CCT cap rate advantage faces reversal risk

Government could spoil the party.

Here's more from Maybank Kim Eng:

Higher DPU, thanks to Twenty Anson. CapitaCommercial Trust’s (CCT) FY12 DPU of 8.04 cents was in line with expectations, as contributions from Twenty Anson aided in the 7% YoY growth in DPU. 4Q12 DPU came in at 2.05 cents (+7% YoY, flat QoQ). The yield protection at One George Street (OGS) will end in July 2013, and with a slightly below-market occupancy rate of 92.5%, CCT’s 2H13 DPU may be impacted. We see few positive catalysts to warrant its FY13F DPU yield of 4.6%.

Portfolio remained generally resilient… On a portfolio basis, CCT’s office portfolio is at a healthy 97.2% occupancy, with the average monthly office portfolio rent inching up from SGD7.53 psf in 3Q12 to SGD7.64 psf in 4Q12. For the whole of FY12, CCT signed new office leases and renewals of ~459,500 sq ft, of which 54% were new leases.

…but eyes will be on One George Street. OGS has been operating at occupancy rates of below 95% since 2011 – 92.5% as at 4Q12. With its yield protection guaranteeing an NPI yield of at least 4.25% expiring in July 2013, we expect some downward pressure on CCT’s DPU, considering that the implied rent from the yield protection works out to ~SGD11.20 psf, compared with recent leases signed at rents ranging from SGD8-9.50 psf.

Cap rate compression offset by subdued growth assumptions. CCT enjoyed a 2.5% upside revaluation of its portfolio, mainly on the back of cap rate compression for its office properties, offset by more muted assumptions of rental growth by the valuers. The valuers have now assumed a cap rate of 3.75% for Grade A offices, partly benchmarked against strata-titled office transactions. There is, in our view, a risk of a reversal to cap rate expansion should the government also clamp down on speculative investment activity in the strata-titled office space, just as they have already done for industrial properties.

Valuations are not attractive. Even as we raise our DDM-derived target price to SGD1.43, CCT’s valuations are unattractive, especially when we see little upside potential to its FY13F DPU yield of 4.6%.