• KEPPEL REIT (SGX:K71U)'s 2Q19 DPU of 1.39 cents is in line with our expectations and a decent performance despite the high base created by one-off income of S$12m from the early termination of leases in 2Q18.
• We expect Keppel REIT to maintain positive rental reversion for its Singapore office portfolio. 311 Spencer will start contributing upon completion in 1H20.
• Keppel REIT has capital gains of S$105m available to top up distribution or be deployed in share buyback.
• Maintain BUY and target price of S$1.37.

2q19 Results

Results in line with expectations.

• KEPPEL REIT (SGX:K71U)’s reported 2Q19 DPU of 1.39 cents (-2.1% y-o-y), bringing 1H19 DPU to 2.78 S cents (-2.1% y-o-y).
• Property income declined 22.7% y-o-y due to a high base as a result of one-off income of S$12m received from the early surrender of leases.
  • Contribution from Ocean Financial Centre (OFC) declined 31.6% y-o-y as Keppel REIT divested a 20.1% stake in OFC in Dec 18.
  • Contribution from Bugis Junction Towers declined 21.6% y-o-y as key tenants Keppel Land and Keppel Capital have shifted out (management indicated that new tenants will shift in and start contributing in 3Q19).
  • Income contribution from One Raffles Quay (ORQ) declined 6.7% y-o-y on a lower occupancy of 97% (2Q18: 100%).
  • Income contribution from Marina Bay Financial Centre (MBFC) was stable at S$20.1m.
• Contribution from JVs declined 2.7% y-o-y due to depreciation of the A$. T Tower made maiden contribution of S$1.3m after the acquisition was completed in May 19. There was no rental support in 2Q19.
• Distribution income was bolstered by capital gains of S$3.0m.

Stock Impact

Expect continued positive rental reversion.

• According to CBRE, Singapore disclosed that the average rents for expiring leases are S$10.70psf pm for 2019, S$9.70psf pm for 2020 and S$9.60psf pm for 2021. Thus, Keppel REIT is likely to maintain positive rental reversion for its Singapore office portfolio.
• Committed occupancy was 98.9% for Singapore and 99.5% for Australia as at Jun 19. T Tower is fully occupied.

Pockets of ORQ.

• UBS is expected to vacate Suntec City Penang Road (NLA: 381,000sf). Keppel REIT has received enquiries for the vacated space and discussions are on-going. Management expects new leases to be committed by end-19.
• Deutsche Bank occupies seven floors at ORQ (200,000sf or 16% of total NLA). Management expect Deutsche Bank’s restructuring to affect the bank’s Hong Kong operations, more so than Singapore.

Acquisition of 99.4% in T Tower has been completed

• Acquisition of 99.4% in T Tower has been completed and extends Keppel REIT’s footprint into Seoul (South Korea accounts for 3.6% of Keppel REIT’s S$8.4b commercial portfolio). With an NPI yield of 4.7%, T Tower is expected to boost pro-forma 2018 DPU by 2.5% to 5.70 S cents, based on debt financing. Transacted price is also attractive, which is at a 2.5% discount to an independent valuation by C&W. T Tower was completed in 2010 (226,945sf in attributable NLA), and enjoys 100% committed occupancy.
• The outlook for Seoul’s office market appears robust, with office investments reaching a historical high in 2018 amid ample liquidity and positive investment sentiment. Management cited JLL which expects CBD Grade A occupancy to decline 1.3ppt to 81.9% in 2020 before rising in subsequent years on lack of new supply.

Development of 311 progress.

• The freehold Grade A office building will be 100% leased to Victoria Police for 30 years, upon completion expected in 1H20 (rental income to start flowing through).

Australia CBD Office to see further improvements.

• According to JLL, Australia’s absorption across Sydney and Melbourne also saw occupancies rise to 964% (+0.4ppt q-o-q) and 976% (+0.6ppt q-o-q) respectively. Sydney CBD is seeing steady leasing demand and limited supply. For Melbourne CBD, vacancy is expected to remain tight as majority of projects have been pre-committed.

Proactive capital management.

• Management has undertaken measures to extend debt maturity and manage interest costs, and have managed to refinance all 2019 loans. Keppel REIT issued S$200m in 5-year convertible bonds at 1.9% coupon rate to lower interest costs as well as fund the acquisition of T Tower in Seoul.
• Keppel REIT also obtain its first green loan facility of S$505m, of which proceeds were used to refinance loans maturing in 2022.
• 2Q19 gearing stable at 38.4% (+2.7ppt y-o-y). The weighted average term to maturity of its debt has been extended from 3.3 to 3.7 years. Its all-in interest rate is 2.86%. 92% of its debt is fixed-rate borrowings.

Active share buyback programme.

• Keppel REIT has purchased and cancelled 9.7m issued units. Management would continue the share buyback programme so long as unit price is below NAV of S$1.36/share. Keppel REIT has capital gains of S$105m available to top-up distribution to unitholders, or alternatively could be deployed in its share buyback programme.

Earnings Revision

• We retain our earnings estimates.

Valuation / Recommendation

• Maintain BUY and target price of S$1.37, based on DDM (required rate of return: 6.25%, terminal growth: 2.0%).

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 - 16 Jul 2019