• Acquisition of 94.9% interest in Main Airport Center for EUR 251.5m on initial 4% NPI yield from CapitaLand.
• Timely DPU-accretive acquisition while CapitaLand Commercial Trust undertakes value-enhancing AEIs and navigates fit-out period for new WeWork lease at 21 Collyer Quay.
• 2Q19 DPU of 2.20 Scts (+1.9% y-o-y) in line with expectations.
• Maintain BUY, Target Price of S$2.40.

What’s New - Deepens Presence in Frankfurt

• CAPITALAND COMMERCIAL TRUST (SGX:C61U) announced the acquisition of a 94.9% interest in Main Airport Center (MAC) for EUR 251.5m (S$387.1m) from its Sponsor, CapitaLand (SGX:C31) and Lum Chang Holdings (SGX:L19). CapitaLand will hold the remaining 5.1% interest in the property.
• The purchase consideration is based on an agreed property value of EUR 265.0m (c.S$407.8m) on a 100% basis. This is at the lower end of the EUR 265.0- 267.3m independent valuation conducted by CBRE and Cushman & Wakefield. Total acquisition costs including acquisition fees (to be paid in units) and other fees are estimated to be EUR 253.4m (c.S$390m).
• The initial NPI yield for the building is 4.0% assuming 90% occupancy rate.
• The acquisition is expected to be either 100% debt funded with EUR borrowings (c.1.1% interest rate) or a combination of equity and debt. Accretion to proforma 1H19 DPU is expected to range from 1.0% (40%/60% debt and equity split) to 2.5% (100% debt funding).
• Under the mix of debt and equity scenario, proforma leverage would stabilise at 35.0% or 37.0% under the 100% debt-funding scenario. Current aggregate leverage stands at 34.8%.
• The acquisition is subject to unitholders’ approval with the EGM expected in September 2019 and the completion of the acquisition by 4Q19.
• Post-acquisition, CapitaLand Commercial Trust’s exposure to Germany by property value will increase to 8% from 5%. CapitaLand Commercial Trust currently owns Gallileo, an office building in Frankfurt which is leased to Commerzbank.

Main Airport Center Overview

• Main Airport Center is a freehold office property located near the Frankfurt Airport and a 20-minute drive to Frankfurt’s CBD. The building was completed in 2004.
• The property has a total net lettable area (NLA) of 60,200 sqm with 53,900 sqm of high-specification office space and 6,300 sqm in ancillary space housing a conference hall, meeting rooms and 1,510 car park lots.
• Committed occupancy was approximately 90% as at 30 June 2019.
• Key tenants include
  • IQVIA (16.6% of gross rental income) - a Fortune 500 company providing integrated healthcare services
  • Dell (16.2%) – regional corporate headquarters
  • Miles & More (14.4%) – corporate office of Lufthansa’s frequent flyer and awards programme
• Other tenants include Aston Martin, Sodexo, Lufthansa, Kemira and Beam Suntory.
• Weighted average lease expiry (WALE) is 4.7 years as at 30 June 2019. There are minimal leases up for renewal in FY19 (1.7%). In FY20, 25.2% of leases will be up for renewal, with over half (15.1% of leases) already in advanced negotiations.
• Leases at the MAC have inbuilt rental escalations pegged to inflation.

Our Thoughts on CapitaLand Commercial Trust

• We had previously assumed a S$500m acquisition in FY20 on an initial yield of 4.5% with a debt cost of 1.4% and S$200m equity-raising at S$2.00 per share. Thus, we are surprised by the earlier-than-expected acquisition, with the lower acquisition yield (4.0%) partially offset by lower borrowing costs (1.1%).
• We are supportive of CapitaLand Commercial Trust’s deepening its exposure into Frankfurt given the expected DPU accretion and projected uplift in rents in the Frankfurt market. Furthermore, the airport submarket vacancy rate is at a 10-year low of 4%, which should be supportive of rents going forward.
• CapitaLand Commercial Trust did not disclose whether MAC’s passing rents are below market. However, with a WALE of 4.7 years and office rents in Frankfurt up on the same time period, CapitaLand Commercial Trust could achieve positive rental reversions as the leases come up for renewal over the coming few years.
• In terms of valuation, while the initial NPI yield of 4.0% is lower than the estimate 4.2% yield when CapitaLand first bought the property in December 2017, the lower cap rate is reflective of the decline in German interest rates. In December 2017, the German 10-year bond yield was around 0.3% versus -0.25% currently. Furthermore, with 4.0% initial yield based on 90% occupancy and the submarket vacancy at 4.0%, we believe the actual yield to be delivered may be higher as CapitaLand Commercial Trust lifts the occupancy rate and benefits from the in-built step-up in rents.
• We expect push back from some investors given CapitaLand Commercial Trust’s expansion into “business parks” or decentralised offices from its current positioning as a Grade A CBD office REIT. However, as Frankfurt is a “new” market for CapitaLand Commercial Trust, we believe it may be beneficial for the REIT to offer prospective tenants flexibility and a variety of office locations with “cheaper” rents. Average rents in the airport submarket of EUR 25.5 psm/mth is 6% below CBD rents of EUR 27.1 psm/mth. In addition, given some frictional vacancy/fit-out period that CapitaLand Commercial Trust may experience as it undertakes some AEI in Singapore over the next two years, we believe the acquisition is timely to mitigate any short-term loss in income.
• Assuming 21 Collyer Quay is closed for a year, CapitaLand Commercial Trust will lose S$23-25m in NPI, while MAC should be contributing around S$15m in NPI (assuming no increase in occupancy rates).

2Q19 DPU of 2.20 Scts (+1.9% Y-o-y)

• As expected, 2Q19 DPU rose 1.9% y-o-y to 2.20 Scts. This takes 1H19 DPU to 4.40 Scts (+2.8% y-o-y) which represents 49.5% of our FY19F DPU.
• 2Q19 revenue and NPI were also up 3% and 0.8% y-o-y respectively on the back of the acquisition of Gallileo as well as higher income from 21 Collyer Quay, Asia Square Tower 2 and Capital Tower (impact of higher rents and uptick in occupancy). This was partially offset by the earlier divestment of Twenty Anson as well as lower earnings from Six Battery Road (lower occupancy of 97.2% versus 99.9% in 2Q18) and Bugis Village.
• Overall portfolio occupancy remains healthy at 98.6%, up from 97.8% in 2Q19, although a touch lower than the 99.1% recorded in 1Q19.

Positive Rental Reversions

• On the back of higher spot market rents, over the quarter signing rents were 9-20% higher (mid-point of disclosed signing rent range) than the disclosed expiring rents. This should translate into higher income over the coming quarters.

Secures WeWork as Tenant at 21 Collyer Quay and AEI at Six Battery Road

• With the exit of HSBC in April 2020 from 21 Collyer Quay, CapitaLand Commercial Trust has secured WeWork for the building. Commencing 2Q21, WeWork will be occupying 100% of the building for seven years. During the changeover in tenants, CapitaLand Commercial Trust will undertake a S$45m AEI which will have an expected return on investment of 9%. The entire building will be closed from 2Q20 to 4Q20. 21 Collyer Quay contributes 5% of CapitaLand Commercial Trust’s 1H19 income.
• Furthermore, upon the expiry of Standard Chartered Bank’s lease in 2020, CapitaLand Commercial Trust will conduct a S$35m AEI in phases from 1Q20 to 3Q21. We understand Standard Chartered will remain as an anchor tenant and continue to lease office space and house its flagship branch in the property. At this point, it is unclear whether Standard Chartered will give back space.
• However, there is some risk in our view, as we understand Standard Chartered has sublet some of its space. Mitigating any potential loss in income is the fact that this space missed the AEI that was undertaken in 2013 upon which CapitaLand Commercial Trust could charge a higher rent.
• Subject to government approval, the AEI at Six Battery Road will include a new 24/7 through-block link connecting Raffles Place to the Singapore River with new F&B offerings.
• CapitaLand Commercial Trust will be targeting an ROI of 8% for the AEI at Six Battery Road. The last AEI conducted at Six Battery Road in 2013 achieved an ROI of 8.6% on a S$85.8m investment.

Gearing at 35%

• CapitaLand Commercial Trust reported a S$70m uplift in property values, largely on account of an increase in earnings. Cap rates were stable.
• As a consequence, gearing fell marginally to 34.8% from 35.2%. Likewise NAV per unit (excluding distributions) rose to S$1.81 from S$1.80.
• The average cost of debt and proportion of fixed rate debt were stable at 2.5% and 92% respectively.

Maintain BUY, Target Price of S$2.40

• Given the lack of clarity over the exact funding structure for the MAC acquisition, we are maintaining our DPU estimates and Target Price of S$2.40.
• Nevertheless, we also maintain our BUY call on CapitaLand Commercial Trust given its exposure to the rising Singapore office market and in the medium term the uplift in earnings from the proposed AEIs and MAC acquisition.

Source: DBS Research - 17 Jul 2019