Elevator Pitch

I maintain a Neutral rating on Singapore-listed office REIT Capitacommercial Trust (OTCPK:CMIAF, CCT:SP), or CapitaLand Commercial Trust.

This is an update of my initiation article on published on October 8, 2019. Capitacommercial Trust share price has declined by -18% from S$2.05 as of October 7, 2019 to S$1.68 as of July 29, 2020 since my initiation. It trades at 0.94 times P/B, which is on par with its historical five-year and 10-year mean P/B multiples of 0.94 times and 0.93 times, respectively. The trust also offers a consensus forward FY2020 distribution yield of 4.3%.

Capitacommercial Trust’s 1H 2020 financial results were uninspiring, but market consensus expects a decent performance for the trust in 2H 2020, supported by expectations of positive rental reversions and its long Weighted Average Lease Expiry, or WALE, of 5.7 years. As such, the trust is expected to be resilient in the near term, but there are concerns in the medium to long term, such as significant lease expires in 2021 and 2022, working-from-home trends and co-working operator tenant exposure. Capitacommercial Trust has also proposed to merge with Singapore-listed retail REIT CapitaLand Mall Trust (OTCPK:CPAMF, CT:SP) to form a diversified commercial REIT to be named CapitaLand Integrated Commercial Trust, and the transaction is pending approval at extraordinary general meetings expected to be held soon.

Readers have the option of trading in Capitacommercial Trust shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the ticker CMIAF or on the Singapore Stock Exchange with the ticker CCT:SP. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For those shares listed in Singapore, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Singapore Stock Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $15 million, and market capitalization is above $4.7 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own Capitacommercial Trust shares listed in Singapore include BlackRock, The Vanguard Group, Schroder Investment Management and Norges Bank Investment Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

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1H 2020 Results Were Uninspiring

Capitacommercial Trust reported 1H 2020 financial results on July 23, 2020, and the trust’s financial performance was uninspiring.

Gross revenue declined by -2.2% YoY to S$196.4 million in 1H 2020, while its net property income decreased by -4.5% YoY to S$151.1 million in the first half of the year. There was a divergence in the performance of the trust’s two markets, Germany and Singapore, which led to the disappointing results.

Capitacommercial Trust’s Gallileo, a commercial property located in the prime Central Business District of Frankfurt, Germany, saw gross revenue grow from S$13.3 million in 1H 2019 to S$13.8 million in 1H 2020. Main Airport Center, a freehold office building in Frankfurt, Germany, in which the trust acquired a 94.9% stake in 2H 2019, also contributed S$12.3 million of gross revenue in 1H 2020. In contrast, all of the trust’s Singapore properties saw lower gross revenue on a YoY basis in the first half of this year. Lower occupancy rates, rent waivers and the expiry of leases for the 21 Collyer Quay and the Bugis Village properties were the key factors that contributed to the weaker performance of Capitacommercial Trust’s Singapore property portfolio in 1H 2020.

The trust’s distributable income and distribution per unit dropped by -21.7% YoY and -24.4% YoY to S$129.3 million and S$0.0334, respectively. The relatively larger fall in distributable income relative to gross revenue and net property income in 1H 2020 was mainly attributable to the payment of asset management fees for the Asia Square Tower 2 property in cash (rather than issuance of new units) and the poor performance of its 60%-owned joint-venture RCS Trust, which owns the Raffles City Singapore property. As Raffles City Singapore is a mixed-use development comprising of retail space, hotels and offices, the property has been hit more badly by COVID-19 as compared to Capitacommercial Trust’s other office properties.

Notwithstanding the lackluster financial results for 1H 2020, Capitacommercial Trust’s operating metrics were still decent. As of June 30, 2020, the trust’s average occupancy rates for its properties in Singapore and Germany were 95.2% and 95.4%, respectively. In comparison, the occupancy rate for Singapore’s core Central Business District office properties was 94.4%, while average office market occupancy rate in Frankfurt was 93.1% as of end-2Q 2020. In other words, the trust’s office properties have outperformed the broader market. Notably, Capitacommercial Trust also achieved positive rental reversions for new and renewal leases in the most recent quarter, as per the table below.

Capitacommercial Trust’s Positive Rental Reversions For New And Renewal Leases In 2Q 2020

(Source: 1H 2020 Results Presentation Slides)

Decent 2H 2020 Performance Expected

Sell-side analysts are expecting Capitacommercial Trust’s distribution per unit to decrease by -16% YoY, from S$0.0888 in FY2019 to S$0.0725 in FY2020, but recover by +18% YoY to S$0.0839 in FY2021. With its distribution per unit down -24.4% YoY at S$0.0334 for 1H 2020, market consensus FY2020 numbers imply a decent performance for the trust in 2H 2020.

Capitacommercial Trust has a relatively long Weighted Average Lease term to Expiry, or WALE, of 5.7 years of end-2Q 2020. The trust only has 8% (in terms of rental income) of its leases expiring in 2020. This implies that weak economic conditions brought about COVID-19 should have a relatively muted impact on its overall gross revenue and net property income in the near term.

More importantly, the trust emphasized at its 1H 2020 results briefing on July 23, 2020 that “we believe that we can still achieve some positive reversions for the remaining leases expiring in 2020, given our relatively low average expiring rent for some of our assets.”

The key downside risk for its financial performance in 2H 2020 is larger-than-expected rental rebates for small to medium enterprises, or SMEs. Singapore Ministry of Law has introduced a new “rental relief framework for Small and Medium Enterprises (SMEs)” in June 2020, and Capitacommercial Trust estimates that around 20% of its tenants are SMEs.

Concerns In The Medium-To-Long Term

As highlighted in the preceding section of this article, I expect Capitacommercial Trust to be resilient in the near term and deliver a decent performance in 2H 2020. But there are concerns regarding its future prospects in the medium to long term.

Firstly, approximately 25% and 20% of leases (in terms of rental income) will expire in FY2021 and FY2022, respectively. Assuming economic conditions in Singapore and Germany remain weak beyond 2020, Capitacommercial Trust could possibly witness negative rental reversions in the next year or two.

Secondly, the working-from-home, or WFH, trend has gained significant momentum in the past few months, thanks to COVID-19, and there is uncertainty over how WFH could impact office space demand in the future.

At its 1H 2020 results briefing on July 23, 2020, Capitacommercial Trust noted that it expects “demand for office space still remains more or less similar” going forward, as trends such as de-densification (due to social distancing) and hybrid work models (offices, homes and other alternative locations all have a part to play as a place for work) could potentially offset the decline in office space demand resulting from WFH.

Thirdly, Capitacommercial Trust’s exposure to co-working space operators is also a concern. Earlier, it was estimated that co-working space operators will represent approximately 10% of the trust’s Net Lettable Area, taking into account a new lease signed with WeWork (WE) in July 2019. Given possible changes in the way people work post-COVID-19, there have been questions raised about the viability of the co-working space model.

The trust acknowledged at its 1H 2020 results briefing that co-working space operators are witnessing “lower levels of committed occupancy within the portfolio” since the COVID-19 outbreak, but the trust highlighted that ” there is no change” with respect to the status of its lease with WeWork for the 21 Collyer Quay property despite delays in upgrading works. More importantly, Capitacommercial Trust remains positive on the future of co-working, as it is of the opinion that “element of flexibility is a crucial component as companies want to make sure that their employees can work possibly from different locations.”

Proposed Merger Is Pending Approval

In my earlier article published on January 29, 2020, I highlighted that Capitacommercial Trust has proposed to merge with Singapore-listed retail REIT CapitaLand Mall Trust to form a diversified commercial REIT to be named CapitaLand Integrated Commercial Trust.

Capitacommercial Trust guided at the recent 1H 2020 results briefing that extraordinary general meetings to approve the proposed merger are still targeted to be held prior to the transaction’s long-stop date, September 30, 2020.

Valuation

Capitacommercial Trust trades at 0.94 times P/B based on its net asset value per share of S$1.79 as of June 30, 2020, and its share price of S$1.68 as of July 29, 2020. As a comparison, its historical five-year and 10-year mean P/B multiples were 0.94 times and 0.93 times, respectively.

It is worth noting that the value of the trust’s investment property portfolio, as determined by third-party valuers, declined by -1.7%, from S$11,123 million as of December 30, 2019 to S$10,930 million as of June 30, 2020. In its 1H 2020 financial results presentation, the trust attributed the reduced portfolio valuation to assumptions of “lower market rents and rental growth rates,” with capitalization rates used in the valuation remaining unchanged.

There remains the risk of a further decline in the value of Capitacommercial Trust’s investment property portfolio if market rents fall by a greater extent than earlier expected and capitalization rates expand as per the valuation implied by market transactions.

It offers consensus forward FY2020 and FY2021 distribution yields of 4.3% and 5.0%, respectively.

Risk Factors

The key risk factors for Capitacommercial Trust are office leasing demand falling short of expectations due to a greater-than-expected negative economic impact from COVID-19, a lower-than-expected valuation assigned to its investment property portfolio and a reduction in distributions going forward.

Note that readers who choose to trade in Capitacommercial Trust shares listed as ADRs on the OTCBB (rather than shares listed in Singapore) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.