• We cut 2015-17E DPU
• Upgrade to Hold (3); lower TP to SGD1.57
■ What's new
After having declined by 10.8% YTD to SGD1.565, and underperforming at both the FSTREI and FSSTI YTD, CCT units no longer look overvalued to us and we take this opportunity to relook at CCT’s investment merits.
■ What's the impact
We believe the primary reason for CCT’s unit-price underperformance is the rapid YTD swing in sentiment towards the Singapore office sector, from positive to cautious.
Singapore’s office-rent growth has cooled, having slowed down sharply QoQ in 4Q14 and 1Q15. Although there will likely be no significant supply of new office space in the CBD until 2H16, demand appears to be softening on a combination of YTD weakness in some business segments (such as investment banking and oil & gas), and a few major technology companies moving away from the CBD on the lure of cheaper, brand new business-park space. We also notice a growing consensus that the new supply in 2H16E, even if some of it were to slip to 2017, will likely take several years to be absorbed and the overhang could be a major resistance for rental growth. These concerns have hit the unit prices of all office S-REITs YTD.
On top of the sector-wide malaise, CCT faces its own issues such as a possible increase in the vacancy rate at Capital Tower in the coming quarters due to the departure of Mizuho (8411 JP, JPY257.8, Outperform ), which recently relocated to Asia Square Tower 2. Mizuho contributed about 2% to CCT’s overall gross rental income as at 31 March 2015. Since the average monthly rent for leases expiring at Capital Tower (including the former Mizuho space) for the rest of 2015 is SGD10.15/sq ft (higher than current spot rates in the vicinity), we believe leasing might be a challenge for the rest of 2015.
Moreover, CapitaGreen, its 40%- owned newly completed office building, could now be perceived as a risk factor, in our view. We believe instead of focusing on CapitaGreen’s strong leasing progress and its contribution to CCT’s DPU from 2016, the market might now be concerned that CCT could buy another asset near the peak of the cycle, assuming management exercises its option to buy the remaining 60% of CapitaGreen within the next 12 months.
We lower our rental-growth assumptions for prime grade-A office rents to 5.4% YoY (from 8.9% YoY) for 2015 and 2.1% YoY (from 4.8%) for 2016. After incorporating our new office-rent assumptions, we revise down our 2015-17E DPU for CCT by 1.9-2.5%. Our forecasts assume no further increase in its stake in CapitaGreen.
■ What we recommend
Considering our forecast revisions, we lower our 12-month target price, pegged to our DDM valuation, to SGD1.57 from SGD1.63, but we upgrade our rating on the stock to Hold (3) from Underperform (4). CCT now trades on par with its mean PBR of 0.9x since listing. The 2016E DPU yield of over 6% is also on par with the S-REIT sector average. At this stage of the office cycle, we believe CCT units are fairly valued. A downside risk to our call is further weakness in the office sector, while a positive catalyst could be high signing rents for CapitaGreen.
■ How we differ
Our target price is now the lowest among the 19 firms in the Bloomberg consensus and we believe street target prices could come down in the coming quarters. (Read Report)