• Pare our occupancy assumptions
• FY18F distribution yield of 7.3%
• Negatives likely priced in

Share price weakness likely due to HP lease overhang

Frasers Commercial Trust’s (FCOT) share price has declined by 0.8% YTD, underperforming the FTSE ST REIT Index (+4.0%) and STI (+9.2%). We believe this underperformance could be attributed to lease renewal uncertainties for FCOT’s major tenants, Hewlett-Packard (HP) Singapore Pte Ltd and Hewlett-Packard Enterprise Singapore Pte Ltd at its Alexandra Technopark (ATP) property. The leases will expire in Nov 2017 and Sep/Nov 2017 for the former and latter, respectively.

Collectively, both HP entities contributed 17.5% of FCOT’s gross rental income, as at 31 Dec 2016. From our understanding, HP has not given clarity to FCOT on whether it will be renewing its leases. HP is currently utilising ~2.1m sq ft of space in Singapore.

Its new built-to-suit project at Telok Blangah, which is 100% leased from Mapletree Industrial Trust, has a total GFA of 824,500 sq ft. Hence, we believe it is unlikely HP will vacate its entire premises at ATP. We conservatively assume only partial renewal by HP, and lower our FY18 occupancy assumption at ATP from 95% to 80%. Our FY18 DPU forecast is consequently cut by 9.0%.

Office market showing signs of stabilising

Singapore’s Grade B office rents in the CBD core and islandwide declined by 2.1% and 2.0% QoQ, respectively, in 4Q16, based on data from CBRE. Both represented seven consecutive quarters of decline, but the magnitude of decrease was similar to 3Q16. Hence we believe the office market is showing signs of stabilising.

Maintain BUY

Despite our revised forecast as highlighted earlier, FCOT is trading at FY18F distribution yield of 7.3%. This still comes in approximately 0.5 standard deviation (SD) above its 5-year forward mean of 7.0%. Hence, we believe uncertainties over its ATP asset have been priced in by the market. Current FY17F distribution yield of 7.9% remains attractive, in our view, as it is ~1.4 SD above the 5-year forward mean. We reiterate our BUY rating on FCOT, but with a lower fair value estimate of S$1.39 (previously S$1.48), as a result of our reduced DPU forecasts, coupled with a higher cost of equity assumption (8.48% to 8.54%) as we factor in a higher risk-free rate in our model.

Source: OCBC Research - 14 Mar 2017