K-REIT Asia

Kim Eng on 6 Jul 2012

Busy improving unitholders’ returns. In a space of two weeks, K-REIT announced that it had obtained tax transparency for rental income from MBFC Phase 1, and that it had acquired another 12.39% stake in Ocean Financial Centre (OFC). We recognize that these are proactive steps to improve unitholders’ returns. As we raise our DPU forecasts, we are also upgrading K-REIT to a HOLD recommendation.

Greater tax transparency. One of the advantages of investing in a REIT for individual unitholders is the tax transparency. However, K-REIT’s one-third stake in MBFC Phase 1 was previously held by a private limited company, which meant that the rental income attracted corporate income tax of 17%. The vehicle was recently converted to a limited liability partnership (LLP), which is tax exempt. This should result in estimated annual tax savings of SGD2.2-5.2m for FY12-15F, leading to higher distributions to unitholders.

Almost full control of OFC. K-REIT also acquired an additional 12.39% stake in Ocean Properties LLP, taking its 99-year interest in OFC to 99.9%. Including rental support of SGD24.1m, the stake is valued at SGD285.7m, or SGD2,600 psf – in line with what K-REIT had paid for the original 87.51% in Oct 2011. The acquisition will be partly funded by a placement of 60m new units to the Vendor, pegged at a price of SGD1.17 per unit, which was at a 14.6% premium to the VWAP then. With the remainder funded by borrowings, K-REIT’s look-through gearing is expected to increase to 43.9% from 41.8% as at 1Q12.

Raising our estimates. On the back of these corporate actions, we have raised our DPU estimates by between 6% and 12% for FY12-14F respectively. DPUs are expected to remain fairly stable up till FY15, with further upside possible if the vehicle holding its one-third stake in One Raffles Quay is also converted to an LLP for tax transparency. With a long WALE of 6.4 years as at 1Q12 (peers average at 3-4 years), K-REIT will be able to weather the near-term market volatilities.

Upgrade to HOLD. We raise our DDM-derived target price to SGD0.99, on the back of higher DPUs and a terminal growth rate assumption of 1.5% (previously 0.5%) as we become less pessimistic on the long-term prospects. 1H12 results will be released on 16 July.