SINGAPORE (Feb 4): OUE Commercial REIT (OUECT) could well have started to reap profits from its merger with OUE Hospitality Trust (OUEHT). 

Following the merger, OUECT has become one of the largest diversified REITs with total assets of some $6.8 billion and seven properties across the commercial and hospitality segments in Singapore and Shanghai to its name. 

For one, the OUECT’s results for 4Q19 ended December were largely “in line” with analysts’ expectations. The REIT booked a distribution per unit (DPU) of 0.84 cent, some 12% higher than the 0.75 cent DPU back in 4Q18. However, FY19 DPU fell 4.9% y-o-y to 3.31 cents on an enlarged base. 

Revenue for the quarter surged 80.7% to $86.8 million from the previous year, while net property income (NPI) correspondingly grew 92.6% to $70.6 million on the back of the consolidation of OUE Downtown Office’s income since Nov 2018, as well as contributions from OUEHT. 

According to Rachel Tan, an analyst at DBS Group Research, OUECT appears to be “firing on all cylinders” following the merger. “Being a larger entity now, Singapore-centric with strong underlying performance, and working towards potential indexation, OUECT should start to draw investor interest,” says Tan in a report on Jan 31. 

Strong performance for Singapore offices

OUECT’s commercial portfolio consists of four office properties, namely  OUE Bayfront, One Raffles Place, OUE Downtown and Lippo Plaza (Shanghai), as well as one retail property, Mandarin Gallery. 

Reported committed occupancy of the portfolio came in at 95.2% in 4Q19, up from 94.7% in 4Q18. 

OCBC Investment Research analyst Chu Peng hones in on the REIT’s Singapore office properties, which recorded strong positive rental reversions in the range of 9.4% to 26.5% in 4Q19 as rents for renewed leases were higher than expiring rents. “Average passing office rent for Singapore offices were higher y-o-y as a result of consecutive quarters of positive rental reversions,” says Chu. 

“We expect good rental reversions potential with 20% of OUECT’s commercial portfolio by gross rental income (GRI) due for renewal in 2020, and 28% due in 2021,” adds Chu. 

Looking ahead, DBS’s Tan expects OUECT’s portfolio to continue to display strong operational performance, which will in turn drive near-term growth. In addition, the recent merger would allow the REIT to ride on the recent upturn in Singapore’s hospitality sector. 
“Despite slowing growth in office spot rents, management believes its Singapore office assets will continue to enjoy strong positive rental reversions between high single digit to mid-teens in FY2020 given the low expiring rents,” says Tan. 

Potential inclusion into EPRA NAREIT Index

Tan highlights how the merger also allows OUECT to work towards potential inclusion into the EPRA NAREIT Index, designed to track the performance of listed real estate companies and REITs worldwide. The index is also seen as the leading benchmark for listed real estate investments. 

“However, management said they are probably short of an acquisition to bring them towards index inclusion,” observes Tan. 

Yet, the REIT’s management chooses to exercise discipline in acquisitions, without rushing into any deals without certainty that they will be DPU-accretive. 

Central business district (CBD) offices and hotels have been identified as the management’s preferences, especially those in overseas markets such as Europse, UK, Australia and Japan. 

Apart from paving the way for an inclusion into the much sought-after index, OCBC’s Chu highlights that DPU-accretive acquisitions are one of the potential catalysts for the REIT. Another catalyst includes a stronger-than-expected growth in leisure demand for hotels. 

Chu shares that investment risks include a weaker rebound in Singapore’s hospitality sector, as well as a slower-than-expected recovery in portfolio rental reversions.

While the recent outbreak of the coronavirus might have caused some concern for businesses and investors alike, OUECT’s management remains optimistic, citing minimal impact from the cancellation of a group tour from China. 

“Management communicated that the exposure of its hotels to Chinese tourists is 10% and will continue to monitor the situation closely,” says Tan. 

Analyst sentiments remain mixed

On the whole, market watchers appear to remain cautious on OUECT, with the consensus having a “hold” call on the REIT. 

According to DBS’s Tan, this comes on the back of the given the overhang from a potential
18% dilution from the conversion of the convertible perpetual preferred units (CPPUs). 

“OUECT currently has $375 million worth of CPPUs owned by its Sponsor which is a potential medium-term dilution risk,” says Tan, adding that these units may not be converted to OUECT units till Oct 2019. 

Following this, one-third of the total number of CPPUs can be converted in any financial year, translating to some $183 million worth of funds. 

“With OUECT’s share price currently below the CPPU conversion price, we believe there is limited conversion risk in the near term,” says Tan. 

OCBC, keeping in line with the consensus, is maintaining its “hold” call on OUECT with a higher fair value of 55 cents, up from the previous 53.5 cents. 

Meanwhile, DBS has a more bullish view on OUECT, maintaining its “buy” call and target price of 60 cents. 

As at 1.29pm, units in OUECT are trading flat at 53.5 cents. This translates to a price-to-earnings (P/E) ratio of 17.6 times and a distribution yield of 6.3% for FY20F according to DBS valuations.