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CICT garners mixed results from analysts following 3QFY2023 update; RHB upgrades to ‘buy’

CapitaLand Integrate Commercial Trust has garnered mixed results from analysts following its Q3FY2023 update.

Analysts are remaining upbeat on CapitaLand Integrated Commercial Trust C38u’s (CICT) prospects after the REIT released its results for the 3QFY2023 ended Sept 30 on Oct 26. CICT’s distribution per unit (DPU) for the quarter rose by 4.6% y-o-y to $391.3 million.

RHB Bank Singapore upgraded its call to “buy” from “neutral” while DBS Group Research, OCBC Investment Research and Citi Research have all kept their “buy” calls.

Except for the OCBC team, which has reduced its fair value to $2 from $2.19 previously, while the DBS team, Citi analyst Brandon Lee and RHB analyst Vijay Natarajan have all kept their target prices of $2.30, $2.20 and $2 respectively.

Natarajan writes that the REIT’s 3QFY2023 headline numbers are “in line”, and its Singapore operational performance has outperformed the analyst’s expectations, leading to more attractive valuations of a price/book value (P/BV) ratio of 0.8x following the recent market sell-off.

“The strong operational growth should help offset interest cost pressures, with CICT having a relatively healthy debt hedge of around 78%,” writes Natarajan.

The REIT’s retail rental reversion was stronger than expected at 7.8% higher year-to-date, with downtown malls showing a 8.4% increase, registering a strong turnaround as more workers have returned to the office and tourist arrivals have increased.

The analyst writes: “We expect the retail rental reversion in FY2024 to be a mid-single digit, backed by higher tourism revenue and wage growth.”

CICT has also benefited from some higher variable rent leases signed during the Covid-19 pandemic, with higher gross turnover rental rates that came up to 5% to 15% of respective mall incomes.

Meanwhile, overall mall occupancy rate increased 0.3 percentage points (ppts) q-o-q to 99%.

Office portfolio occupancy rates on the other hand rose to 96.4% from 95.4% in 2QFY2023, which was mainly driven by occupancy rates at Capital Tower with 97.4%, CapitaGreen with 97.1% and Six Battery Road with 97.9%, all of which saw new leases signed in 3QFY2023.

The REIT has also highlighted that discussions are currently ongoing with WeWork, which accounts for 2.4% of office portfolio income and is an anchor tenant at 21 Collyer Quay and to a smaller extent Funan, and there have been no rent arrears thus far.

Natrajan writes: “We are less concerned on WeWork leases which, based on our estimates, were signed at much lower rates of around 30% below against current market levels. As such, in the worst case of its exit, this could be back-filled at higher rental rates.”

He continues noting that CICT’s overseas assets’ occupancy rates, however, are expected to take a hit with the departure of Commerzbank from Gallileo, Frankfurt by Jan 2024, and a tenant exit at 100 Arthur Street (100AS), which accounts for around 15% of building net lettable area (NLA).

The REIT is in advanced talks on backfilling 67% of vacated space at 100AS , as well as finalising the Gallileo asset enhancement plan, which could lead to a downtime of around 18 months.

Natarajan observes that divestments will likely be a key catalyst for CICT with its gearing on the “higher side” of around 40.8%, and the REIT could look at divesting some of its smaller retail malls and paring down stakes in office assets to unlock value.

The analyst notes that acquisitions, however, are unlikely, as its high cost of capital limits yield-accretive acquisition opportunities.

For the 3QFY2023 and 9MFY2023, CICT’s net property income (NPI) increased by 1% and 7% y-o-y, driven by strong organic income growth from its assets, and was partly offset by higher operating expenses.

“We expect NPI margins to stabilise around current levels. The average borrowing cost rose to 3.3% against 3.2% in 1HFY2023 and should stay below 3.5% for the full year. We expect its overall portfolio to remain stable with slight gains in its Singapore assets, mainly from income growth offsetting a slight valuation decline for overseas assets (from cap rate expansions) and the foreign exchange (forex) impact,” writes Natarajan.

Key drivers noted by the analyst include the largest retail-cum-office REIT in Singapore benefitting from scale and diversification, good-quality assets and a management team and a strong sponsor and asset pipeline. Conversely, key risks include the continued spike in interest rates and the economy falling into a recession, structural headwinds facing the office & retail sector and lastly a weak performance of overseas markets.

The DBS team similarly expects CICT’s performance to remain stable, due to a potential uptick boosted by tourism spending at the end of the year.

“With more than 90% of its portfolio comprising Singapore assets, we believe CICT is a close proxy if the Singapore economy remains to be more resilient compared to other developed markets,” writes the team.

Meanwhile, the team at OCBC is less rosy on the REIT’s prospects, as they observe that CICT’s aggregate leverage increased from 40.4% to 40.8 % as at June 30.

“We believe this is a metric which investors would frown upon given the growing narrative of a higher-for-longer interest rate environment,” notes the team.

Following high debt cost assumptions, the team has lowered its FY2023 and FY204 DPU forecast by 2% and 2.6% respectively.

The team writes: “Given increased market volatility and potential for interest rates to stay elevated, we also raise our cost of equity assumption from 6.5% to 6.6%, and lower our terminal growth rate by 25 basis points (bps) to 1.00%.”

Potential catalysts noted by the team at OCBC include the divestment of assets at prices significantly above valuation, DPU accretive acquisitions and a better-than-expected momentum in footfall and tenants’ sales for its malls. At the other end of the spectrum, investment risks include the slowdown in macroeconomic conditions which may dampen consumer and business sentiment, a rising interest rate environment which could raise the borrowing costs for CICT and a lower-than-expected recovery in portfolio rental reversions.

Finally, Citi analyst Brandon Lee is mixed on CICT’s 3QFY2023 business updates, as despite a slightly improving office landscape, he expects the heightened caution of tenants in an uncertain macro environment to weigh on the REIT’s rental trajectory which could result in a starker rental decline in FY2024.

Lee writes: “While we agree with CICT’s defensive stance on the investment front, we would like to see a more proactive asset divestment/redevelopment strategy to lower gearing from the current 40.8%, which is one of the key share price catalysts.”

Lee’s target price is based on the average of a dividend discount model (DDM) and revised net asset value (RNAV) valuation, with the assumptions of a risk-free rate of 3.5%, overall cost equity of 8.6% and terminal growth of 3.3% included in his DDM valuation. For RNAV, the analyst values the REIT’s properties at a weighted average cap rate of 4.3%.

Key upside risks noted by Lee include a faster-than-expected recovery in tenants’ sales after re-opening, higher-than-expected retail rental rates following asset enhancement initiatives which would drive up DPU and higher-than-expected office rental rates should the ongoing office down cycle end earlier than Lee’s forecast for FY2023, as well as a stronger economic growth.

Conversely, downside risks noted by Lee include a sharp decline in economic activity that could result in reduced demand for retail and office space, a sharp rise in interest rates which would raise CICT’s cost of debt, lower its DPU, increase the cost of capital and lower the analyst’s DDM valuation.

As at 2.30pm, units in CapitaLand Integrated Commercial Trust are trading at three cents higher or 1.75% up at $1.74.

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