• SOILBUILD BUSINESS SPACE REIT (SGX:SV3U)'s 2Q19 DPU of 1.18 Scts in line.
• Rental reversions, while still slightly negative, have remained stable over the last two quarters.
• However, asset-specific challenges (particularly NK Ingredients and Eightrium) may cap share price performance over the medium term.
• HOLD; Target Price unchanged at S$0.63 after lowering risk-free rate assumptions by 50bps.

Maintain HOLD and Target Price of S$0.63

• While industrial rents have been on a bottoming trend, weaker-than-expected occupancy levels suggest that the leasing environment for selected assets could remain challenging over the near term. This includes Eightrium, which is undergoing a temporary flux in occupancy following the departure of a key tenant. We have also lowered our FY19F-20F DPU projections by 2-5% after factoring in incremental costs on the back of NK Ingredients’s default.
• Our DCF-based Target Price of S$0.63 is unchanged as we lower our risk-free rate assumptions by 50bps to reflect market expectations of a lower interest environment.
• Maintain HOLD.

Where We Differ: More Conservative Outlook Projections

• We believe investors’ focus will shift towards asset-specific concerns, particularly for Eightrium, which could see near-term volatility in occupancy levels amid tenant relocations. The pending resolution of NK Ingredients’s tenancy may also cap 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 Business Space REIT, which could 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 would provide an earnings uplift in FY20F.

Valuation

• Maintain HOLD; DCF-based Target Price unchanged at S$0.63 as we lower our risk-free rate assumptions by 50bps to 2.5%.
• After factoring incremental costs arising from uncertainty over NK Ingredients’s default, the REIT still offers a decent 7.5% yield.

What's New - SBREIT’s 2Q19 Results in Line

2Q19 DPU of 1.18 Scts (-6.7% y-o-y).

• Led by higher Solaris, Soilbuild Business Space REIT’s gross a 7.4% y-o-y decline in distributable income to S$25.3m, which includes approximately S$0.7m in capital distributions.
• Stripping out the one-off divestment gain, we estimate that the decline in distributable income (excluding capital distributions) would have been more modest at < 4% y-o-y. Overall, 1H19 numbers formed 50% of our full-year projections, which was in line.

Australia and Solaris to challenges.

• Occupancy moderated further – albeit at a smaller Manager, the underlying lease was signed about two years ago when rents were at sub-four-dollar levels vs current effective rents of S$5.35-5.44 psf/mth across Soilbuild Business Space REIT’s business parks, which limits downside to rents, in our opinion.
• However, the key challenge lies in the Manager’s ability to backfill the sizeable vacant plot, as tenant profiles at Eightrium have generally leaned towards small-to mid-sized space requirements historically. We note that the Manager is in the midst of dividing the unit into smaller spaces, which should improve marketability.
• At first glance, the substantially lower effective rent of S$3.51 for new business park leases vs passing rent of S$5.44 appears alarming. However, we understand that this mainly relates to the conversion of common corridor spaces into additional NLA for an existing tenant at Solaris, resulting in incremental income. Meanwhile, reversions for the renewal of an existing space at Solaris were understood to be flat during the quarter.

NK Ingredients now in arrears.

• NK Ingredients, which makes up approximately 7% of Soilbuild Business Space REIT’s NPI, failed to fulfil its rent obligations (rental charges, property tax and land rent) for July 2019 – one of the criteria for its extended moratorium application to 22 July 2019. While Soilbuild Business Space REIT has filed for the appointment of a Judicial Manager over NK Ingredients, it awaits further clarity pending the court hearing on 20 August.
• As of 2 July, rents owed by NK Ingredients amounted to S$2.7m, exceeding the security deposit of S$2.55m – which according to the REIT, translates into approximately half a month’s rent.

Stable gearing level of 394% vs 39.3% (1Q19).

• Soilbuild Business Space REIT's gearing is relatively stable q-o-q with all-in approximately S$130m of swaps are due to expire next year, which allows the REIT to enjoy upside from a lower-for-longer interest rate environment – albeit at a more modest pace.

Source: DBS Research - 19 Jul 2019