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Analysts mixed on Keppel DC REIT’s acquisition prospects in FY2023

CGS-CIMB and DBS have maintained 'add' and 'buy' calls while Citi and OCBC have kept to 'neutral' and 'hold'.

Analysts are mixed on Keppel DC REIT (KDC REIT) following its FY2022 report released on Jan 31. CGS-CIMB Research and DBS Group Research have maintained their “add” and “buy” calls for the REIT, while Citi Research and OCBC Investment Research have kept their “neutral” and “hold” recommendations.

CGS-CIMB’s Lock Mun Yee and Natalie Ong have increased their target price (TP) to $2.39 from $2.12 previously, while Dale Lai and Derek Tan of DBS have increased their TP to $2.35 from $2.20 previously. OCBC’s research team has also increased its TP to $1.98 from $1.78 previously. Citi analyst Brandon Lee’s TP for the REIT stands at $1.91.

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KDC REIT’s DPU of 10.214 cents for FY2022 was 3.7% higher than its DPU of 9.851 cents in FY2021, and in line with CGS-CIMB expectations at 100.6% of its FY2022 forecast. Lock and Ong believe the REIT’s global acquisitions will be enough to overcome near-term headwinds. “KDC REIT is largely insulated from rising energy costs as electricity costs are borne or largely (over 90%) passed through to tenants,” they say.

They note that the REIT’s balance sheet remains robust, and also saw positive reversions and rental escalations on leases signed in FY2022.

KDC REIT’s gearing improved q-o-q from 37.5% to 36.4% due to revaluation gains of $68 million. The average cost of debt for 4QFY2022 inched up q-o-q from 2.3% to 2.7% and averaged 2.2% for the year, on the low side amongst its Singapore REIT (S-REIT) peers. About 74% of its borrowings are on fixed rates, with 11.1% of loans up for refinancing in 1HFY2023.

“According to KDC REIT, a 100 basis points (bps) increase in interest rates would lower 4QFY2022 DPU by 2.1% on a pro-forma basis. While the improvement in gearing would allow KDC to fully debt fund progressive payments for Guangdong DC3, during the analysts’ briefing, the management said that it prefers to raise equity to provide the REIT with more debt headroom for opportunistic acquisitions,” they explain.

Although their FY2023 to FY2024 DPU estimates have fallen on higher borrowing costs, they have raised their TP on lower cost of equity and beta assumptions. “We think that tenant stickiness due to the high cost of relocation and limited supply in the near term in KDC REIT’s key markets will continue to underpin income resilience and positive reversions,” says Lock and Ong.

DBS’s Lai and Tan add that KDC REIT’s portfolio of DCs in Asia Pacific and Europe continue to benefit from the structural tailwinds of the sector. “Its reputation and capability to manage DC assets is reflected in its consistently high occupancy rates. In addition, KDC REIT benefits from the support of its sponsor, which provides it with pipeline assets and DC development capabilities to further grow its portfolio,”

Meanwhile, the resumption of accretive acquisitions and asset enhancement initiatives (AEIs) will drive organic growth for the REIT. “For FY2023, the full-year contribution from acquisitions will support earnings growth, and the protracted completion of Guangdong DC 3 will lead to higher income contribution from the asset,” say the DBS analysts.

“Although KDC REIT continued acquisitions over the past year, the rate at which it does this has slowed down notably due to stubbornly low cap rates and rising financing costs. As such, we have not priced in any acquisition assumptions in our estimates. But with interest rates hikes seeming to have slowed and potentially stabilising, KDC REIT could resume accretive acquisitions in the near future,” they add.

The upward revision in their TP to $2.35 implies forward yields of an estimated 4.3% to 4.7%, in line with historical average. Further catalysts to their projections will come from accretive acquisitions as well as a lower-than-projected rise in financing cost, although the analysts note that equity fundraising could be a risk in the near term.

OCBC’s team notes that while KDC REIT “remains on the lookout” for acquisitions, and believes there is still a healthy pipeline of opportunities, it has also acknowledged that sellers have generally not been keen to lower asking prices.

OCBC has raised its FY2023 and FY2024 DPU forecasts by 3.3% and 3.8% respectively and lowered its COE assumption from 7.1% to 6.9%, part of which is due to KDC REIT’s ESG rating upgrade. As a result, its fair value estimate for the REIT has increased to $1.98 from $1.78 previously.

However, Citi’s Lee says that while KDC REIT continues to explore acquisitions, the flattish cap rate movement by vendors in DCs and high debt cost — albeit mitigated by improved COE — suggest DPU accretion for potential opportunities may not be that straightforward, unless it is located in Singapore. “Most importantly, its relatively high gearing of around 39% (post fit-out of Guangdong DC 3) implies a mix of debt and equity will be required to finance any prospective acquisitions,” he adds.

Although KDC REIT has outperformed S-REITs by some 8 percentage points year-to-date (YTD) and is the best-performing S-REIT under Lee’s coverage, at a 1.5x price-to-book value (P/Bv) and a 5% FY2023 yield, he sees better value in Digital Core REIT — another DC S-REIT — which has a 0.7x P/Bv and 6.4% yield.

“Digital Core REIT, as the only pure-play data centre S-REIT sponsored by a global best-in-class pure-play listed DC owner and operator, offers unique exposure to a differentiated asset class. Leasing risk is low over the coming years, with 0% of NRSF expiring in 2022 to 2023,” says Lee.

His $1.91 TP for KDC REIT is based on an average of dividend discount model (DDM) and revalued net asset value (RNAV) valuations. Lee has made the assumptions a risk-free rate of 3.5%, an overall COE of 8.6% and terminal growth of 1.0% in his DDM valuation. He has not factored in any potential earnings accretion or dilution from any unannounced acquisitions. For RNAV, he values KDC REIT’s properties at a blended cap rate of 5.5%.

As at 4.08pm, units in KDC REIT are trading 2 cents or 0.94% up at $2.14 with a dividend yield of 4.5%.

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