• Keppel REIT 1Q19 results were in line, with DPU of 1.39 S cents/share at 24.1% of our full-year estimate.
• Keppel REIT continues to achieve high overall occupancy (98.7%) and positive rental reversion (14.4%). Rising office rents on the back of firm leasing momentum (amid tight forward supply) should underpin earnings.
• A near-term challenge is UBS vacating its One Raffles Quay premises in Dec 20, which will create a void period (fit-out periods).
• Maintain BUY and target price of S$1.35.

1q19 Results

Results in line with expectations.

• KEPPEL REIT (SGX:K71U) reported 1Q19 DPU of 1.39 S cents/share (-2.1% y-o-y) due mainly to impact of occupancy changes, weaker Australian dollar, and lower contributions from Ocean Financial Centre (following divestment of 20% stake in mid-Dec 18). This was partially offset by higher other income (one-off income of S$3m from certain tenants) and rental support (+24.9% y-o-y), as well as capital gains of S$3m.
• Results were in line, with 1Q19 DPU of 1.39 S cent accounting for 24.1% of our 2019 estimate.

Stock Impact

Firm conditions in Singapore office segment.

• Keppel REIT's overall committed occupancy remained high at 98.7% (+0.3ppt q-o-q). Committed occupancy of its Singapore office portfolio stood at 98.5% (core CBD: 95.2%) and committed occupancy of its Australian portfolio was 99.4% (Australia’s CBD average: 91.4%). Tenant retention declined to 69% in 1Q18 vs 83% in 2018.

Positive rental reversion of 14.4%, mainly due to leases signed at MBFC.

• All the leases concluded during the quarter were from Singapore. Of this, about half were renewals, while the rest were new leases and expansion (mainly from tenants in TMT, banking, financial services and energy sectors).
• Average signing rents for Keppel REIT was S$12.03psf, which compares favorably to the Grade A core CBD average of S$11.15psf (+3.2% q-o-q).
• Overall, Keppel REIT has a well-spread lease expiry, with 4.2% of portfolio NLA for renewal in 2019 (8.2% in 2020) and 0.4% for review in 2019 (3.5% in 2020).

Impact of UBS vacating ORQ premises.

• UBS is set to leave its One Raffles Quay (ORQ) premises (17% of total NLA at ORQ) in Dec 20. UBS is consolidating its employees from ORQ (NLA: 230,000sf) and Suntec City (NLA: 90,000sf) to the new 9 Penang Road (NLA: 381,000sf).
• For management, the challenge is to minimise the void period after UBS vacates. When the space is being leased out in 2021, there will likely be 3-9 months fit-out period (depending on negotiations). On our estimates, we see 2% decline in 2021F DPU (assuming a 6-months rent-free fit-out period).
• Regardless, management expressed confidence that the space can be leased out comfortably (eg with some upper floors of ORQ North tower offering good views), and may also see positive rental reversions. They also guided they may look for 1-2 large tenants, and lease out the remaining floor-by-floor. In conjunction with 8 Exhibition Street leased spaces, UBS made up 3% of the portfolio NLA (this forms part of the 16.7% of portfolio NLA expiring in 2021). Most of the other financial institution tenants are also seeing their leases expire from 2021.

More overseas acquisitions to come (with debt-funding).

• Management is looking beyond Singapore at markets such as South Korea, Japan and New Zealand for acquisition targets. They prefer not to raise equity funding (units issued at discount in a private placement) but utilise debt financing.

Positive outlook for office segments in Singapore and Australia.

• The Singapore office industry outlook remains sanguine as supply-side pressure is expected to be limited over the next three years. Occupancy has also improved to 95.2% (+0.4ppt q-o-q), and rents have risen in tandem to S$11.15psf pm (4Q18: S$10.80). Supply could further tightened in view of URA’s CBD incentive scheme which stipulates the redevelopment of older buildings.
• In Australia, office leasing activity remains healthy, with national CBD occupancy continuing the rising trend from 90.9% in 3Q18 to 91.4% in 4Q18. Moving forward, vacancy rates are expected to remain low with a limited supply pipeline.

1Q19 gearing remained stable at 35.7% (-1.3ppt qoq).

• Keppel REIT lowered its gearing from 36.3% in 4Q18 to 35.7% in 1Q19 through the optimisation of its working capital. Part of the proceeds from the sale of 20% of OFC was used to repay outstanding loans. The weighted average term to maturity of its debt is 3.3 years and its all-in interest rate cost is 2.88% (+0.1ppt q-o-q). Some 91% (+4ppt q-o-q) of its debt is fixed-rate borrowings.
• In terms of sensitivity, every 50bp change in the SOR translates to a 0.04 cent change in DPU.

Unit buy-back in progress.

• Keppel REIT has purchased and cancelled about 34m issued units since the initiation of its unit buy-back scheme in 3Q18. In the upcoming AGM, management will be seeking approval to continue with the buy-back programme.

Earnings Revision

• We maintain our earnings estimates.

Valuation / Recommendation

• Maintain BUY and target price of S$1.35, based on DDM (required rate of return: 6.9%, terminal growth: 2%).

Share Price Catalyst

• Higher office rentals in Singapore and Australia.
• Positive newsflow on leasing activity, employment and economic growth.
• Compression in office cap rates.

Source: UOB Kay Hian Research - 18 Apr 2019