• SOILBUILD BUSINESS SPACE REIT (SGX:SV3U)'s 3Q19 NPI down 8% q-o-q due mainly to rent arrears from NK Ingredients.
• 22.1% decline (q-o-q) in 3Q19 DPU mainly attributed to the 19% enlargement in shareholder base.
• Positive rental reversions at business park properties; Industrial properties still facing rental pressures.
• Newly acquired Grade A office building in Adelaide to contribute from 1 November.

Maintain HOLD and Target Price of S$0.55

• While business park assets continue to see positive rental reversions that will span well into next year, we continue to see headwinds within SOILBUILD BUSINESS SPACE REIT (SGX:SV3U)'s industrial segment. We expect income weakness for its master-leases to NK Ingredients and BENG KUANG MARINE LIMITED (SGX:BEZ) to remain an overhang.
• Our DCF-based Target Price has been lowered to S$0.55 to account for the drag on earnings caused by the enlarged shareholder base, and our revised earnings estimates.
• Maintain HOLD.

SBREIT’s 3Q19 Results Dragged Down by Rental Arrears and Preferential Offering

3Q19 DPU impacted by larger unit base.

• Led by higher contributions from its earlier Australian assets and Solaris, Soilbuild Business Space REIT’s gross revenue and net property income rose by 14.2% and 8.3% y-o-y to $66.2m and $53.6m respectively for 9M19. The higher revenue was partially offset by lower contribution from Eightrium, KTL Offshore (divested in February 2018), 39 Senoko Way, West Park BizCentral and NK Ingredients. The decrease in interest income of S$1.1 million was related to the repayment of the S$55 million interest-free loan from the Sponsor and the increase in finance expenses of S$1.7 million was mainly attributed to higher loan principal and higher weighted average borrowing costs in YTD FY2019.
• Total return before distribution was $2.6m lower primarily due to the absence of a non-recurring gain on divestment of KTL Offshore. This resulted in a 9.0% y-o-y decline in distributable income to $36.9m
• See Soilbuild Business Space REIT's announcements.

NK Ingredients still in arrears.

• Since the court hearing on 20 August on NK Ingredients rental arrears, the Manager has agreed to give NK Ingredients a 2-month rent holiday (up to end-October). This has put further pressure on the 3Q19 earnings as NK Ingredients makes up approximately 7% of Soilbuild Business Space REIT’s NPI.
• Should NK Ingredients eventually vacate the premises, management highlighted that they could potentially consider redeveloping the site, which we view positively. With an estimated redevelopment cost of $60m, Soilbuild Business Space REIT will be able to maximise plot ratio from the current 0.55x, to 1x. This, in our view will result in higher revenues and asset values in the medium-term, which will be value accretive to Soilbuild Business Space REIT.

Pockets of positives from portfolio.

• Despite the slight negative rental renewals at the industrial properties, the positive renewals at the business park properties translated to an overall positive reversion of 1.0% in 3Q19.
• Negative renewals were mainly at Tuas Connection and West Park, while Solaris was the main source of upside in rentals. Improvement in occupancies at the business parks were also the positives in portfolio management for the quarter. Occupancy at Solaris is currently at 94%, and Eightrium occupancy increased from 75% to 84% q-o-q.
• Occupancy at 72 Loyang Way at 25% is below optimal levels but the sale of the property is expected to go through in the near-term (pending approval from authorities), and will be a positive development in our view. Management expects the occupancy at 39 Senoko Way (currently at 34%) to improve once the AEIs are completed.
• Rejuvenation works at Solaris (amounting to $4m) commenced in 3Q19 and is expected to complete in 8 months. Soilbuild Business Space REIT believes that this enhancement works would reinforce Solaris’ position in the one-north business park precinct and enable them to retain and attract quality tenants.

Temporary decline in gearing to 36.5%.

• Once the acquisition of Grenfell Centre in Adelaide is completed in 4Q19, gearing is projected to head back up to 38%. This is still lower than the 39.4% gearing in 2Q19, in part due to the preferential offering.
• All-in interest cost fell marginally to 3.56% in 3Q19, and we do not expect any increase in all-in cost even with the additional debt taken to fund the Grenfell Centre acquisition.
• The lower gearing, coupled with divestment proceeds from 72 Loyang Way will provide a good buffer for Soilbuild Business Space REIT, should there be any devaluation in the portfolio at year-end.

Australian properties increasing in significance.

• Post the acquisition of Grenfell Centre, Soilbuild Business Space REIT’s Australian portfolio will make up 19.7% of GRI.
• Grenfell Centre currently has a committed occupancy of more than 88%, and management is confident that occupancy rates would improve given the property’s ideal location. Weighted Average Lease Expiry (WALE) of the property is also at a healthy
• 5.0 years, and annual rental escalations are between 3.50% and 3.75%. The initial NPI yield of 7.67% for Grenfell Centre will only begin contributing to Soilbuild Business Space REIT from 1 November.
• With the long WALEs and in-place annual rental escalations, the three Australian properties will provide stability and help to mitigate any uncertainties in the Singapore portfolio.

Where We Differ: Australia Strategy to Bear Fruit Over Time

• The recent foray into Australia may prove to be a rewarding one in time to come. Including the latest acquisition in Adelaide (Grenfell Centre), these Australian assets will provide some earnings stability and potential upside in the medium-term. The ability to continue gaining scale in Australia will provide investors comfort this diversification strategy.

Potential Catalyst: Efficient Use of Capital

• With the proposed sale of 72 Loyang Way expected to complete in the near-term, net proceeds of approximately S$34m for Soilbuild Business Space REIT could be deployed to better use. Paring down debt or redeploying proceeds to other income producing use could provide an earnings uplift in FY20F.

Valuation

• Maintain HOLD; DCF-based Target Price lowered to S$0.55 as we revise earnings estimates and account for the drag in earnings by the preferential offering during the quarter. See Soilbuild Business Space REIT's share price.
• After factoring incremental costs arising from uncertainty over NK Ingredients’ default, the REIT still offers a decent 8.0% yield. See Soilbuild Business Space REIT dividend history.

Source: DBS Research - 18 Oct 2019