• Keppel REIT's 3Q19 DPU of 1.4 Scts (+2.9% y-o-y) in line, aided by contributions from T Tower and higher rentals.
• 9M19 rental reversion of +14.8% points to stronger earnings and DPU ahead.
• Minimal exposure to co-working operators.
• Maintain BUY; Target Price of S$1.45.

3Q19 DPU of 1.4 Scts (+2.9% Y-o-y) Supported by Maiden Full Quarter Contributions From T Tower, and Higher Rentals

• KEPPEL REIT (SGX:K71U) reported 3Q19 DPU of 1.40 Scts which was up 2.9% y-o-y and 2.8% q-o-q, aided by maiden full quarter contributions from T Tower, higher rentals and one-off income. See Keppel REIT's announcements.
• Stripping out S$8m worth of capital distributions made in 9M19, core 3Q19 DPU would have come in at 1.34 Scts, down 1.5% y-o-y and up 2.64% q-o-q. With core 9M19 DPU of 3.94 Scts (-6.2% y-o-y) representing 74% of our core FY19 DPU forecast, this was largely in-line with our expectations.
• The y-o-y decline in core 3Q19 DPU was largely on the back of:
  1. loss of income from sale of a 20% stake in Ocean Financial Centre (OFC) in late 2018,
  2. lower contributions from Bugis Junction Tower (-10% y-o-y), and
  3. the impact of a weaker AUD.
• Partially offsetting these headwinds was stronger underlying income from MBFC due to positive rental reversions achieved over the past few quarters, maiden full quarter contribution from the recently acquired T Tower in Seoul, and higher one-off income.
• Overall portfolio occupancy remains healthy but fell marginally q-o-q to 98.9% from 99.1% in 2Q19, mainly from MBFC where 2 tenants terminated their leases early and committed occupancy at Bugis Junction Tower fell to 99% from 100% in 2Q19. This was offset by 275 George Street’s occupancy inching up to 99.6% from 98.5% in 2Q19.

Rental Reversions to Remain Healthy; Spot Rents Could Plateau

• Keppel REIT disclosed that average signing rents for 9M19 stood at S$12.35 psf/mth, an increase from S$11.93 psf/mth reported for 1H19. Management attributed the high signing rents from renewals of larger corporates spread across the portfolio. Hence, Keppel REIT reported strong positive rental reversions of 14% in 3Q19, taking 9M19 rental reversions to 14.8%.
• With average expiring rents for FY20, FY21 and FY22 at S$9.59 psf/mth, S$9.53 psf/mth and S$10.00 psf/mth respectively compared to current Grade A core CBD rents of S$11.45 psf/mth, we believe Keppel REIT should continue to report healthy rental reversions going forward in spite of spot rents potentially remaining flattish.
• After taking into account leases signed in 9M19, there are minimal (0.8%) leases expiring for the remainder of FY19. There is another 11.9% of leases due to expire in FY20, of which 3.6% are rent review leases. Heading into peak supply in FY22, Keppel REIT has 23.2% and 22.0% of leases up for renewal in FY21 and FY22 respectively, of which 7% are rent review leases in FY21.
• Over the quarter, we understand new leasing demand and expansion came mainly from the technology, media and telecommunications segment, real estate and property services, and banking and financial sectors. Keppel REIT also notes that the co-working sector continues to be active but corporates are generally turning cautious on expansion plans given the slower GDP growth outlook. However, management remains confident that new signing rents should remain relatively stable at current levels despite the expectation that spot rents growth may plateau.
• Despite vacancies expected in both its Singapore and Australia properties, management expects valuations to hold up.

Minimal Exposure to Co-working Sector

• Given the recent concerns on co-working operators, management mentioned that while there are benefits of having some flexible space in a commercial building, Keppel REIT’s exposure is largely service office. Its exposure to co-working operators is only 0.8% of NLA and 0.7% of GRI.
• With the divestment of Bugis Junction Tower, its exposure will be further reduced to 0.2%.

Borrowing Costs Trending Down Following Divestment of Bugis Junction Tower

• Gearing level remained relatively stable q-o-q at 38.9%.
• Average borrowing costs fell marginally to 2.82% from 2.89% in 2Q19, and borrowing cost expected to continue to trend down following the divestment of Bugis Junction Tower.
• NAV per unit (excluding distribution) was relatively stable at S$1.35, aided by the buyback of 32m units in 2Q19.

Maintain BUY; Target Price of S$1.45

• We maintain our BUY rating and Target Price of S$1.45.
• We lowered our FY20F-FY21F DPU estimates marginally by 1% to 3% to factor in the divestment of Bugis Junction Tower, and frictional occupancy when UBS vacates One Raffles Quay (ORQ). See Keppel REIT's dividend history.
• We have assumed that the proceeds from the divestment of Bugis Junction Tower will be used to pare down its debt, thus lowering the gearing level to 34%.

Where We Differ – Trading Up Portfolio Quality

• While concerns of an economic slowdown might slow the upward trajectory in market rents, we believe the divestment of Bugis Junction Tower has improved its commercial assets portfolio anchored by Singapore Grade A offices in prime CBD locations.
• The long WALE of 5.1 years (Singapore 4.2 years), strong committed occupancy and the ability to sign higher than market rents are strong attributes of its portfolio, contrary to consensus’ hold rating, in our view.

Source: DBS Research - 17 Oct 2019