Frasers Commercial Trust

UOBKayhian on 7 Mar 2012

What’s New

• Re-iterate BUY with a target price of S$0.93 (previously S$0.96).
• We visited China Square Central (CSC), which is Frasers Commercial Trust’s (FCOT) largest asset by value, accounting for 28% of its portfolio by asset size and 17% of net property income (NPI). CSC is an office and retail development 500m from the Raffles Place and Chinatown MRT stations, comprising a 15-storey office tower, a podium, two basement levels and two clusters of shop houses. CSC’s master lease with a subsidiary of The Straits Trading Company Limited is due to end in 29 Mar 12.
• Room for improvement in occupancy and tenant mix. Our site visit to CSC’s retail space suggests further room for improvement in terms of occupancy and tenant mix. Channel checks revealed that there were a few unoccupied units on the ground floor, while tenant mix at the basement is too broad, including a gym, low-end eateries, a Christian bookstore, a laundry and a redemption fulfilment centre, amongst others. In addition, the retail podium lacks strong anchor tenants to draw and retain shoppers.
•  Higher foot traffic at shop-house clusters. We noticed that foot traffic at the shop-house clusters was clearly higher than that at the retail space within the office block, benefitting from a good tenant mix and their close proximity to neighbouring Far East Square. In addition, we also note that there was a lack of synergy and connectivity between the shophouse clusters and the main office block.
• Telok Ayer MRT could boost connectivity. Telok Ayer MRT, part of the Downtown line, is scheduled to be completed in 2013 and will be located 50m across the road from CSC. Upon completion of the MRT, we believe that there will be better connectivity between properties in the vicinity through underground walkways and connectors. 

Stock Impact

• Potential asset enhancement on the cards. In our view, FCOT is likely to revamp CSC’s tenant mix through asset enhancement initiatives (AEI) after taking over direct management of the asset. This could include moving the gym from the retail podium to the lower-rent office block, enhancing connectivity between the office and shop-house clusters and sub-dividing office space into smaller units to cater to small and medium enterprises (SME). FCOT may also revive its plan to build a hotel at CSC, which, due to development limitations, may have to be executed at the parent Frasers Centrepoint level.
• Temporary dip in occupancy during transition phase. We believe that occupancies may dip temporarily in 2012-13 if FCOT decides to embark on AEIs. A major tenant, Marsh & McLennan, is also due to vacate three floors in the office block in mid-12. However, rental rates and occupancies should benefit over the longer term from initiatives to improve the asset.
• Beneficiary of revitalisation of Tanjong Pagar and Shenton Way. CSC will benefit from the revitalisation of Tanjong Pagar and Shenton Way that includes new offices and residential developments. CSC houses the nearest supermarket to upcoming residential developments such as Robinson Suites and One Shenton. ParkRoyal on Pickering, a new hotel, is also due to be completed by end-12.
• S$90m cash on hand. As of end-1QFY12, FCOT had S$90m cash on its balance sheet, which could be deployed for potential AEIs. However, we note that FCOT may need to raise additional debt or equity for projects exceeding this amount. FCOT’s current gearing is at 36%.

Earnings Revision

• Assume more conservative occupancy rate. We reduce our FY13 NPI by 0.7%, to account for lower-than-expected occupancies at CSC arising from a potential AEI.

Valuation

• Re-iterate BUY with DCF-derived target price of S$0.93 (previously S$0.96), implying 12.0% upside from current price and FY13F DPU yield of 9.0%. We use an 8.7% discount rate and long-term growth rate of 1.0%.