CapitaCommercial Trust: Slowdown in negative rental reversion impact (KimEng)

(NEUTRAL, $1.46, TP S$1.38)

2Q11 DPU in line with expectations. CapitaCommercial Trust (CCT) reported lower 2Q11 DPU of 1.92S¢ (+4.3% QoQ; -2.5% YoY) due to 1) smaller portfolio size (sales of Robinson Point in Apr 2010 and Starhub Centre in Sep 2010), 2) negative rental reversion and lower occupancy at Six Battery Road. Rental reversion is likely to stay negative in 2011. However, the extent of negative reversion will decline as office rental rates are expected to rise further going forward, underpinned by expectations of a robust Singapore economy in 2011. We raised our FY11-FY12 DPU estimates by 1.1-0.9% respectively to account for slightly higher than expected interest expense savings from the recent loan financing at the RCS Trust level which has a cost of debt of ~3.03-3.09% (prev est: 3.3%). Coupled with the half-year rollover in our 10-year DDM valuation (COE: 8.7%; TGR: 3.0%), we raise our TP to S$1.38. Maintain NEUTRAL.

Signed JV agreement with CapitaLand (CapLand) and Mitsubishi Estate Asia (MEA) to redevelop Market Street Car Park (MSCP). As part of the JV agreement, MSCP was sold to MSO Trust which is jointly owned by CCT, CapLand and MEA in their respective 40%:50%:10% interest. Total redevelopment cost is S$1.4b (c. S$1,900psf based on net lettable area) and the project is expected to be completed in end 2014. Upon completion, the Grade A office tower is expected to have a stabilised annual rental yield of >6.0%. As MCSP has ceased operation in end Jun 2011, we expect the gross rental income to decline by ~S$2m/year, which represents only <1% of CCT’s total gross rental income.

Extent of negative rental reversion expected to decline in subsequent quarters. Average rent of CCT’s remaining leases expiring in 2011 is S$13.91 psf, which is higher than average Grade A office rent of S$10.60 psf (2Q11). We expect negative rental reversion to end in late 2011/early 2012, while strong positive rental reversion to occur only in 2013. Given CCT’s rich valuation with FY11-FY12 dividend yield spread at close to pre-crisis mean spread of 2.9%, we maintain NEUTRAL on this counter at this juncture.