• 2Q18 DPU of 2.16 Scts (-1.6% y-o-y adjusted for rights issue impact) in line with expectations. 
• Benefit from Asia Square Tower 2 and Gallileo acquisitions not fully realised yet. 
• Negative rental reversions but narrowing gap between expiring and spot rents bodes well for positive rental reversions in the future. 
• Upside risk to DPU estimates from deployment of proceeds from sale of Twenty Anson.

Undervalued

We keep our BUY call on CapitaLand Commercial Trust (CCT) with a Target Price of S$2.12. With the correction over the past few months, we believe CCT remains undervalued ahead of a multi-year upturn in office rents in Singapore.

In addition, with its property valuations below physical market transactions, CCT is trading at attractive valuations at the current share price. Also, the recent expansion into Europe provides another growth avenue which we believe the market has not fully appreciated. 

Where We Differ – Deserves a Bigger Premium

Consensus’ target prices have moved from over the past year.

Overall portfolio occupancy remains healthy at 97.8%, marginally up from 97.3% and 97.6% at end-1Q18 and 2Q17 respectively. The uptick in occupancy was largely due to improvements at 6 Battery Road (99.9% versus 98.5% in 2Q17) and Twenty Anson (95.8% versus 84.2% in 2Q17). Further progress has been made at AST2 with occupancy now at 91.9% compared to 90.8% at the end of 1Q18.

Negative rental reversions but gap between expiring rent and spot rents narrowing

Based on the disclosed expiring rents and committed rents achieved over the quarter, it appears CCT may have faced negative rental reversions in 2Q18, following small positive rental reversions in 1Q18.

However, the gap between spot Grade A office rents and average expiring rents has narrowed. For 2Q18, spot rents of S$10.10 psf/mth are now marginally below average expiring rents of S$10.73 psf/mth. This compares to spot rents of S$9.40 psf/mth and average expiring rents of S$11.09 psf/mth in 4Q17. The narrowing gap and if spot rents continue to climb as expected, should bode well for CCT starting to deliver positive rental reversions ahead. In addition, signing rents for CCT’s various buildings remain above the various sub market rents. 

Over the quarter, AST2 achieved committed rents of S$8.40-9.86 psf/mth.

Post the leases signed in 2Q18, only 2% and 24% of office leases by gross rental income are up for renewal for the remainder of FY18 and FY19, down from 5% and 31% respectively.

Revaluation gains from further compression of cap rates

On the back of a 10-bp compression in cap rates for CCT’s Singapore office buildings, CCT reported a 1.3% increase in property values for its Singapore portfolio, resulting in NAV per unit (excluding distribution income) rising to S$1.80 from S$1.74. 

CCT’s Singapore office buildings are now valued using a cap rate of between 3.5-4.0% versus 3.6-4.10% previously. The higher property values resulted in aggregate leverage being stable at 37.9% offsetting the impact from higher borrowings to fund the acquisition of Gallileo.

On the back of higher benchmark interest rates, average borrowing costs ticked up marginally to 2.8% from 2.7% at end-2Q18. The proportion of fixed rate borrowings fell to 85% from 90% in the preceding quarter.

Upside risk to earnings estimates

Following the divestment of Twenty Anson on an exit yield of 2.7%, CCT’s gearing is projected to drop to 35%, should it use the proceeds from the sale to pare down debt. 

Completion of the sale is risk to our earnings/DPU estimates.

We believe the likelihood of CCT expanding into Europe is high given the need to build scale in Europe following its maiden acquisition there, the lack of investment opportunities for prime Grade A offices in Singapore and the better yield spreads on offer in Europe.

Europe currently represents 5% of CCT’s portfolio by asset value versus its long-term target of having 10- 20% of assets outside Singapore. Given our view that CCT is likely to buy in Europe sometime in 2H18, we maintain our earnings and DPU estimates for now.

Source: DBS Research - 19 Jul 2018