Are troubles ahead for Capitacommercial Trust?

Main underperformer YTD
YTD, CCT has been the worst performing S-REIT in our coverage, underperforming the STI and FSTREI by 15% and 20% respectively. Plagued by fears of an office slowdown as the global economy decelerates, the selldown of the REIT has intensified in the past month, with the REIT down by 12% in the past month, underperforming the FSTREI by 9%.

Distress valuations implied. Trading at 0.7x P/BV and forward yields of 7%, the market appears to be pricing its Grade A offices at capital values of S$1.4k psf, way below the S$1.7k psf for prime office assets during the last crisis in 2008/9. Implied cap rates of 6.7% are also much higher than CCT’s asset valuations by valuers in Jun 09 (4.5-4.75%) and cap rates implied by the transactions in 2009 (estimated 4.4-6.8%).

Distress valuations unjustified
Stress-testing portfolio. We stress-test our renewal rental and occupancy assumptions for CCT’s key assets. We make no changes to our rental and occupancy assumptions for One George Street given its 4.25% NPI yield support. Even in the worst case in which office rents fall to S$4-5psf (during 2003), FY12 DPU yield of 5.8% is still rather attractive for CCT’s office assets.

Mitigation for rental downside. Downside for CCT’s portfolio should be mitigated by:

• 4.25% income yield support for One George Street (until Jul 13) which ensures NPI contributions of about S$50m per year (18% of CCT’s NPI)

• Strong committed occupancy for its prime office assets even during past downturns

• A relatively long WALE of 4.8 years for its top 10 tenants

• Long and under-rented leases for HSBC Building and GLC tenants in Capital Tower

Trough valuations unlikely to be revisited. CCT hit a bottom of 0.2x P/BV during late 2008 to early 2009 on fears of dilutive cash calls after its asset leverage rose to a high of 42% in Jun 09. This was on the back of rising borrowings to fund the acquisition of One George Street and asset devaluations. Investors’ fears were exacerbated by debt (34% of total debt) due for refinancing in 2010 as at end-Mar 09. Valuations, however, crept back to 0.6-0.8x P/BV in 2H09 as the completion of a rights issue strengthened its balance sheet with more moderate book values following asset-value write-downs.

Balance sheet stronger this time round. Asset leverage of 27% or 30-31% on a full draw-down of loans relating to the redevelopment of Market Street Car Park is among the lowest of the S-REITs, with a 20% haircut in valuations still expected to keep its leverage below 40%.

While assets have been revalued upwards, book valuations for its key office assets (except HSBC Building) are still 8-20% below previous peaks in Jun 08, implying less downside. Though about 34% of its borrowings will fall due again next year, we do not expect major refinancing risks, in view of its strong balance sheet, an untapped MTN balance of S$1.9bn and its strong parentage. On top of that, 50% of its assets are unsecured.