The Positives

+ Positive rental reversions ranging 4.4% to 27.5% above the average expiring rent. With office rents still growing, albeit at a slower rate (2Q19: 1.3% vs 1Q19: 3.2% QoQ), CCT was able to capture positive rental reversions. Reversions ranged 4.4% to 27.5% above the average expiring rents.

+ AEIs at 21 Collyer Quay and 6 Battery Road to give ROI of c.9% and c.8%. AEI at 21 Collyer Quay comes after a 14-year master lease to HSBC (ending April 2021) and capitalises on transitional occupancy downtime, before the lease to We Work kicks in early 2Q21. The AEI will cost S$45mn and the refreshed building will be able to command higher rents, giving an estimated 9% ROI. S$35mn AEI to create a new through-block link with F&B units in the retail podium, and reconfigure space in levels 3 to 10 of the office block. The office tower will remain in operation and while the AEI is conducted in phases from 1Q20 to 3Q21. ROI of c.8% is expected to come from better floor configuration as well as new F&B tenants in the podium block.

+ New seven-year lease of 21 Collyer Quay to We Work commencing early 2Q21 (post-AEI). This will put CCT’s exposure to co-working operators at 7%. The lease has no break clause and periodic rental step-ups.   

The Negatives

– DPU disruption is possible as revenues affected by the lack of income during AEI. 21 Collyer Quay will not be generating cash rents during the AEI and fit-out period from 2Q20 to 2Q21. However, the long runway until 2Q20 gives CCT the ability to grow revenues to offset maintain DPU stability. If approved, the proposed acquisition of MAC (elaborated below) and subsequent completion in 4Q19 will help to grow and stabilize DPUs. Options to distribute capital gains and tax savings exist which the management can explore. However, the management has also expressed that their focus will be on longer-term growth over transitional disruptions to DPU.

– A slight dip in occupancy, mainly due to AST2. Occupancy at AST2 fell 2.3pp from 98.1% in 1Q19 to 95.8% in 2Q19, due to non-renewal of a single tenant.

What else was new?

The proposed acquisition of 94.5% effective stake in Main Airport Centre (MAC), an 11-story office building located in near the 3rd busiest airport in Frankfurt, Germany. Total acquisition outlay is expected to be S$390 and translates to a 4.0% NPI yield (based on committed occupancy of c.90%) and pro-forma 1H19 DPU accretion of 1% (40% debt) to 2.5% (100% debt). Pro-forma leverage expected to increase from 34.8% to 35-37% and will increase CCT’s exposure to Germany from 5% to 8%.

Marco conditions for the airport submarket look positive with vacancy rates for the airport submarket (4.0%) consistently lower than the broader Frankfurt office market (7.5%). The airport submarket rents are also competitive relatively to CBD districts. (€25.5 vs €27.1 psm/month).

This proposed acquisition comes one year after the acquisition of Galileo, CCT’s first foray overseas, located in the Frankfurt CBD Banking district. CapitaLand will hold the remaining 5.5% stake in Galileo. If approved by the unitholders at the September 2019 EGM, the acquisition will be headed for a 4Q19 completion.

CCT has closed the private placement of c.102mn new units for $220mn, 98.5% or S$216.7mn will be used to partially fund the acquisition of MAC. Without further equity  raising, the LTV for this acquisition will be c.56%.

Outlook

Outlook remains positive for CCT, with expiring rents for 2019 and 2020 on the downtrend ($10.35/$9.60 psf, 2021: $10.69 psf), below the average market rent of $11.30. Average annual supply of office space coming onto the market from 2019 to 2023 (0.8mn sqft) is 27%  lower than the 10-year average supply of 1.1mn sqft and should help to support rents and deliver positive rental reversions for CCT.

Maintain NEUTRAL with higher TP of $2.18 (prev. $1.93).

We revise our forecasts to incorporate newly announced AEIs, new shares from placement to fund the acquisition of MAC, and the proposed acquisition of MAC. Our higher TP of $2.18 is partly due to the items previously mentioned, and a downward revision of our COE from 6.76% to 6.34%, due to the lower interest rate environment. We maintain NEUTRAL due to the run-up in prices year-to-date and the expensive valuation of >2 std. dev P/NAV which CCT now trades at. Our TP translates to a distribution yield of 4.1% and limited upside of 1.5%.