K-Reit Asia: Cloudy outlook

K-reits results were in line with expectations, with the effect of positive rental reversions offset by declining occupancy, as weak demand for office space amid rising supply dragged on rental rates and DPU performance. Office concerns have been well documented and share price appears to have largely factored in a deteriorating operating environment. While valuation is inexpensive at implied NPI yield of 6.8% and DPU yield of 12.4%, near term catalyst is lacking. Maintain HOLD with TP of $0.80.

1Q09 results in line. Kreit reported a 29% yoy rise in revenue to $14.8m, lifted by positive rental reversions vs a year ago. NPI and distribution income improved 19% and 38% yoy to $10.8m and $15.7m respectively, as the impact of higher property taxes was offset by reduced interest expense following its rights issue. However, quarterly operating performance was eroded by c9% as higher portfolio rents (+5.9% qoq to $8.06psf vs $7.61 psf in 4Q08) was offset by lower occupation of 95.8%. Both Bugis Junction and Prudential Tower saw take up moderating to 88-92%, and higher costs.

Challenging times. Looking ahead, Kreit's strategy is to retain tenants and manage cost efficiently amid difficult market conditions. While its portfolio seems fairly resilient with a long WALE of 5.5 yrs and 28% of its leases on LT structures, maintaining occupancy would remain challenging with new supply coming in over the next 2-3 years. Our assumptions of a 15% vacancy and 50% peak/trough rental declines till 2010/11 translate to an average DPU decline of 3% pa.

No near term visibility. At the current share price, valuation for Kreit is inexpensive with implied NPI yield of 6.8%. However, give the ongoing sector headwinds, we are hard put to find near-term re-rating catalyst and maintain our Hold call with a TP of 0.80.

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