• SBREIT’s 3Q18 DPU of 1.245 Scts in line.
• Australia and Solaris to anchor an earnings recovery from 2H19.
• Offers attractive FY18F-20F yields of 8.9-9.3%.
• Value has emerged at current levels – upgrade to BUY with higher Target Price of S$0.65.

Upgrade to BUY; Target Price raised to S$0.65 as SBREIT’s Australian acquisitions usher in a new era of stability (and even growth).

• We upgrade Soilbuild Business Space REIT (SBREIT) to BUY with a higher Target Price of S$0.65, implying a total return of 21%. As industrial rents continue to bottom out, we believe the timely expansion into Australia and positive contributions from crown jewel Solaris will help anchor resilience and yields.
• This may help revive investor interest in SBREIT as DPU outlook reverts to positive trajectory after a three-year hiatus. Offering attractive FY18F-20F yields of 8.9-9.3% (+1SD of historical range), we believe that value has emerged at current levels and it is worth a relook.

Where We Differ: More Optimistic over DPU Prospects.

• While 3Q18 results remained weak, we believe that it has been largely priced in by the market. DPUs have also been under pressure over the last few years, but is set to change as contributions from SBREIT’s Australian assets kick in.
• Coupled with positive reversions for Solaris which provide an earnings buffer, this should augment the resilience and even growth of DPUs hereon.

Potential Catalyst: Portfolio Reconstitution.

• After its maiden acquisition in Australia, we believe that the Manager may still be on the lookout for more acquisition opportunities ahead.
• While Australia remains a new market for the group, strong demographics and still-attractive yields help mitigate downside risk and promotes growth.

Key Risks to Our View

• Potential asset revaluations. Gearing could head up to 40% on asset devaluations. Acquisitions could mean equity fund raisings which could be dilutive.
• Risk of tenant defaults such as NK Ingredients on concerns over recent rent delays. Downside is mitigated by security deposit, while upside could come from potential redevelopments, which are not factored into our estimates.

WHAT’S NEW - Value has Emerged for SBREIT

9M18 results weak as expected.

• For 9M18, revenue and net property income fell by 9.5% and 11.3% y-o-y to S$58m and S$49.4m respectively. Similar to previous quarters, the decline was largely attributed to
  1. lower contributions from 72 Loyang Way, West Park BizCentral and Eightrium by S$2.6m, S$2.1m and $1.1m respectively, and
  2. absence of nearly S$2.1m worth of rental income post the divestment of KTL Offshore in February 2018. However, higher contributions from Solaris provided some relief.
• NPI margins also contracted on a sequential basis, from 86.7% (2Q18) to 81.9% (3Q18) mainly on the conversion of Solaris into a multi-tenanted property in August.
• Income available for distribution to investors in 9M18 fell by 7.5% y-o-y to S$36.7m, largely reflecting the lower NPI, with partial offsets from the divestment gain on KTL.
• Overall, 9M18 DPU fell by 11.5% y-o-y to 3.833 Scts (vs 4.329 Scts for 9M17), which formed 75.8% of our full-year forecasts.

Glimpse of a silver lining as negative rental reversionary trends show signs of bottoming.

• Notwithstanding the slight dip in portfolio occupancy from 87.6% in 2Q18 to 87.2% in 3Q18, we believe that the worst may soon be over for SBREIT as its
  1. operating performance steadies sequentially – NPI flattened q-o-q after posting declines over the last few quarters, and
  2. negative reversionary trends moderate.
• SBREIT signed over 665,000 sqft of leases over 9M18, of which 110,000 sqft (or 16.7%) were signed in 3Q18. Notably, rental reversions on lease renewals/forward renewals turned positive during the quarter to 3.6% vs -9.7% in 2Q18, mainly reflecting the positive demand for Solaris.
• Reversions on new leases, while still negative, also moderated substantially from -16.4% (2Q18) to -2.4% (3Q18). On a blended basis for 9M18, the decline in gross rents also moderated to 5.8% vs 9.8% for 1H18.

Receipt of S$3.3m dividend from Technics Offshore to boost 4Q18 DPU.

• SBREIT also announced the resolution of its rent dispute with Technics Offshore Engineering, which has been undergoing liquidation proceedings since mid-2016.
• Subsequent to the resolution, SBREIT has received a dividend of > S$3.25m, which it intends to include in its distributable income for 4Q18.

Concerns over NK Ingredients, but upside could come from redevelopment potential.

• While there were concerns over NK Ingredients falling behind on its rental obligations, we note that downside over the near term is protected by 6M of security deposits currently withheld by the REIT.
• This may also incentivise SBREIT to step up on its redevelopment plans for 2 Pioneer Sector, which has unutilised GFA given its approved plot ratio of 1.0.

Upgrade to BUY with higher Target Price of S$0.65. 

Australian assets and Solaris to anchor stability as softness in industrial space bottoms out.

• On a standalone basis, we predict that the newly acquired Australian properties will help boost NPI by S$7.9m p.a., contributing 10.5% and 0.6% of FY19F NPI and DPU respectively.
• Coupled with positive reversions at Solaris, SBREIT’s single largest asset by GRI, should help mitigate the impact of still-negative reversions for industrial leases and anchor yields as the REIT enters an era of stability (and even growth) amid tapering supply from 2H19F.

Value has also emerged at current levels.

• SBREIT currently offers prospective yields of 8.9-9.3% over FY18F-20F – above +1SD of its historical range.
• Our revised DCF-based Target Price of S$0.65, which we have already factored in a potential 50-bp increase in borrowing costs, implies target yields of 8.0-8.2%, which remains attractive.
• Upgrade to BUY.