• Sells 20% interest in Ocean Financial Centre for S$537m, 2% above latest valuation and 17% higher than the original purchase price. 
• Normalised exit yield of 3.1% or S$3,061 psf.
• Upside risk to consensus estimates if proceeds are reinvested into a higher yield property or share buyback.

Leveraged to Office Upturn

• We maintain our BUY call on KEPPEL REIT (SGX:K71U) with a revised Target Price of S$1.32.
• Keppel REIT’s share price typically leads a recovery in spot office rents by 6-12 months. According to CBRE, Grade A CBD rents had risen by another 4% q-o-q to S$10.45 psf/mth by end-3Q18, and is 17% higher from the low of S$8.95 psf/mth in 1H17. Thus, we believe office rents are on a sustained upturn and Keppel REIT’s share price should start to stage a rally following the correction over the past few months.

Where We Differ – Large Discount to Book Unjustified

• Consensus has a HOLD rating with a Target Price implying Keppel REIT should trade at a large discount to its book value. However, with FY18 marking the cyclical low in Keppel REIT’s DPU, we are more forward looking and are focusing on the projected growth in DPU from 2019 onwards which would be the first y-o-y increase in DPU in over five years.
• In addition, with management announcing its intention to start a buyback, the first S-REIT to do so, this should send a strong signal that Keppel REIT is significantly undervalued, considering several office buildings in less prime locations have been sold at a cap rate of between 1.7-3.2%, below the 3.75% used to value Keppel REIT’s best-in-class Grade A buildings in Singapore.

Recovery in DPU and Positive Rental Reversions

• We believe the expected recovery in DPU and delivery of positive rental reversions on the back of higher spot rents, would be catalysts to close the discount to Keppel REIT’s book value of S$1.40.

Key Risks to Our View

• Key risks to our positive view are weaker-than-expected rents sing DPU to come in below expectations.

What's New - Crystallising Book Value

Incorporating higher borrowings costs, share buyback and disposal of 20% interest in OFC

• After accounting for higher borrowing costs of 3.0-3.2% from 2.9-3.0% previously, S$25-33m share buyback per annum and recent disposal of a 20% interest in Ocean Financial Centre, we tweaked our FY18/19/20F DPU by 0.4%/0.9%/-1.4% respectively.
• In addition, to better reflect our DBS economist's more hawkish interest rate outlook, we lifted our long-term cost of debt assumption to 3.5% from 3.0%, which leads us to cut our DCF-based Target Price to S$1.32 from S$1.41 previously.
• Post the disposal of a 20% stake in Ocean Financial Centre, we expect gearing to fall to 35-36% from 39% currently, assuming that the proceeds are used to repay debt.

Maintain BUY With Revised Target Price of S$1.32

• We believe the sale of a 20% stake in Ocean Financial Centre reaffirms the holding value of Keppel REIT’s portfolio, robustness of the valuations used for its buildings and its attractive valuation at current levels (with Keppel REIT trading close to a 20% discount to book value).
• As Keppel REIT is leveraged to the expected multi-year upturn in the Singapore office market, we reiterate our BUY call with a revised Target Price of S$1.32.

Source: DBS Research - 26 Dec 2018