CapitaCommercial Trust - Office rentals still declining

Management expects office rents to be on a declining trend till the end of the year. Write-down in asset values expected to increase gearing from 30.6% to 37.0%. Maintain HOLD.

Office rentals still declining. CapitaCommercial Trust (CCT) has received more enquiries from financial institutions (fund management), oil & gas companies (HQ functions) and professional services (legal and accounting) recently. However, these enquiries have not translated into take-up for office space. Management expects office rents to be on a declining trend till the end of the year, although the magnitude of decline has moderated. According to Colliers, average rents for Grade A office space within Raffles Place has dropped by a severe 29.0% qoq to S$7.45psf. We continue to expect rents for Grade A office space within Raffles Place to slide further to S$6.00psf by end-10, representing a two-third correction from the last peak.

Further write-down on revaluation. Based on transactions for strata office space at Suntec City Office Towers, capital values rebounded 38% in 1H09 from the bottom in Feb 09 and remained stable in Jul and Aug 09. The huge correction in office rents could once again put pressure on capital values. We estimate NAV/share will be reduced from S$1.50 to S$1.14, assuming 6 Battery Road and One George Street are valued at S$1,680psf (current: about S$2,320psf) while HSBC Building, Robinson Point and Capital Tower are valued at S$1,200psf (current: about S$1,520psf). Gearing will correspondingly increase from 30.6% to 37.0%.

Redevelopment of Market Street Car Park postponed indefinitely. New anchor tenant Koufu, a food court operator, has opened for business at Market Street Car Park after completing renovations. Net lettable area has increased as Koufu occupies the whole atrium/courtyard. Planned redevelopment for Market Street Car Park has been postponed indefinitely as the new lease with Koufu will expire at least three years later. The Outline Planning Permission (OPP) for the redevelopment of Market Street Car Park has lapsed. CCT will have to reapply to Urban Redevelopment Authority if it intends to redevelop the property at a later stage.

We believe office rents will continue to be under pressure due to large new supply coming on stream in 2010 and 2011 and competition from business parks outside the Central Business District (CBD).

We have assumed portfolio occupancy tapering off from 94.9% in 2Q09 to 90% by 2Q11 (previous: 88%). Maintain HOLD. Our fair price of S$1.09 is based on the Dividend Discount Model (required rate of return: 7.7%, terminal growth: 2.5%).

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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.

CapitaCommercial Trust: Outlook Remains Challenging

2QFY09 results in-line with expectations. CCT reported a (pre-rights adjusted) 31.5% YoY increase (+5.6% QoQ) in 2Q09 DPU to 3.42¢, in-line with ours and consensus estimates. Adjusted for the rights units, 2Q09 DPU would have been 1.71¢, with an annualised DPU of 6.86¢. Revenue was up 34.4% due to positive rental reversion. CCT will trade ex-2Q09 distribution on 31 Jul 2009. We are reviewing our Neutral Rating on CCT (with a view to downgrade). Our TP of S$0.71 may be adjusted.

Cautious on office sector. CCT share price has almost doubled since Mar 09, and now trades at a forward 420bps above risk-free instruments, providing a mere 110bps cushion over its historical 310bps average. Premising on our forecast FY10 DPU of 6.24¢, our bull-case scenario implies a 28% upside with a fair-value of S$1.11 (~5.6% yield at fair-value) should the current market rally continue. In contrast, our bear-case scenario could see the stock retracing 43% to the S$0.50 level, with the stock yielding at 12.5% (1,000bps spread over 10-year bonds yields). From current levels, we view risk-returns on the counter as unfavourable and recommend investors not to accumulate on the stock.

Refinancing concerns lifted; CCT now boasts sturdier financial credit metrics. Post the equity fund raising in Jun 09, management intends to utilize 80% of its S$828m proceeds (or S$664m) to repay loans comprising the two-year secured term loan maturing in Jun 10 and the bridge loan facility maturing in Aug 09. With that, the next maturing debt of S$150m (8% of total debt) comes due in Mar 10 and S$85m (4%) in Aug 10. Following the EFR, CCT’s gearing is projected to fall to 32% (from 43%) and interest cover to improve to 3.5x (from 2.4x). On the back of these improvements, Moody’s has recently upgraded CCT’s debt rating to stable whilemaintaining its corporate rating at Baa2.

Further rent declines expected in coming quarters. According to CBRE, prime office rents averaged S$8.60/sqft in 2Q09, reflecting a 18.2% QoQ decline (1Q09: S$12.90/sqft). Despite the economy being technically out of a recession, it is clearly still a tenants’ market and the focus on tenant retention remains paramount for all landlords including CCT. In our view, most office landlords will likely shift their focus on occupancy optimisation at the expense of rental rates. This will likely put further downward pressure on rents in the coming quarters. Our channel checks indicate that some landlords in prime areas are currently negotiating rents at between S$6-7/sqft, 20% lower than 2Q09 figures.

CapitaCommercial Trust - Basking in a well-timed rights issue

We maintain our (Outperform) rating. We still have a positive view on office-sector S-REITs and believe a stabilisation of the spot-rent decline could trigger another round of outperformance. CCT’s rights issue has helped it to recapitalise, but has also diluted the potential valuation upside, based on our forecasts.

CCT’s S$823m (gross) one-for-one rights issue, announced on 22 May 2009, at S$0.59 per rights unit, has eliminated effectively, in our view, the rights-issue overhang. With a post-rights issue leverage ratio of 30.7%, which captures a 10% asset-value decline (based on 22 May valuations), CCT is now one of the most well-capitalised S-REITs, in our view.

CCT has no debt-financing requirements for 2009, a S$650m (25%) secured term loan and a S$235m (9%) medium-term note (MTN) for 2010, and S$520m (20%) in CMBS (for Raffles City), a S$100m (4%) MTN, and S$370m (14%) of convertible bonds for 2011.

We maintain our RNG-valuation-method-derived target price of S$0.94, based on capitalising CCT’s estimated FY08 core operating distribution (at an average passing rent of S$6.84/sq ft/month) at an effective cap-rate assumption of 6.5%. CCT’s target price to post-rights (pro-forma) BVPS of S$1.51 is 0.62x.

CapitaCommercial Trust: Results above expectations

Results exceeded our expectations. CapitaCommercial Trust (CCT) delivered a strong set of 1Q09 results that exceeded our expectations. Gross revenue increased 34.5% YoY to S$97.5m but on a QoQ comparison, the increase was a marginal 0.3% as higher contributions from the positive rental reversions of the office buildings were offset by the weaker contribution from Raffles City's hotel revenue. Property operating expenses increased 27.9% YoY due to its acquisitions but fell 12.6% QoQ as cost savings measures took effect. As such, net property income for 1Q09 increased 40.8% YoY and 6.5% QoQ to S$69.9m. DPU for 1Q09 has also increased25.1% YoY and 19.6% QoQ to 3.24 S-cents, translating to an annualized yield of 15.2%.

89% of FY09 forecast GRI locked in. During the first 4 months of 2009,CCT secured new leases and renewals for 335,800 sq ft of spaces. Positive rental reversion on a weighted average basis was ~49% higher than previously signed rents. This was also better than our expectations as we had expectedweaker reversionary growth from CCT due to the declining office rentalmarket. With that, CCT has now locked in 89% of our forecast gross rental income (GRI) for FY09, which amounts to S$318.1m. An additional GRI of S$35.8m had been locked in since CCT announced its FY08 results, which further enhanced DPU visibility for FY09.

Completed refinancing for FY09. CCT also announced that it had secured commitment for a 3-year secured term loan of up to S$160m. The loan is secured against HSBC Building and the all-in margin for the term loan is 3% per annum, which is lower than what we have expected in the current tight credit market. As at end-1Q09, CCT had a gearing level of 38.3% which we think, is unsustainable in light of the falling rents and capital values of office buildings in Singapore. With another S$885m and S$1,012m (assuming early redemption by bond holders) of borrowings due for refinancing in FY10 and FY11, we continue to believe that an equity fund raising will be inevitable over the mid-term.

Fair value raised to S$1.33; Maintain BUY. After a better-than-expected positive rental reversions in 1Q09, we are now raising our FY09 and FY10 DPU forecasts to 11.2 S-cents (previously 10.2 S-cents) and 9.9 S-cents (previously 8.7 S-cents) respectively, which translate to attractive FY09 and FY10 DPU yields of 13.1% and 11.5%. Our fair value has now been raised to S$1.33 (previously S$1.06). We maintain our BUY recommendation for CCT.

CCT - Signs of easing credit

CCT delivered a 25.1% yoy jump in its 1Q09 DPU to 3.24 cents (annualised distribution yield of 15.9%), and is on track to deliver its forecasted 12.34 cents for the full year. Despite the challenging business environment, the DPU grew by almost 20% sequentially, aided by lower property operating expenses and borrowing costs.

CCT signed on new leases and renewals for 335,800 sq ft of space in the first four months of 2009, leading to a 49% improvement in signed rents. About 89% of the management’s forecast gross rental income of $408m has already been locked in with committed leases. The current portfolio committed occupancy is 97.7%.

CCT has a buffer against the still-falling market rates, which are relatively higher than the office passing rent of $7.73 psf. The limited percentage of leases expiring for its four key office buildings (Capital Tower, Six Battery Rd, One George Street and Raffles City Tower) also lowers its downside risks associated with the weakening office market.

Pursuant to the $580m already refinanced earlier this year, CCT announced that it has obtained a commitment for a $160m, 3-year term loan secured over the HSBC Building. The all-in margin for the loan is 3.0%. This compares favourably against the 3.75% margin obtained by Suntec REIT in the refinancing of $825m in debt. CCT’s gearing level remains at a comfortable 38.3%.

Based on our forecasts and the current price, we expect CCT to be able to consistently pay an attractive annual DPU yield of about 14% over the next 3 years, despite the challenging business environment. We reiterate our BUY recommendation, trimming our DDM-derived target price of $1.32, assuming a 0% terminal growth rate, beta of 1.1 and a risk-free rate of 3%. CCT currently trades at 0.3x P/B, which implies the market is valuing its office portfolio at about $793 psf.

CapitaCommercial Trust: Holding up for now

Good showing in 1Q09. CCT's distribution income of $45.4m (27% yoy, +20% qoq) translated to a DPU of 3.24cts and came in slightly ahead of market and our estimates. The better showing was achieved on a 37% yoy increase in topline to $97.5m on new contributions from OGS, Wilkie Edge and positiverental reversions. During the quarter the group renewed/leased 0.38sf of office space (14% of FY09 expiries) at 49% higher rents than preceeding levels. Occupancy remained at 96.7% at end Mar 09. NPI rose 41% yoy to $69.9m on implementation of cost savings measures and expense ratio dipped 5% pt to 28%. The group also secured refinancing for $160m of ST debt at 3% all-in interest margin.

Locked in 89% of forecast gross rental income for 2009. Outlook for the office sector remains soft in the near term owing to poorer economic activity and the large new incoming supply in the next 3 years. CCT's strategy would remain focused on existing tenants and maintaining high portfolio occupancy. To date, it has locked in 89% of its forecasted gross rental income for FY09 or c$318m in committed leases. It has a remaining 7.7% of office and 3.9% of retail lease to renew this year and a further 27% and 23% of leases expiring in FY10/11. Given the current weaker market rents and higher average of some of the upcoming expiries, the reversion gap is expected to narrow significantly.

Maintain Hold. We are maintaining our Hold call but have lifted our TP to $1.11. While we recognize that CCT's valuation is inexpensive, at 0.3x P/bk NAV, the overhang from refinancing and/or potential for capital management exercises remains given that 58% of its total debt (72% if CBs get put) is maturing over 2010/11. Moreover, gearing is at 38.3% and would rise to 45-50% on a 15-20% depreciation of asset values, a scenario that is not improbable given the soft office outlook. The stock is currently yielding 14.5% and 12.9% in FY09 and FY10 respectively.

CapitaCommercial Trust - 1Q09 Outperforming peers

CCT reported DPU of 3.24 cents, an increase of 25.1% yoy and representing annualised yield of 15.9%. The results is better than our DPU forecast of 3.04 cents. Gross revenue increased 36.9% yoy to S$97.5m due to acquisition of One George Street and Wilkie Edge and positive rental reversion for its office properties.

CCT has been renewing leases way ahead of expiry. It has signed new or renewed leases for 335,800sf of space with rentals, on a weighted average basis, increasing 49% compared to previously signed rents. 89% of forecast rental income for 2009 is lock-in under committed leases.

Current average monthly office rent is low at S$7.73psf, slightly higher than S$7.44psf in 4Q08. Committed occupancy on a portfolio basis is 97.7% in Apr 09, compared to 96.2% at Dec 08. The improvement could have came from newly completed Wilkie Edge at Selegie Road.

The average lease term to expiry for its top-10 tenants is 6.4 years. They accounts for about 50% of gross rental income and provide some defensive shelter.

CCT has obtained a commitment letter from a bank for a three-year secured term loan of up to S$160m to refinance the remaining outstanding debt maturing this year. This is secured against HSBC Building with all-in margin for the term loan at 3.0%.

CapitaCommercial Trust: Looking beyond the weak office market outlook

Wide tenant base mitigates tenancy risk. Tenancy risk for CCT is well-managed, with a wide base of 540 tenants. CCT's maximum exposure to a single tenant is ~13% of its monthly gross rental income and this comes from RC Hotels. The top ten tenants contribute approximately 50% of monthly gross rental income. Other than RC Hotels and Standard Chartered Bank, the remaining tenants each contribute ≤ 5% of CCT's monthly gross rental income.

Strong landlord-tenant relationship minimizes tenant turnover. CCT has maintained good relationship with its tenants. This is seen from the long term relationship between CCT and some tenants who have stayed with CCT since its establishment. Some tenants, such as Standard Chartered Bank, have also taken up long term lease contracts with CCT. S$282.3m of gross rental locked in for FY09. CCT's income visibility remains very healthy for FY09. At the end of FY08, CCT had already locked in 79% (~S$282.3m) of its forecast gross rental income for FY09. As prime and Grade A office average rents continue to decline, rental upside from lease renewals is expected to decline but the impact is mitigated by the small % of expiring lease in FY09.

An equity fund raising may be needed by 2011. While we do not foresee major issues with the refinancing of borrowings due in FY09 and FY10, chances of an equity fund raising appear to be higher in FY11 with the significant liquidity needs. Total borrowings due for refinancing in FY11 could increase to S$1,006m if convertible bonds holders exercise early redemption option. With the declining valuation of its properties, gearing level is expected to trend upwards and CCT may also have to consider equity fund raising to keep its gearing level in line with the S-REITs sector's gearing level.

Go for the yield and assets; re-initiate with BUY. We advise investors to look beyond the weak office market outlook and focus on the quality of CCT's assets and the DPU yield of CCT over the next 2 years. For FY09 and FY10, we still expect CCT to deliver DPU yields of 12.3% and 10.5%,respectively. Having a strong sponsor in CapitaLand could also providesupport to CCT if there is any need for fund raising. We derive a RNAV estimate of S$1.06 per share for CCT and we peg our fair value estimate at S$1.06, which is at par to its RNAV. We re-initiate coverage on CCT with a BUY rating.

CapitaCommercial Trust (CCT) - Negative outlook on Singapore office

Potential equity raising: We believe CCT will come to the market for equity within the next six months as asset write downs hit the balance sheet. We believe gearing will need to be addressed via equity issuance in order for CCT to secure future financing commitments. As CCT is trading at a large discount to NAV, potential capital raisings will be highly dilutive to valuations and future distributions.

Negative outlook on Singapore office: We continue to see office as the asset class with the greatest downside risk to capital values and rentals. With expectations of demand contraction and massive supply coming onstream, we now expect rentals to decline faster than previously expected and revise our forecast Grade-A office rents to fall to S$8 psf pm, S$5 psf pm and S$4 psf pm in 2009, 2010 and 2011 respectively. About 75% of CCT’s portfolio is exposed to the Singapore office market, with leases representing 14% of its gross income up for renewal in 2009.

Geared up on peak capital values: Our biggest concern for the office REITs is potential asset value write-downs and the implications for gearing. Assuming a 30% asset write down, CCT’s NAV will halve and gearing will increase to 53% from 37%. In addition, CCT has S$1.0bn of debt due for refinancing by 2010.

Better-than-expected renewal rates: CCT’s portfolio is under-rented versus market rents. If the company is able to secure better-than-expected renewal rates, earnings may beat our expectations.

Improvement in global economic outlook: If we see a turnaround in the global economic outlook, demand for office space may pick up and relieve the additional pressure on office rentals and capital values.

CapitaCommercial Trust – Attractive yields to prevail, against all odds

CCT’s shareprice has underperformed the market since the beginning of the year, declining by about 25% YTD, versus the STI’s 13% decline and the FSTREI Index’s 23% decline. We believe that the concerns of DPU sustainability and a rights issue in the near future still weigh on the investor’s psyche.

We reiterate that having already locked in 79% of the forecast in gross rental income, CCT’s management is confident of delivering its forecast DPU of 12.34 cents in FY09. This represents a 12.2% growth in the DPU, due largely to the greater contributions from One George Street, Wilkie Edge, as well as positive rental reversions.

Given the severity of the global recession and the new supply of Grade A office space coming onstream from 2010, spot rents and the average occupancy rate for CCT’s portfolio of properties may be affected. We now factor a 20% decline in spot rents in FY10, and office portfolio occupancy rates of 92.5% and 90% respectively for FY10 and FY11. Even so, we still expect FY10 and FY11 DPUs of 12.4 and 12.5 cents respectively.

Unlike CapitaMall Trust, CCT does not have significant CAPEX requirements, having aborted its plans to redevelop Market Street Car Park. As for the $885m-debt maturing in 2010, we reckon that it can be secured against One George Street and 6 Battery Road (combined value of $2.5b) at a 50% LTV, even if their valuations decline by 30% from Dec 08. Hence, we do not foresee the need for CCT to undertake any rights issue in 2009 and 2010.

Despite adopting more stringent assumptions, we think that CCT can still provide attractive DPU yields of 18.0% and above, a hefty 1500 bps spread over the average 10-year government bond yield. We reiterate our BUY recommendation, with a DDM-derived target price of $1.40, assuming a 0% terminal growth rate.