The Positives
+ Revenue in line; NPI and DI exceeded by 4%/6%. A 1.6% YoY improvement in NPI was attributed to better 313 operations, higher revenue from Sky Complex following €/S$ appreciation and lower operating expenses, offset by doubtful debt provisions of S$1.5mn amid the impact of COVID-19 on some tenants at 313. Revenue was in line at 98.5% of estimate but NPI and DI exceeded by 4%/6% on the back of higher-than-expected NPI margins.
+ Recovering sales with higher occupancy at 313. 313’s occupancy improved to 98.7% from 95.6% in 1Q21, underpinned by new experiential retail and F&B tenants such as Paris Baguette and New World Carnival (VR Arcade). Tenant sales improved 19.5% QoQ and footfall, 12.4%. That said, sales and footfall were still only 75%/60% of pre-Covid levels. Tenant retention rate was lower at 58.8% vis-à-vis 80% last quarter as the mall’s mix was adjusted to accommodate more pandemic-resilient concepts such as omnichannel retailing.
+ More valuation upside expected for Sky Complex as Milano Santa Giulia (MSG) continues to urbanise. The northern zone of the MSG district in Milan will be developed into a smart urban park to host the 2026 Winter Olympics. This is also part of Milan’s plan to turn MSG into one of its key decentralised office and mixed-use destinations. The transformation is expected to attract investments to the district in the coming years. Sky Complex is located in the south of MSG, which is the new business district of Milan (Figure 1). The development of a new metro line connecting MSG to the Linate Airport should further augment Sky Complex’s appeal. Sky We factor in a 3% improvement in Sky Complex’s FY21e valuation to reflect this and further €/S$ appreciation.
The Negative
– Slow rent recovery amid weak leasing. Despite Singapore’s move into Phase 3 reopening, demand for retail space is still soft as safe-distancing measures and border closures remain in place. To maintain occupancy at 313, LREIT has offered several tenants leases with a bigger gross turnover (GTO) component and two tenants with pure GTO terms in a test run. Even then, its GTO component stayed at 3% of total gross rental income, supported by contributions from Sky Complex. This was similar to pre-Covid levels.
Outlook
LREIT places priority on maintaining occupancy at 313 and helping tenants stay viable. Given this, we believe weak retail demand will continue to weigh on its rents in the short term. Further out, we expect the Singapore government’s plan to vaccinate residents by end-2021 to bolster shopper and visitor confidence in FY21/FY22. Stable revenue contributions from Sky Complex are also expected to mitigate Covid-19 risks.
Over in Milan, LREIT’s broadcasting tenant continues to operate with safe-management measures in place. Milan’s office vacancy rates remained stable at 9.9% in 3Q20. Although there was a decline in absorption in its submarkets, largely attributable to occupiers seeking cheaper alternatives, a general flight to quality brought total office investments in 9M20 to €1.9 bn, up 25% YoY.
As part of MSG’s urban redevelopment, 90k sqm of new office supply is expected to come onstream from two projects over the next two years. One of the projects has been 80% pre-let to a global engineering company. Given that the lease at Sky Complex will expire only in 2032 (with a break-lease option in 2026), Sky Complex’s income is expected to be resilient.
Maintain ACCUMULATE with higher DDM target price of S$0.82, from S$0.78. We raise gross NPI margins from 69%/71% to 73%/72% for FY21/FY22e to reflect better 313 operations. We also include a 3% p.a. rental step-up for Sky Complex in FY22e – previously 0% – as the property’s rent climbed 4% HoH in 1H21 despite Covid-19. The € also appreciated 3% HoH against S$ in 1H21. All in all, we raise FY21 and FY22 DPUs by 7.7% and 4.8%, which lifts our DDM TP to S$0.82.
Current price translates to a 6.1% FY21e distribution yield for total potential upside of 10.9%.
