CapitaCommercial Trust - Moderating decline in office rents

We raise our distributable income forecasts to S$180.6m (up 18% yoy) for FY09 and S$188.7m (up 23% yoy) for FY10. This arises from lower interest costs as debt is paid down in 2H09 with rights proceeds of S$828m. FY09 rental income should be resilient, with 6% up for renewal in the office segment in 2H09. We expect negative rental reversion to kick in next year when 18% of rental revenue in the office segment is due for renewal, thus resulting in a 3% yoy decline in revenue to S$357m in FY10. We expect office rents to decline 20% by end-2009 from 2Q09, and an additional 15% yoy in 2010, owing to a full supply pipeline.

According to management, leasing enquiries for office space have increased as Grade A rents now look attractive, having declined a steep 48% from the 3Q08 peak to S$9.50 psf in 2Q09. In addition, we are confident of management’s ability to retain tenants through proactive leasing. For instance, 9% of leases due for renewal in FY10 have been renewed ahead of time, and 29% of those due in FY12. CCT also strictly forbids subletting by tenants to prevent dilution of its bargaining power. We assume occupancy rates of 95% in FY09 and 90% in FY10.

A decline in office rents is now widely expected by the market, with Bloomberg consensus forecasting a 5% yoy decline in CCT’s net profit in FY10 and 3% yoy decline in FY11. Despite this, yields will still be an attractive 7.9-7.5% in FY10-11, based on consensus.

We lower our DCF-based target price to S$1.00 (from S$1.60) to reflect the higher share base following the rights issue in May. However, our valuation of CCT increases 13% to S$2.6bn to reflect our higher earnings assumptions. Dividend yields are a decent 7.6% for FY09F and 7.8% for FY10F.

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