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Morningstar | CCT’s FY18 Results In Line; Gallileo and CapitaSpring Underpin Growth; FVE Raised to SGD 1.70

CapitaLand Commercial Trust’s, or CCT’s full-year 2018 results were in line with expectations. Net property income increased by 18.5% year over year to SGD 314.6 million on the back of a 16.7% year-over-year increase on revenue to SGD 394 million. Distribution per unit only increased by 0.5% year over year to SGD 0.087, which is lower than the 11.4% year-over-year growth on distributable income due to an enlarged total unit base. The higher net property income was driven by higher contributions from CapitaGreen, Six Battery Road, Asia Square Tower 2, or AST2 (acquired in fourth-quarter 2017), and Gallileo (acquired in second-quarter 2018) mitigated by lower contribution from Twenty Anson (divested in third-quarter 2018) and the loss of contribution from Wilkie Edge (divested in third-quarter 2017) and One George Street (divested 50% stake in second-quarter 2017). After rolling forward our cash flow model, we raise our fair value estimate to SGD 1.70 per unit from SGD 1.68. Our narrow economic moat and stable moat trend ratings remain unchanged. We think the units are slightly overvalued at the current price, with future growth mainly driven by the acquisition of Gallileo in 2018 and the development of CapitaSpring that is due to be completed by first half of 2021.

Occupancy rates for its portfolio remained stable at 99.3% in fourth-quarter 2018. It is worth noting that four of the nine properties it owns recorded 100% occupancy, which includes Six Battery Road, Bugis Village, HSBC Building, and Gallileo. We expect occupancy rates to remain stable. Renewal for around half of the 30% of leases that are up for renewal in 2019 has already been completed. The trust has managed to secure above market rents for most of the renewals done in fourth-quarter 2018. New leases in 2018 were largely from the real estate and property services, business consultancy, IT, media and telecommunications, financial services, energy, commodities, maritime, and logistics sectors. Management also noted that they have seen an increase in demand from co-working operators.

For HSBC Building, where HSBC has said that it will be moving out of in April 2020, management is considering a few options, with the focus on refurbishing and leasing it. Management does not rule out the option of redeveloping the property or selling it if the price is right. However, we think that the trust will only sell the property if it can receive a substantial premium, as it is one of the crown jewels for the trust given its location in the central business district and its 999-year lease profile, which is as good as a freehold lease and is very rare now.

Average Grade A office monthly rental rates in the fourth quarter of 2018 continue to increase to SGD 10.80 per square foot after hitting a bottom of SGD 8.95 in first-half 2017. This supports our view that office rental rates troughed in 2017 and are expected to recover in the next few years. This is supported by improving demand and normalized supply for office space from 2018 to 2021 after a big increase in net supply in 2016 and 2017. It is expected that only around 0.8 million square feet on average will be added every year from 2018 to 2021, which is close to the long-term historical average of 0.8 million square feet of annual net supply additions. For the remainder of the leases that are expiring in 2019, the average rental rate of SGD 10.46 per square foot is below the market rental rate of SGD 10.80 per square foot in fourth-quarter 2018 and will support near-term rental revision in 2019, in our view. In the medium term, we expect a large increase in rental revision in 2020 as the average rents for leases that expire then are significantly below the current market rents. However, we could see some downside risks in rental rates in 2022 as a huge supply of 1.8 million square feet is expected to be completed then.

In the medium term, we continue to expect contributions from AST2 and Gallileo to offset net property income lost from Twenty Anson and Bugis Village. In the long run, we expect the development of CapitaSpring, which is expected to be completed in the first half of 2021, and potential overseas acquisition, which could be mainly in Germany following its acquisition of Gallileo, to drive growth. Management expects that in the long run, overseas property could contribute up to 20% of its portfolio.