• Manulife US REIT poised to deliver a strong 3-year DPU CAGR of 4.5%,fastest amongst peers.
• Portfolio to benefit from strong market dynamics with positive leasing spreads to result in higher earnings.
• Potential index inclusion a catalyst for the stock.
• Pricing in acquisitions in our estimates.

Poised to Move Higher

• We maintain our BUY call on MANULIFE US REIT (SGX:BTOU) with a revised Target Price of US$1.10.
• With tax concerns largely allayed in our view, we believe that investors will look towards Manulife US REIT’s consistent delivery of a 4.5% CAGR in FY19-21F DPU to drive higher valuations for the stock. Supported by conducive cost of capital, we see Manulife US REIT soaring to greater heights.
• BUY with a Target Price of S$1.10.

Where We Differ: Pricing in Acquisitions in Our Forecasts

• On the back of the recent completion of Fairfax Center, we believe that Manulife US REIT remains poised to continue acquiring as the manager looks to deliver on both organic and inorganic growth. We believe Manulife US REIT will continue to offer investors compelling value as its DPU remains on an uptrend given its
  1. ability to surprise on accretive acquisitions, and
  2. positive leasing spreads to drive earnings and NAV higher.
• Moreover, Manulife US REIT’s forward yield of 7.0% stands at 150bps higher than the S-REIT average but offers a superior 3-year DPU CAGR of 4.5%.

Indexation a Catalyst for the Stock

• We believe that Manulife US REIT is on the cusp of being considered for inclusion into the FTSE EPRA Nareit Developed Asia Index and is noted to be US$130- US$140m away.
• We have priced in an accretive acquisition of US$200m (funded by 70% equity) which, in our view, will likely pave the way for the REIT’s potential index inclusion. This will likely herald a virtuous cycle of greater investor visibility, trading liquidity and over time, yield compression of the stock.

Valuation

• We have revised up our DCF-backed Target Price to US$1.10 on the back of acquisition and lower WACC assumptions.

What's New - Moving Up to the Big Leagues

Robust NPI growth of 33.8% y-o-y in 2Q19 concluded a healthy first half

• Manulife US REIT reported a strong set of results. In 2Q19, total revenue and net property income (NPI) increased by 33.2% and 33.8% y-o-y to US$43.3m and US$27.4m respectively. This increase was attributable to additional income arising from the new contributions of Centerpointe (1Q19), Penn and Phipps buildings which were acquired back in June 2018.
• Excluding the impact of the three acquisitions, underlying NPI dipped 2.5% y-o-y in 2Q19, mainly due to the 4.3% y-o-y drop in NPI for Plaza and 2.0% y-o-y drop in Michelson. This was largely due to lower rents for renewals.
• Distributable income came in 25% higher y-o-y but DPU rose by 17.7% to 1.53 Scts. After adjusting the impact of the rights issue a year ago, DPU would have come in flat y-o-y. On a 1H19 basis, DPU of 3.04 Scts formed 50% of our full-year forecasts.
• Manulife US REIT also has a well-diversified tenant base with its largest tenant contributing not more than 6.7% of its total rental income in 1H19.
• Overall portfolio occupancy improved to 97.2% in 2Q19 from 96.0% in 2Q18 and 97.4% at end-1Q19 due to a robust leasing momentum as high-quality tenants signed long leases in 1H19.

Portfolio occupancy rates improved q-o-q.

• Overall portfolio occupancy rates remained stable at 97.2% (-0.2bps q-o-q). We note that most of the properties maintained above-market occupancy rates, owing to their “best-in-class” property attributes.
• Amongst the properties, we note a slight dip in occupancy rates for the Exchange (95.8% vs 97.7% a quarter ago) while other properties continue to maintain high occupancy rates of > 93%.

Positive leasing momentum.

• Weighted average lease expiry (WALE) improved from 6.0 years to 6.2 years. Manulife US REIT renewed 367k sqft of leases in 1H19 with an average positive rental reversion of +0.3%, due to the “marking of market” of Michelson’s leases. A bulk of the renewals came from the Michelson (c.41% of NLA) where two anchors renewed for another substantial 11-year term, a positive in our view as it reduces leasing risk for the property.
• Escalations of 3% per annum for the two leases ensure a steady rate of growth over time.

Improved gearing; minimal refinancing needs in 2H19.

• Manulife US REIT’s gearing dropped to 37.1% (1Q19: 37.6%) with average cost of debt at 3.32%. During the quarter, Manulife US REIT refinanced US$117m of the Figuero Loan by securing US$193m 5-year committed Trust level credit facilities with a Singapore-based bank. The remainder of the facility consists of Centerpointe acquisition term loan of US$33m and revolving credit facility of US$50m.
• The refinancing improved average debt maturity to 3.1 years compared to 2.3 years as at 30 June 2019. As at end-2Q19, the proportion of fixed rate debt had dropped to 96.1% (1Q19: 98.2%) with NAV per unit at US$0.79.

Forward Outlook

Positive leasing spreads underpin a steady organic growth profile.

• With less than 1% of NLA up for renewal in 2H19, income is fairly secured with a focus on the forward renewals of 7.3% of NLA (c.7.7% of gross rental income) in FY20. We anticipate strong rental reversionary trends driven mainly by positive leasing spreads across its portfolio where the majority of its properties in-place rents are below market transaction levels.

Indexation a catalyst for a further re-rating.

• The manager noted that the REIT is US$130-140m away from the minimum threshold for consideration for inclusion in the FTSE EPRA Nareit Developed Asia Index. The manager believes that in the longer term, this inclusion will bring about more liquidity, international visibility and potentially a further rally in share price.

Acquisitions.

• The manager remains on the hunt for more assets and we believe given the deep pool of available assets in the US, supported by a strong sponsor presence, acquisitions will be a main driver of growth for Manulife US REIT. We have priced in a further US$200m acquisition (70% or US$140m of equity raised) in our estimates for FY20. With this acquisition, Manulife US REIT would offer investors

Source: DBS Research - 22 Aug 2019