• Boost from Google largely priced in.
• Uncertainty over timing of Brexit will likely delay acquisition of UK business parks.
• Downgrade to HOLD with unchanged Target Price of S$1.70.

Downgrade to HOLD

• We downgrade our call on FRASERS COMMERCIAL TRUST (SGX:ND8U) from BUY to HOLD with an unchanged Target Price of S$1.70.
• Our previous bullish call was premised on Frasers Commercial Trust backfilling the space vacated by HP at Alexandra Technopark (ATP). With the signing of Google which has increased committed occupancy to 93.7%, this re-rating catalyst has largely played out.

Where We Differ – Close to Average Spread to Large-cap Office REITs

• Frasers Commercial Trust on average has historically traded at 1.2% higher yield than its large-cap office peers given its Grade B, business park and overseas exposure. Frasers Commercial Trust’s earnings are expected to recover in FY21 when full year contribution from Google kicks in and Frasers Commercial Trust no longer needs to rely on capital distributions to support its DPU.
• Then, its estimated forward yield of 6% would be close to its average historical spread. Thus, compared to more bullish investors, we believe there is limited valuation support to drive Frasers Commercial Trust’s share price higher in the near term.

Catalysts for Turning More Bullish

• While we believe Frasers Commercial Trust’s share price is likely to be range-bound near term, we would turn more bullish should Frasers Commercial Trust acquire UK assets at a faster pace or at a higher yield.
• In our numbers, we have priced a S$250m UK acquisition at an initial NPI yield of 6% in 3QFY20.

What's New - Large Priced in

Bullish thesis has largely played out

• Our bullish thesis Frasers Commercial Trust over past was premised Frasers Commercial Trust space vacated by Alexandra in our view has largely played out.
• After the that HP (HP Enterprise and HP Singapore) would 2017, Frasers Commercial Trust had to rely on paying out capital distributions and paying 100% of its management fee in units to maintain a stable DPU. HP used to occupy a total of 496,766 sqft or 44% of ATP. Due to uncertainty over Frasers Commercial Trust’s ability to find a replacement tenant, its share price had been depressed.
• The recent signing of Google as a major tenant at ATP (see report: Frasers Commercial Trust - DBS Research 2019-06-26: Secures Google As Tenant At Alexandra Technopark) has increased committed occupancy to 93.7% from 59.2% at end-March 2019, and removed the overhang on Frasers Commercial Trust. This resulted in Frasers Commercial Trust’s share price rallying close to our Target Price of S$1.70.

Delaying park acquisition

• With the sale of 55 UK business park on a 6% initial NPI yield in FY19. This was premised on Brexit occurring in March this year and Frasers Commercial Trust’s previous guidance that it would expand its UK portfolio after Brexit.
• Given the delay in Brexit, we now assume Frasers Commercial Trust will 100% debt fund its S$250m UK acquisition in 3QFY20.
• Contribution from Google will only kick in from 2QFY20 versus initial expectations of Frasers Commercial Trust finding a large tenant that starts contributing in FY19. Moreover, we have lowered our GBP/SGD FX assumption to 1.72 from 1.80 previously, and these have reduced our core FY19-20F DPU (excluding capital distributions) by 10-18%.
• Nevertheless, we expect Frasers Commercial Trust to maintain a DPU of 9.60 Scts over the next two years before FY21 when it should deliver a “clean” DPU (no support from capital distributions) of 10 Scts in FY21.
• In addition, we have maintained our DCF-based Target Price of S$1.70 as the expected dip in core earnings is offset by a lower assumed risk-free rate (2.5% versus 3.0% previously) and cost of debt (3.25% versus 3.75% previously).

FCOT’s spread to office on a near historical

• Based on FY19F yield, Frasers Commercial Trust’s yield spread to its large cap office REITs (CAPITALAND COMMERCIAL TRUST (SGX:C61U) and KEPPEL REIT (SGX:K71U)) stands at 1.6% versus average historical yield spread of 1.2%. While this looks attractive, we believe a more relevant comparison would be once Frasers Commercial Trust has a “clean yield” in FY21 when it no longer needs to rely on capital distributions to support its DPU.
• In addition, while not a like for like measure given current earnings are depressed, stripping out the capital distributions, FY19-20F core DPU is below the 1.2% average spread.
• Based on our estimates, Frasers Commercial Trust is trading on a FY21 forward yield 6%. This compares to the FY21F yield for large-cap office REITs (CapitaLand Commercial Trust and Keppel REIT) of 4.6%. Thus, the yield differential between Frasers Commercial Trust and its large-cap office peers of 1.3% based on FY21 DPU is close to the historical yield spread of 1.2% and Frasers Commercial Trust does not looks as attractive now as at first glance.

Downgrade to HOLD

• We downgrade our Frasers Commercial Trust upside to our Target Price of S$1.70.
• The re-rating catalyst from Frasers Commercial Trust backfilling the space vacated by HP has occurred. Moreover, Frasers Commercial Trust is now trading close to its historical yield spread to its large-cap office peers on a normalised basis. Hence, we believe Frasers Commercial Trust’s share price will be range-bound near term.
• Factors which would cause us to review our cautious stance are faster-than-expected expansion into the UK, acquisition on a higher initial NPI yield and/or higher-than-expected signing rents.

Source: DBS Research - 12 Jul 2019