. He has also increased his DPU estimates for FY2024, FY2025 and FY2026 by 0.2%, 1.0% and 1.3% respectively on ION’s acquisition and fees in units at 70% from 50% now.
“ION’s acquisition is [a negative] 0.4% to [CICT’s] 1HFY2024 DPU is fees [are] in units at 50% and tax transparency is obtained,” says Lee. His downgrade comes on a total return of 9%.
‘Win-win’ ION deal is a ‘positive’ sector read through, says Maybank Securities
Maybank Securities analyst Krishna Guha remains “positive” on the Singapore REITs (S-REITs) sector after the “win-win” and “accretive” deal made by CICT.
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"The purchase will boost CICT’s presence in the Orchard Road shopping precinct, bring in new tenants to the portfolio and reinforce CICT’s position as a proxy for Singapore commercial real estate," notes the analyst in his Sept 9 report.
"The mall encompasses major transport hubs, has a catchment of [over] 10,000 hotel rooms and [over] 20,000 residential units and no known new retail supply until 2027. Tailwinds of tourism recovery, positive economic outlook and limited supply should support rental growth.
Guha also sees financial merits to the deal. On a pro-forma basis, CICT's net asset value (NAV) and gearing remain relatively unchanged with the REIT funding the purchase through an equity fund raising (EFR) exercise.
CICT has already raised $350 million through a private placement. It aims to raise another $757 million through an underwritten rights issue.
On CLI's end, the group will unlock value from the asset and recognise divestment gains of over $100 million. CLI will also get to recycle capital to diversify its footprint and, or product mix.
At the same time, CLI will retain the "very healthy" management fee stream while sacrificing part of the dividend from the asset.
"All in, the deal fits with the sponsor’s asset-light growth strategy and the REIT’s pursuit of growth through active asset management," says Guha.
He adds: "The deal underscores our view that impending rate cuts will help lift sector sentiment, flows, asset values, transactions and capital recycling."
While Guha's DPU estimate for FY2024 remains unchanged at 10.99 cents for CICT, he has upped his FY2025 and FY2026 DPU estimates tby 0.7% and 0.4% to 11.23 cents and 12.01 cents respectively from 11.15 cents and 11.96 cents.
"This is on the back of factoring in $70 million for distribution from the ION Orchard joint venture or JV (as guided in the SGX disclosure), increasing [the] number of units by 558 million (8.3% of current outstanding shares) and raising the proportion of management fee in units to 70% from 50%," he writes.
Guha's target price on CICT is $2.35. He has also raised his target price for CLI to $3.10.
For CLI, the analyst has factored in $150 million of divestment gains and the acquisition fee of $18 million for FY2024. However, he has lowered his share of results from JV by $80 million.
"We arrive at the divestment gain using book value of $3.39 billion in CLI’s annual report and transaction value of $3.7 billion (about 9% premium). The estimated premium matches against the FY2023 gross yield of 7.75% against the transaction yield of 7.1%," he says.
On the S-REIT sector, the analyst still likes industrial and retail S-REITs over office and hospitality names.
"However, taking into account potential upside, we shuffle our preferred picks removing Frasers Centrepoint Trust J69U (FCT) and including Far East Hospitality Trust Q5T (FEHT)," he says. "We retain CapitaLand Ascendas REIT A17U (CLAR) even though upside is limited, as manufacturing has returned to growth and should benefit further from [the] broadening of electronics demand. FEHT’s master lease structure should limit downside while retaining upside from variable rents and lower refinancing due to the lowest hedge ratio."
As at 2.56pm, units in CICT are trading 5 cents lower or 2.34% down at $2.09.
