RHB Bank Singapore analyst Vijay Natarajan is maintaining his “buy” call on Keppel Pacific Oak US REIT (KORE) after the REIT’s results for the 3QFY2023 ended Sept 30 stood “slightly above” his expectations.
For the three-month period, KORE reported a distributable income of US$13.1 million ($17.93 million), down 10.7% y-o-y.
Natajaran estimates KORE’s 3QFY2023 distribution per unit (DPU) to be at 1.3 US cents, which is down by 11% y-o-y but flat on a q-o-q basis. The lower DPU was due to higher financing costs and mitigated by adjusted net property income (NPI) growth of 5% y-o-y.
“Based on the current gearing, KORE’s valuation has to decline by [over] 23% for it to breach the regulatory 50% gearing threshold to which its bank covenants are tied to. Despite a highly volatile US office market environment, we believe a gearing breach is unlikely for now, given its minimal tenant concentration risks – with none of its Top-10 tenant leases expiring in the next two years – and its portfolio focus on non-gateway key growth markets, which have comparatively fared much better,” the analyst writes.
“Our base case expectation is for a 10% decline in valuation by end-2023, with the worst case at 15%, which should still keep gearing at 42% - 46% levels,” he adds.
Furthermore, KORE’s next loan refinancing of US$75 million is due only in November 2024. At present, all of the REIT’s debt is fully unsecured and from non-US local banks. Its interest cover for the 9MFY2023 remains healthy at 3.3x, well above the loan covenant’s minimum of 1.5x.
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“Despite rising rates, we expect it to stay above 2.5x for the next year. About 76% of its debt is currently hedged,” says Natarajan.
KORE’s portfolio occupancy, which improved by 0.6 percentage points q-o-q to 91.4%, is also a bright spot, which “surprised on the positive side”.
“Key sectors driving new and expansionary demand include technology, advertising, media, and information (TAMI) as well as professional services. A key highlight was the healthy expansionary demand during the quarter (from 12 tenants) outpacing downsizing requests as more tenants implemented return-to-office mandates,” says Natarajan.
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The healthy figure is, however, expected to dip slightly in the 4QFY2023 on known vacates.
“Key market concerns remain around the extent of potential valuation decline and gearing impact – management expects this to be contained in high-single digits, considering KORE’s differentiated market portfolio and healthy operational numbers,” adds the analyst.
That said, the analyst has lowered his target price further to 48 US cents, down from 56 US cents previously. Natarajan had lowered his target price estimate to 56 US cents from 64 US cents in his July 27 report.
“We have further raised our equity risk premium by 120 basis points or bps in our dividend discount model (DDM), factoring in strong headwinds facing the sector and resulting in the lower target price,” he explains. “Our environmental, social and governance (ESG) score of 3.1 is a notch above the country median, and as such, we apply a 2% ESG premium to our target price.”
Units in KORE closed flat at 20.5 US cents on Oct 19.
