• Soilbuild REIT's 1Q19 DPU of 1.20 Scts represents a respectable 3.5% y-o-y growth, excluding one-offs.
• Stock has done well but there are several hurdles to be addressed, such as the default of NK Ingredients.
• Earnings performance could tread lower before a sustained recovery kicks in.
• Downgrade to HOLD; Target Price cut to S$0.63 in anticipation of near-term leasing challenges.

Downgrade to HOLD With Lower Target Price of S$0.63; Stock Has Done Well But There Are Hurdles on the Horizon

• SOILBUILD BUSINESS SPACE REIT (Soilbuild REIT, SGX:SV3U) has gained traction amongst investors post its Australia acquisitions, which coupled with Solaris, offer resilience and potential for growth.
• While industrial rents have also been on a bottoming trend, weaker-than expected occupancy levels suggests that the leasing environment for selected assets could be challenging.
• Downgrade to HOLD as we lower projections to reflect expectations of delays to the onset of a sustained DPU recovery for Soilbuild REIT. That said, we believe that decent FY19F-20F yields of 7.6-7.8% should continue to hold up the stock for now.

Where We Differ: More Conservative Outlook Projections

• We believe investors’ focus will shift toward asset-specific concerns, particularly for West Park BizCentral and Eightrium, which could see near-term volatility in occupancy levels amid tenant relocations.
• Concerns over the financial strength of Beng Kuang Marine (SGX:BEZ) and NK Ingredients, which make up 8% of top-line, may also cap Soilbuild REIT's share price performance over the medium term.

Potential Catalyst: Portfolio Reconstitution

• The proposed sale of 72 Loyang Way is expected to net approximately S$34m for Soilbuild REIT, which could potentially be deployed. After its maiden acquisition in Australia, we believe that the Manager may still be on the lookout to bulk up further.
• We have also assumed the deployment of proceeds from 72 Loyang Way at 6% yield, which provides an earnings uplift in FY20F.

Valuation

• Downgrade to HOLD; DCF-based Target Price of S$0.63.
• After lowering our projections, implies target yields of 7.6-7.8% for FY19F- 20F, which is decent.

Key Risks to Our View

• Potential asset revaluations. Gearing could head up to 40% on asset devaluations. Acquisitions could entail equity fund raisings, which may 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 - Delivers Core 1Q19 DPU Growth of 3.5% Y-o-y But Leasing Challenges Clouds Near-term Outlook

1Q19 DPU of 1.20 Scts (-9.4% y-o-y).

• Led by higher contributions from its Australian assets and Solaris, Soilbuild REIT’s gross revenue and net property income rose by 16.5% and 7.7% y-o-y to S$22.7m and S$18.3m in 1Q19 respectively.
• Meanwhile, the sequential decline from 4Q18 was mainly due to the absence of approximately S$3.25m in one-off liquidation proceeds from Technics Offshore Engineering, as well as lower revenue contributions from West Park BizCentral, Eightrium and 72 Loyang Way. The lower NPI margins of 80.6% (1Q19) vs 87.4% (1Q18) mainly reflect the higher property expenses for Solaris (post conversion to a multi-tenanted building in August 2018) and 14 Mort Street.
• While income available for distribution to investors fell 8.7% y-o-y to S$12.7m in 1Q19, we note that this was mainly driven by a higher-base effect as Soilbuild REIT recorded S$1.7m gain from its divestment of KTL Offshore last February.
• Stripping out the one-off divestment gain, we estimate that distributable income would have otherwise increased by 4.3% y-o-y. Similarly, 1Q19 DPU would have been 3.5% higher compared to adjusted 1Q18 DPU of approximately 1.16 Scts.
• Overall, 1Q19 numbers formed 23% of our full-year projections, slightly below expectations.

Australia and Solaris stay resilient, but multi-tenanted properties remain challenged.

• After delivering three consecutive quarters of growth, portfolio occupancy dipped marginally q-o-q to 89.0% (1Q19) from 89.5% (4Q18), mainly due to the relocation of a key tenant at Eightrium. While revenue contributions across the Business Park and Industrial categories strengthened sequentially in 1Q19, they could ease ahead given the lower portfolio occupancy.

Cautious on upcoming expiries at key assets.

• During the quarter, Soilbuild REIT signed > 175,000 sqft of leases, featuring only industrial leases, with an average negative rental reversion of 3.3%.
• While the moderation in negative rental reversions compared to previous quarters is encouraging (where reversionary trends were down at double-digit levels), Soilbuild REIT could see some downside risks ahead given asset-specific challenges for larger, upcoming lease expiries. These include Eightrium, which is in the midst of remarketing recently vacated spaces, and WestPark Biz Central, which has been facing challenges from an adjacent property with competitive rents, though occupancy had increased by 1.4% to 87.4% q-o-q in 1Q19.
• Rents at Beng Kuang Marine may also be under pressure when leases fall due in 2020.

Overhang from NK Ingredients, but upside could come from redevelopment potential.

• NK Ingredients has entered into a two-month moratorium expiring May 2019. While we understand that Soilbuild REIT has successfully collected rent for April, also note that only one month’s worth of security deposits remains, which does not offer substantial buffers in the event of further slowdowns. However, the Manager sees potential from redevelopment or divestment opportunities, which may enhance the asset’s profile over the longer term.

Pending JTC’s approval on proposed 72 Loyang Way divestment.

• To recap, Soilbuild REIT entered into a sale and purchase agreement with Kim Hock Enterprise on 21 March 2019 regarding the divestment of troubled asset 72 Loyang Way, including the existing mechanical and electrical equipment for a consideration of S$34.08m – in line with the property’s valuation as at 31 December 2018. After taking into account divestment-related expenses, is expected to net a S$55,000 gain for Soilbuild REIT.
• The asset has been underutilised (occupancy < 30%) following the default of anchor tenant Technics Offshore in 2017 and limited flexibility on backfilling the space given restrictions under JTC’s anchor tenant ruling which requires the anchor tenant to satisfy JTC’s requirements such as usage, value-added, remuneration per worker, as well as occupying at least 70% of the premises’ Gross Floor Area (GFA).
• While the sale consideration is substantially lower compared to Soilbuild REIT’s original acquisition price of S$97m back in 2015, this is a painful but necessary step that would allow Soilbuild REIT to finally move forward and refocus on growth as proceeds are redeployed, with minimal near-term earnings impact. For FY18, the asset contributed 1.7% of net profits.

Stable gearing levels of 39.3% (1Q19) vs 39.1% (4Q18).

• Soilbuild REIT's gearing was relatively stable q-o-q with all-in interest cost of 3.53%. Approximately 77.6% of borrowings are hedged into fixed rates, implying lower interest expense volatility in the medium term.

Source: DBS Research - 22 Apr 2019