• Expanding into Sydney metropolitan office market with A$306m acquisition.
• DPU accretive transaction, gearing increased to 38.7%.
• Reiterate ADD on Keppel REIT with a higher DDM-based Target Price of S$1.25.

Expanding Into Australian Metropolitan Office Space

• Keppel REIT (SGX:K71U) has entered into an agreement to acquire a 100% stake in Pinnacle Office Park for A$306m. The property comprises three freehold Grade A office buildings located within Macquarie Park, a key metropolitan office park in Sydney.
• The property is well-located, near the Macquarie Park Metro Station and a major bus interchange, and is well served by major arterial roads that provide direct links to the Central Business District. There is also redevelopment opportunity for one of the three buildings in the medium term.
• The property has a total NLA of 35,132 sqm and has a 96.3% committed occupancy as at Jun 2020, with a weighted average lease expiry (WALE) of 4.8 years.
• Key tenants include Aristocrat Technologies, Konica Minolta and Coles Supermarkets. Existing leases have fixed annual rental escalations of 3-4% p.a. The transaction is expected to be completed in 4Q20F.

Enhancing Portfolio Resilience, DPU-accretive Transaction

• The acquisition enhances the resilience of Keppel REIT’s portfolio and complements the existing CBD-focused portfolio with the addition of metropolitan office space. Post-acquisition, Keppel REIT’s AUM is expected to increase to S$8.2bn, of which 23% are located overseas – in Australia and Seoul.
• Portfolio WALE is also lengthened to 6.9 years. In addition, the partial redevelopment opportunity will likely enable Keppel REIT to improve returns from the property in the medium term, in our view.
• Management indicated that the purchase will be fully funded with an A$-denominated loan and is expected to raise gearing to 38.7%. At a net yield of 5.25%, inclusive of a A$2.1m income guarantee, the transaction is expected to be DPU- accretive.

Potential Savings From New Perpetual Securities Issue

• In addition, Keppel REIT announced in Sep 2020 that it will be issuing S$150m 3.15% subordinated perpetual securities. According to management, proceeds from the new issuance will be used to refinance its existing perpetual securities expiring on 2 Nov 2020. The latter has a higher coupon of 4.98%. We estimate this is likely to result in S$2.7m in interest savings annually for Keppel REIT or 1.5% of FY19 DPU.

Reiterate ADD Rating

• Overall, we tweak our Keppel REIT's FY20F DPU marginally by -0.01% and raise our FY21-22F DPU by 2.48-3.92% to factor in earnings contributions from the new acquisition, as well as savings from the lower coupon rate of the new perpetual securities. Accordingly, our DDM-based Target Price is lifted to S$1.25.
• Potential catalysts would be redeployment of divestment proceeds into new accretive acquisitions and a better-than-projected office rental market, while downside risk would be longer-than-expected frictional vacancy from tenant movements due to a slowdown in demand for office space.

Source: CGS-CIMB Research - 14 Sep 2020