• SPH REIT's 3Q19 DPU of 1.39 Scts (+1.5% y-o-y) in line.
• Low interest rate environment and SPH REIT’s gearing of 30.1% are conducive for acquisitions
• 1-3% upside to FY20-21F DPU on the back of an assumed S$200m Australian acquisition on 5.7% NPI yield and S$100m equity-raising.
• BUY; Target Price lifted to S$1.20 after lowering risk-free rate assumptions and factoring in M&A.

Maintain BUY; Target Price Raised to S$1.20 After Factoring in M&A Opportunities, Lower Interest Costs

• We continue to see ample organic growth opportunities for SPH REIT (SGX:SK6U) as improving rental reversion prospects (particularly for Paragon, as evidenced by its strong showing in 9M19) and value-add opportunities for The Rail Mall are expected to take DPU to new highs.
• With interest rates now expected to remain lower for longer, we believe SPH REIT may be on the hunt for acquisitive opportunities abroad – particularly in suburban Australia, where its recently acquired Figtree Grove asset continues to beat the odds and grow. After imputing lower interest costs and M&A in FY20F, our DCF-based Target Price is raised to S$1.20.
• Maintain BUY.

Where We Differ: More Bullish on Retail REITs

• Consensus is generally still cautious on the retail sub-sector, especially in Orchard. However, we believe that limited upcoming retail supply in the submarket and well-executed strategies leading to the turnaround at Paragon, are proof of the portfolio’s ability to withstand challenges, and stand the test of time.

Operating Performance Remained Firm in 3Q19

• Paragon remained the key growth driver for the group, delivering positive reversions of 8.6% YTD. We were also heartened to see continued growth exhibited across the remaining malls in SPH REIT’s portfolio. Against the challenging operating conditions, this highlights the REIT’s dominant status in its respective locations. The full-year contribution from Figtree Grove will be an added boost to DPUs through the year.

What's New - Both Organic and Inorganic Growth Opportunities in Store

9M19 performance in line.

• SPH REIT’s growth momentum remained firm in 3Q19, both on the organic and inorganic fronts. Gross revenue and NPI jumped 12.7% and 14.2% y-o-y respectively, mainly on the first full-quarter contributions from Figtree Grove, which was acquired in December.
• On an organic basis, growth would have been closer to 2.6% and 4% - still a commendable set of results, in our opinion.
• Overall, DPU grew 1.5% y-o-y to 1.39 Scts based on a lower 97.7% payout vs 100.3% a year ago.

Singapore malls continue to garner strong interest amongst shoppers.

• Portfolio occupancy remained high at 99%. Similar to the previous quarter, portfolio rental reversions remained stable at 8.4% YTD on the back of healthy leasing momentum. This was mainly anchored by Paragon, which represented the bulk of renewals in 9M19, delivering positive reversions of 8.6% (unchanged q-o-q). The Rail Mall also surprised with positive reversions of 9.1% (vs 6.2% for 1H19), mainly on renewals.
• Additionally, the REIT posted a 4.4% y-o-y growth in shopper traffic across its Singapore portfolio. We believe this should also help to ease market concerns over potential disruptions to shopper trends with the introduction of Jewel on key tourist-centric malls, particularly those along Orchard Road.
• That said, it may be too early to ascertain the true impact of Jewel given its fairly recent launch in late April. According to management, tenant sales across the Singapore portfolio have also improved by over 4% YTD.

Upside from other income at The Rail Mall.

• Looking ahead, with rental reversions in Singapore addressed, the focus will be on 57% of the Rail Mall’s NLA and another 14% of Figtree’s NLA which will be expiring in the last quarter of FY19. Leveraging on the roll-out of new shopper engagement programmes, positive reversionary trends at The Rail Mall are set to continue in the upcoming quarters.
• Further upside could also come from recent moves to convert the majority of its complimentary parking spaces into a timed parking facility in May.

Beating the odds in Australia.

• Despite generally negative press reports on the Australian retail sector amid weak income growth and e-commerce challenges, selected assets with strong property fundamentals can still outperform.
• Figtree is one such asset - benefitting from its predominant focus on non-discretionary retail, limited competing supply and access to a relatively captive shopper pool. Contrary to market trends, we understand that key tenants Coles and Woolsworth are keen to expand their in-mall footprint, driven by strong sales productivity and plans to better serve the sizeable population catchment.
• Rent performance, while undisclosed in quarterly updates, was believed to be tracking above independent valuers’ projections in December 2018.

2-5% upside to FY20-21F DPU if an Australia acquisition materialises.

• With interest rates set to remain lower for longer and conservative gearing of 30.1% (vs 35% for S-REITs on average), we believe that the Manager may be on the lookout for acquisition opportunities. With the timeline for Seletar Mall still uncertain on the back of ownership changes at United Engineers, which holds a 30% stake in the mall, the focus will likely remain in Australia for now.
• Assuming a similar-sized acquisition of approximately S$200m at an NPI yield of 5.7% and S$100m equity funding in mid- FY20F, these could drive 1-3% upside to FY20-21F DPU, based on our estimates. Such an acquisition would nudge gearing slightly higher to 32% and implies DPU accretion of 1.2% in FY21F (first full year of contributions).

Maintain BUY; Target Price Lifted to S$1.20

• Maintain BUY; Target Price lifted to S$1.20 after lowering our risk-free rate assumptions by 50bps to 2.5% and factoring in M&A.

Source: DBS Research - 17 Jul 2019