NDR Highlights: Paragon, Rail Mall and Other Deals

• We hosted an NDR for SPH REIT in Singapore. Key highlights include:
  1. discussions on Paragon’s operational performance;
  2. its recent Rail Mall deal; and
  3. potential acquisition opportunities.
• We tweaked forecasts following in-line 3Q18 results on higher borrowing costs and factoring in the Rail Mall deal.
• SPH REIT remains a strong proxy to growth in tourism spending and recovery in prime Orchard Road rents. However, the shares are fairly valued having outperformed the past year and likely pricing in potential acquisitions which lack timing visibility. Reiterate HOLD with DDM-based SGD1.00 Target Price (WACC: 6.9%, LTG: 1.5%).
• We prefer Frasers Commercial Trust (FCT; Rating: BUY; Target Price: SGD2.55) for its suburban footprint and stronger growth profile.

Further Moderation in Rental Reversion at Paragon

Tenant sales improved and YTD shopper traffic remained stable, but rental reversion at Paragon was -6.2%, albeit a moderation from 1H18.

Management was tight-lipped on rental guidance but explained that tenant negotiations were driven by occupancy cost considerations with leases typically committed a year earlier.

Luxury brands reported double-digit sales growth, which led the recovery in tenant sales and lowered occupancy costs below 19% from 19.6% in FY17. Sportswear sales have also strengthened, explaining an increased visibility of standalone mono- brand stores on the third floor. We forecast rents to rise 3-5% in FY18-19.

How Soon Can Acquisitions Drive Growth?

In terms of acquisition opportunities, Seletar Mall remains a possibility, while third-party Australian retail assets are likely at the ‘tail-end of the investment cycle’ according to management. 

A potential Seletar Mall deal adds 4-8% to FY19 DPU estimates, assuming the purchase of a 100% stake that is fully debt-funded given its low gearing of 26%.

We peg a higher probability to the acquisition of its sponsor’s 70% stake (in the mall), as the rest is owned by United Engineers (SGX:U04), now controlled by two distinct developer parties.

A Small Step With Rail Mall

The Rail Mall deal was completed on 28 Jun. 

Management believes the locality’s private residential catchment is conducive in expanding its F&B tenancies, which are resilient to e-commerce threats. Near-term organic growth is likely to be limited with occupancy at 96% and low footfall. 

We have included the SGD63.2m acquisition assuming an NPI yield of 7.0% given the shorter remaining land lease.

Swing Factors 

Upside 

• Earlier-than-expected pick-up in leasing demand for retail, office space driving improvement in occupancy. 
• Better-than-anticipated rental reversions. 
• Accretive acquisitions or redevelopment projects. 

Downside 

• Prolonged slowdown in economic activity could reduce demand for retail, office space, resulting in lower occupancy and rental rates. 
• Termination of long-term leases contributing to weaker portfolio tenant retention rate. 
• Sharper-than-expected rise in interest rates could increase cost of debt and negatively impact earnings, with higher cost of capital lowering valuations. 

Source: Maybank Kim Eng Research - 13 Jul 2018