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With potential SPH merger, analysts ask if Keppel REIT is the hunter or the hunted

Jovi Ho
Jovi Ho • 4 min read
With potential SPH merger, analysts ask if Keppel REIT is the hunter or the hunted
"SPH REIT has a greater chance of making the acquisition yield accretive... Keppel REIT could be the acquiree."
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Is Keppel REIT the hunter or the hunted? UOB Kay Hian Research analyst Jonathan Koh asks this as Keppel Corporation has proposed to privatise Singapore Press Holdings (SPH). Upon completion of the privatisation, Keppel will own 20% of both Keppel REIT and SPH REIT.

The two S-REITs should be merged to prevent conflict of interest, writes Koh. "Keppel REIT is likely to eventually lose its status and the attached premium as a pure play on office."

Both S-REITs trade at distribution yields of around mid-5%. Keppel REIT has a larger portfolio with assets under management (AUM) at $8.6 billion compared with SPH REIT’s $4.1 billion.

However, SPH REIT has a significantly lower aggregate leverage of 30.3%, compared with Keppel REIT’s 37.6%, writes Koh. "Assuming that both S-REITs’ aggregate leverage are capped at 40%, we estimate that SPH REIT has a larger debt headroom of $667 million compared with Keppel REIT’s $350 million."

SPH REIT also has a lower cost of debt of 1.84% compared with Keppel REIT’s 1.99%. "Thus, SPH REIT has a greater chance of making the acquisition yield accretive by deploying more debts. Keppel REIT could be the acquiree," writes Koh.

In an Oct 27 note, Koh is maintaining "buy" on Keppel REIT, with a lowered target price of $1.25 from $1.49 previously. This represents a 15.7% upside.

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Keppel REIT’s 9M2021 business update was in line with Koh's expectations. Rental reversion weakened to just +1% in 3QFY2021 but committed occupancy edged higher by 0.4ppt q-o-q to 97.1%.

Grade A offices within the core central business district (CBD) are benefitting from a lack of supply, says Koh. "According to CBRE, rents for Grade A core CBD increased 1.4% q-o-q to $10.65 per sq ft/month in 3QFY2021, the second consecutive quarter of increase. Net absorption has reversed to positive territory at 440,352 sq ft in 3QFY2021."

See: Keppel REIT's potential acquisition of SPH REIT could be yield-accretive: UOB Kay Hian

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However, vacancy rates for Grade A core CBD has inched higher by 2.3ppt y-o-y to 5.5%. "Market rent is expected to recover due to demand from the technology companies and nonbank financial institutions as well as limited supply of Grade A office space within the core CBD," writes Koh.

From Jan 1, 2022, employees who are fully vaccinated or have recovered from Covid-19 are able to work at their offices. Unvaccinated employees must be tested negative for Covid-19 before they can return to their offices.

"Thus, physical occupancy is expected to improve significantly in 2022. Average expiring rents are higher at $10.38 per sq ft in 2022, $10.87 per sq ft in 2023 and $10.68 per sq ft in 2024. Thus, rental reversion could be quite neutral in 2022," writes Koh.

Meanwhile, Keppel REIT enjoys long weighted average lease expiry (WALE) for its Australia portfolio (16.4% of AUM).

It could come under some pressure with high CDB vacancy but the negative impact is cushioned by long WALE of 11.2 years.

Similarly, RHB Group Research analyst Vijay Natarajan is maintaining "buy" on Keppel REIT with a target price of $1.25, up from $1.20 previously.

"We expect vacancy to increase slightly in the coming quarters, with DBS' 75,000 sq ft [space] and Standard Chartered Bank expected to surrender some of their office spaces. Management noted that office demand remains strong, driven by tech tenants, co-working operators’ expansions, and some demand from flight-to-quality that offsets the impact of big banks’ downsizing," says Natarajan in an Oct 26 note.

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For more stories about where the money flows, click here for our Capital section

Keppel REIT has been actively rejuvenating its portfolio over the last three years, divesting mature assets and redeploying to higher yielding assets here and Australia, which helped boost operational performances, adds Natarajan.

"In the near term, we see opportunity for the REIT to jointly redevelop Keppel Towers with a sponsor. We also see the possibility of a merger with SPH REIT if sponsor Keppel Corp’s acquisition of SPH is successful. While such a move benefits in terms of scale and diversification, key considerations for unitholders will be pricing and the post-Covid-19 retail landscape," says Natarajan.

As at 3.56pm, units in Keppel REIT are trading 2 cents higher, or 1.85% up, at $1.10.

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