Analysts are upbeat and positive on Keppel REIT’s (KREIT) latest acquisition of the Pinnacle Office Park in Sydney for $303.3 million, a freehold Grade A commercial property comprising three office buildings located within Macquarie Park.
With a total net lettable area (NLA) of 35,132 sm (378,165 sf) across three office buildings, Pinnacle Office Park is the second largest office market in New South Wales.
See: Keppel REIT buying Pinnacle Office Park in Sydney for $303.3 million
The acquisition is targeted to be completed in 4Q20 and will be fully funded with Australian dollar denominated debt for natural hedging. Its assets under management will grow to $8.2 billion across 10 properties in Singapore (77.0%), Australia (19.4%) and South Korea (3.6%) and its portfolio WALE will be approximately 6.9 years, while the freehold portion of the portfolio will increase from 30.3% to 37.1% by NLA.
DBS Group research continues to rate KREIT a “buy” with a target price of $1.35.
In a September 15 report, lead analyst Rachel Tan says, “We believe KREIT's best-in-class office portfolio anchored by Singapore Grade A offices in prime CBD locations is well positioned to benefit from a potential recovery in a very tight net supply market. Valuation remains attractive at 0.8 times P/NAV, below the sector’s historical mean.”
Furthermore, following the merger of CapitaLand Mall Trust and CapitaLand Commercial Trust, KREIT will now be the only pure office play REIT in Singapore, which the analyst believes will be highly valued by investors.
“We believe the DPU-accretive acquisition bodes well for KREIT as it redeploys some of its capital post a series of divestments in the past few years and offers DPU growth with an accretive acquisition and embedded rental escalations. In addition, the redevelopment potential in one of the buildings would boost organic growth in the future when approvals are obtained from the authorities,” says Tan.
In addition, low average expiring rents provide sufficient buffer to weather through rent declines during this period.
CGS-CIMB Research shares the same sentiments with its unchanged “add” call on KREIT with a higher target price of $1.25 from $1.20 previously.
In a September 14 report, analyst Lock Mun Yee says, “The acquisition enhances the resilience of KREIT’s portfolio and complements the existing CBD-focused portfolio with the addition of metropolitan office space. Post-acquisition, KREIT’s AUM is expected to increase to $8.2 billion, of which 23% are located overseas – in Australia and Seoul. Portfolio WALE is also lengthened to 6.9 years.”
In addition, Lock reckons that the partial redevelopment opportunity will likely enable KREIT to improve returns from the property in the medium term. Plus, with the acquisition funded with an AUD denominated debt, gearing is expected to raise to 38.7%. At a net yield of 5.25%, inclusive of a 2.1 million income guarantee, the transaction is expected to be DPU-accretive.
Meanwhile, KREIT will also be issuing $150 million 3.15% subordinated perpetual securities. Of which, the proceeds from the new issuance will be used to refinance its existing perpetual securities expiring on November 2. The latter has a higher coupon of 4.98%, which is likely to result in about $2.7 million in interest savings annually for KREIT or about 1.5% of FY19 DPU.
“Overall, we tweak our 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,” says Lock.
Morgan Stanley is rating the stock "overweight" with a target price of $1.25 and viewing the industry as "attractive".
Head analyst Wilson Ng says in a September 14 report, "We see this acquisition as a move to diversify out of prime CBD office space, which would be prudent considering business continuity planning (BCP) as a result of Covid-19."
The pandemic has caused some occupiers, who were originally considering consolidating staff into a single building, to rethink their office real estate strategy, instead adding secondary locations for BCP. This would not only help mitigate risks of having all staff in the same physical location in the event of a pandemic, but also support a greater diversity of workplace options for companies looking to incorporate more flexible work arrangements for their staff.
On the other hand, JP Morgan is less upbeat on KREIT as it has an "underweight" rating on the stock with a target price of just 85 cents.
In its September report, lead analyst Mervin Song says, "KREIT offers significant exposure to the Grade-A Singapore office (around 80% of NPI), which has seen over 25% increase in spot rents since the lows in 1H17. We expect rental gains to reverse with 2-5% per annum decline in rents over three years as we enter a recession global recession."
In addition, Song expects some potential uplift in vacancy rates and negative drag from AUD/SGD depreciating towards the 85 level.
"Given travel restrictions which may make it difficult for KREIT to conduct due diligence, we have also delayed a 100% debt funded acquisition from mid FY20 to FY21 and downsized the acquisition from $500 million to A$400 million," adds Song.
The analyst believes that this acquisition is to replace the lost income from KREIT divesting Bugis Junction Tower last year. In the meantime, he is positive that KREIT can distribute capital gains to maintain a stable DPU.
"Given an expected decline in office rents, the office sector being one of the most economically sensitive sectors, and we are heading into a recession, we expect KREIT to trade above mean yields and approach PB of 0.60 times the lows in 2016 when we were in the last office downcycle," says Song.
As at 11.40am, units in KREIT are trading at $1.12 or 0.8 times FY20 book with a dividend yield of 5.3%.
