• CapitaLand Commercial Trust's 4Q18 DPU of 2.22 Scts (+6.7% y-o-y) in line with expectations. 
• Strong results due to boost from earlier acquisitions and drag from rights issue in 4Q17. 
• Positive rental reversions and continued uplift in market rents underpin improved earnings momentum. 
• Still on the lookout for accretive acquisitions in Singapore and Germany. 

Undervalued

• We keep our BUY call on CAPITALAND COMMERCIAL TRUST (SGX:C61U) with a Target Price of S$2.00.
• We believe CapitaLand Commercial Trust remains undervalued ahead of a multi-year upturn in office rents in Singapore on limited supply. In addition, with its property valuations below physical market transactions, CapitaLand Commercial Trust is trading at an attractive valuation at current CapitaLand Commercial Trust 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 to Trade at a Premium

• CapitaLand Commercial Trust trades at 1.0x P/Bk but we believe it should trade near 1.10x P/Bk, as it demonstrated the conservative valuation of its properties via the sale of three office buildings at 14-39% premiums to book over the past 1.5 years. Its book also remains understated with buildings such as Capital Tower and 999-year leasehold HSBC Building priced at S$1,847 and S$2,275 psf respectively, a discount to transactions of S$2,400-2,700 psf for comparable buildings.
• In the midst of a multi-year upcycle in office rents, CapitaLand Commercial Trust also typically trades at a premium to its book value.

Multi-year Upturn in Rents

• With Singapore office rents rising for the sixth consecutive quarter, hitting S$10.80 psf/mth at end- 4Q18, up 20% from the lows in 1H17, we believe this should generate increased investor interest in CapitaLand Commercial Trust.
• Focus should turn to the expected multi-year recovery in office rents as new supply over the coming three years is limited. This, and the rise in office rents, should act as re-rating catalysts.

Valuation

• We maintain our DCF-based Target Price of S$2.00. With 8% capital upside and 4.8% yield, we retain our BUY call and CapitaLand Commercial Trust as our top pick in the office sector.

Key Risks to Our View

• Key risks to our positive view are weaker-than-expected rents.

What's New - Surges Past the Finishing Line

4Q18 DPU up 6.7% y-o-y

• CapitaLand Commercial Trust had a strong end to the year with 4Q18 DPU jumping 6.7% y-o-y to 2.22 Scts, translating into FY18F DPU of 8.70 Scts (+0.5% y-o-y) which is in line with our and consensus expectations. The strong result was attributed to the acquisition of Asia Square Tower 2 and Gallileo which were completed on 1 November 2017 and 19 June 2018 respectively. Both acquisitions also resulted in 4Q18 revenue and NPI increasing by 14.8% and 16.6% respectively.
• The jump in 4Q18 DPU was also due to the full impact from the additional shares from the rights issue in 4Q17 but only two months’ worth of contribution from AST2. Stripping out contributions from AST2 and Gallileo and earlier disposal of Twenty Anson, 4Q18 revenue would have been down 0.9% with cost control resulting in 4Q18 NPI being up 1.7% y-o-y.
• This also highlights management’s timely acquisition of AST2 ahead of an upturn in the office market. Post CapitaLand Commercial Trust’s purchase of AST2, it has been able to improve the asset yield from an initial 3.6% to 3.8% currently as occupancy has been lifted to 98.1% from 88.7%.
• 6 Battery Road and CapitaGreen the main growth drivers
• 6 Battery Road and CapitaGreen were the main contributors to the growth in 4Q18 NPI, with their respective NPI increasing by 4.6% and 3.2% y-o-y respectively. While both buildings are close to being fully occupied and there were no material y-o-y changes in committed occupancy, the improvement in earnings was due to better cost control and higher passing rents.
• Meanwhile, earnings from HSBC Building and Bugis Village were stable.
• Capital Tower had a softer quarter, with 4Q18 NPI down 2.2% despite occupancy being maintained at 99.7%. This may be due to the negative rental reversions reported in the prior quarter.
• CapitaLand Commercial Trust’s associates Raffles City and One George Street had a decent quarter, with NPI on a 100% basis up 1.6% and 1.0% respectively. Raffles City benefitted from higher y-o-y occupancy (99.6% versus 98.3% in 4Q17) while OGS enjoyed positive rental reversions over the last few quarters. Occupancy for OGS remains high at 97.8% (98.0% in 4Q17).
• Majority of leases achieved positive rental reversions
• On the back of spot Grade A office rents rising by 20% from the lows in 1H17 and hitting S$10.80 psf/mth at end-4Q18, CapitaLand Commercial Trust reported that the majority of leases signed over the quarter achieved positive rental reversions.
• The positive rental reversions were largely concentrated at Six Battery Road and OGS with CapitaGreen on average still negative (average expiring rents of S$13.62 psf/mth versus committed rents of S$11.31-S$13.00 psf/mth). For Six Battery Road, signing rents ranged from S$11.30- 13.50 psf/mth versus average expiring rents of S$12.38 psf/mth. Meanwhile, OGS achieved committed rents of S$9.35- 10.30 psf/mth compared to average expiring rents of S$9.28 psf/mth.
• Going forward, should office rents maintain their upward trajectory over the course of 2019, we believe more leases will report positive rental reversions as expiring rents for FY19 stand at S$10.46 psf/mth versus current spot rents of S$10.80 psf/mth. For 2020 and 2021, expiring rents stand at S$9.59 and S$10.71 psf/mth.
• Following forward renewals achieved in 4Q18, 15% of leases by gross rental income are due for expiry in FY19 (down from 18% previously), with 28% of leases set to expire in FY20.

21 Collyer Quay (HSBC Building) to undergo refurbishment

• Ahead of HSBC’s planned exit from 21 Collyer Quay at end-April 2020, CapitaLand Commercial Trust’s immediate focus is on refurbishing the property and to release it.
• However, CapitaLand Commercial Trust has not come to a conclusion on whether it will hold or dispose the asset or even undertake a redevelopment.

Still on the hunt for acquisitions in Germany and Singapore

• CapitaLand Commercial Trust guided that it intends to increase scale in Germany following its initial purchase of Gallileo in Frankfurt in 2018 with overseas exposure not more than 20% of the portfolio. However, it remains open to investment opportunities in Singapore.
• In addition, should its Sponsor CAPITALAND LIMITED (SGX:C31) merge with Ascendas-Singbridge (ASB) later this year, CapitaLand Commercial Trust has not come to any decision on whether it would be interested in acquiring office assets owned by ASB in Singapore or Korea.

Marginal increase in capital values

• CapitaLand Commercial Trust reported a marginal 0.3% increase in value for its Singapore properties from the last valuation conducted in June 2018. The uplift from June 2018 was mainly due to higher income as cap rates remain stable at 3.5-4.0% respectively. As a consequence, aggregate leverage fell to 34.9% from 35.3% in 3Q18 while NAV per unit rose to S$1.84 from S$1.80.
• Average borrowing cost was stable at 2.6% as CapitaLand Commercial Trust benefitted from having 92% of its borrowings of fixed rates.

Maintain BUY, Target Price of S$2.00

• With 4Q18 results in line with expectations and CapitaLand Commercial Trust leveraged to the expected multi-year upturn in office rents, we maintain our BUY call and Target Price of S$2.00.

Source: DBS Research - 25 Jan 2019