SINGAPORE (Apr 22): DBS Group Research is maintaining CapitaLand Commercial Trust (CCT) at "buy" and raising its target price from $2 to $2.10, saying CCT remains undervalued "ahead of a multi-year upturn in office rents in Singapore" and limited supply over the next three years.

Based on data from CBRE, Core Grade A CBD office rents rose 3.2% q-o-q to $11.15 ppm in 1Q19, the sixth consecutive quarter whereby rents grew more than 3% q-o-q.

The $11.15 ppm achieved at the end of 1Q19 was also 25% higher than from first-half 2017 lows, which the brokerage says should generate higher investor interest in CCT.

CCT's property valuations are below physical market transactions, and its expansion into Europe provides another growth avenue, DBS adds.

On the other hand, OCBC Investment Research is maintaining its “hold” on CCT saying its valuations are not appealing though 1Q19 results met expectations and implying room for favourable rental reversions ahead.

Based on CCT’s trading price of $1.93 at 3.36pm and its forecasts, CCT is trading at P/B ratio of 1.05x FY19F distribution yield of 4.7% or 1.4 standard deviations below its 8-year average forward yield of 5.6%.

RHB Research is also maintaining CCT at “neutral” as its valuation of 1.1x P/BV and FY19F yield of 5% are “not compelling enough” despite its positive outlook.

“We recommend investors to buy the stock on dips,” says RHB analyst Vijay Natarajan.

Research house Jefferies also has a “buy” on CCT, saying it its preferred office REIT due to quality portfolio, good execution track record and supportive macro.

Analyst Krishna Guha says CCT continues to benefit from office upcycle by active portfolio reconstitution, proactive asset and capital management.

While growth in CBD spot rents is expected to slow down and valuations are stretched on a historical context, Jefferies says CCT remains its preferred pick in office sector.

Guha says key risk to Jefferies' estimates is potential loss of income from 21 Collyer Quay in 2020. However, CCT can mitigate the loss by positive rental reversion as the 2020 passing rent of expiring leases of S$9.6 psf is 14% lower from 1Q19 spot rent of $11.15 psf. Further, current gearing offers financial flexibility.

To be sure, CCT’s 1Q19 results came within expectations, at 24% and 24.2% of RHB and OCBC’s full-year forecast.

See: CCT reports 3.8% higher 1Q DPU of 2.20 cents on higher property contributions

In 1Q19, gross revenue and NPI rose 3.5% and 3.4% y-o-y to $99.8 million and $79.8 million, respectively. Growth was driven largely by Gallileo and Asia Square Tower 2 (AST2), but partially offset by the divestment of Twenty Anson. DPU grew 3.8% y-o-y to 2.20 cents due to lower finance costs and a distribution of tax-exempt income of $3.4 million or 0.091 cents per unit.

Positive rental reversions were largely achieved in 1Q19, according to OCBC. Committed rents (psf/month basis) at AST2, Six Battery Road, One George Street and CapitaGreen were $11.00-$12.50, $11.70-$13.50, $9.50- $10.80 and $12.30-$13.30, versus average expired rents of $10.20, $11.85, $9.91 and $12.13, respectively.

“We believe this was underpinned by CCT’s good quality assets and continued momentum in Singapore’s office market,” says lead analyst Andy Wong Teck Ching.

Looking ahead, CCT’s average expiring rents of $10.44 psf/month in 2019, $9.60 psf/month in 2020 and $10.72 psf/month in 2021 are currently below the market spot rent of $11.15 psf/month, implying room for favourable rental reversions ahead, especially in 2020.

Portfolio occupancy remains high at 99.1%, versus 99.4% as at end-FY18.

RHB’s Natarajan says CCT signed leases for 225,000 sqf, of which 18% were new leases. The tenant mix of new leases was also well diversified across seven sectors.

“We believe that most of the lease renewals were higher than expiring rental rates (5-10%). Based on CBRE preliminary data, Grade-A office rental rates rose 3.2% q-o-q in 1Q19 to $11.15 psf, continuing on its 15% y-o-y increase in 2018.

With limited supply in the pipeline, Natarajan expects Grade-A property rental rates to rise 5-15% in 2019. CCT currently has about 11% of leases by rental income due for renewal in 2019, which should benefit from the current momentum.

Meanwhile, with HSBC – currently the sole tenant of the property – vacating the premises on Apr 2020, CCT could potentially look at redeveloping the property and tapping into any additional benefits from the CBD rejuvenation theme in the draft master plan (2019).

CCT has highlighted that the immediate focus will be on refurbishment and re-letting the premises. Management has, however, noted that it doesn’t expect any significant increase to the current GFA, based on the draft master plan for 2019.