• KEPPEL REIT (SGX:K71U)'s 1Q19 DPU of 1.39 SCTs was broadly in line, at 24% of our FY19 forecast.
• Keppel REIT is benefiting from the office rental recovery in Singapore, though the impact would be partly offset by anticipated frictional vacancy.
• Maintain ADD, with unchanged Target Price of S$1.34.

1Q19 Results Highlights

• KEPPEL REIT (SGX:K71U) reported a slight 0.7%/0.3% y-o-y increase in 1Q19 revenue and net property income. However, distribution income fell 1.9% y-o-y to S$47.3m due to occupancy fluctuations, divestment of a 20% stake in Ocean Financial Centre, and a weaker A$. This was partly offset by lower interest expense and a S$3m capital distribution from divestment gains.
• Keppel REIT's 1Q19 DPU of 1.39 Scts was 2.1% lower y-o-y.

Singapore Office Rental Market Continue to Strengthen

• In 1Q19, Keppel REIT leased/renewed an attributable 57,100 sq ft of space at a positive rental reversion of 14.4%. An estimated 50% of the contracts signed were for new or expansion leases. Demand came from the technology, media and telecoms, banking and financial services as well as energy sectors.
• Keppel REIT's Singapore signing rents averaged at S$12.03psf during the quarter. Committed portfolio occupancy was at 98.7% at end-1Q19, slightly ahead of the 98.4% at end-4Q18.
• Keppel REIT has a remaining 3.6% and 12.1% of rental income due to be re-contracted/renewed in FY19 and FY20, respectively.

Relocation of UBS to 9 Penang Rd

• UBS, which ranks amongst Keppel REIT's top 8 tenants, has just indicated that it intends to relocate to 9 Penang Road, with a target occupation by 2H20.
• According to management, UBS currently occupies 230,000 sq ft at One Raffles Quay, accounting for 17% of that building’s occupancy. We tweak down our FY21 estimates in anticipation of frictional vacancy during the re-leasing period, partly offset by higher rent assumptions.

Lower Gearing of 35.7%

• Keppel REIT’s gearing stood at 35.7% at end-1Q19, down from 4Q18, as proceeds from the sale of its 20% stake in Ocean Financial Centre were utilised to pare down its debts. All-in interest cost was at 2.88%, with 91% of its interest rate on fixed terms.
• Meanwhile, construction of 311 Spenser St in Melbourne is ongoing and slated for completion by 1H20. In addition to exploring acquisition opportunities, the additional debt headroom can be partly used to fund the remaining capex for the office development, in our view.

Maintain ADD Rating

• We lower our FY21 DPU estimates by 4.8% to factor in frictional vacancy from the relocation of UBS. However, we expect this to be offset by a lower cost of equity assumption of 7.33% (from 7.63% previously) as we bake in a lower risk free rate due to the benign interest rate environment. As such, we keep our DDM-based Target Price unchanged at S$1.34.
• Potential re-rating catalysts are faster-than-projected backfilling of the vacated office space and faster-than-projected office rental hikes.
• Downside risks include slower office demand due to a more modest economic growth environment.

Source: CGS-CIMB Research - 17 Apr 2019