Ascendas REIT - Occupancy vs Valuations

Overall occupancy in the AREIT portfolio as at end March 2009 held at 97.8% (vs 97.2% in December 2008), with occupancy in the group’s multi-tenanted buildings (which comprise circa 52% of the portfolio) marginally improving over the quarter to 95.3% (versus 94.0% in December 2008). While AREIT indicated that the industrial market was in the early stages of a cyclical correction, risks remain for an increase in vacancy by a couple of percentage points in its multi-tenanted buildings. Management indicated that every 5% decline in multi-tenanted occupancy would see net property income fall by 3.5%, cutting DPU by S¢0.62. Management suggested that the risks to DPU as a consequence of lower occupancy could potentially be mitigated by 1) positive reversions in certain industrial sectors, eg, passing rents in their light industrial buildings were S$1.17/psf pm, vs market rents of S$1.71/psf pm. 2) While demand remains slow there is evidence of some new leasing demand. 3) A full year contribution of income from development properties completed in the last fiscal year. From our perspective, rising new supply poses an over-riding concern given the weaker outlook for demand. Net demand in the industrial factory space contracted 315,382sf in 1Q09, down from net take-up of 1.5mn sf in 4Q08. Future supply is high, with 18.2-20.2mn sf expected to be completed in 2009 and 11.3-16.8mn sf to be competed in 2010. This is compared to the ten-year average supply of 6.5mn sf and the 15-year average of 9.1mn sf.

Following a modest gross revaluation deficit (3.2% of asset valuations, with the net revaluation a 2.5% decline on the portfolio valued at S$4.4bn), management conceded that downside risks remained to underlying asset values, though it suggested the risks were modest. Management said that the portfolio’s capitalisation rates were circa 7.0%. At NAEF management suggested that a 25bps increase in cap rates would result in a S$0.09/unit fall in NAV, while a 100bps rise in cap rates would result in a S$0.33/unit fall in NAV.

Ascendas REIT’s DPU yield has averaged 6.3% since 2004 (equivalent to 345bp over the average risk free rate). Today AREIT’s FY10F yield is circa 8.0%, producing a 530bp spread over the current risk free rate. While seemingly attractive, the increased spread reflects lower growth expectations, in our view: during 2005-08, AREIT saw average annual compound growth in its DPU of 13.9%, versus our expectations for a fall of 21.1% over FY08-11F, in part due to the rights issue. We believe our asset-based approach to valuing AREIT incorporates the cashflow risks of both negative reversions and higher vacancy risk, and believe such “spread analysis” is overly simplistic. We retain our REDUCE rating with a price target of S$1.24/unit.

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