Keppel Pacific Oak US REIT

Suspension of distributions

Analysts have slashed their target price estimates on Keppel Pacific Oak US REIT (KORE) although they remain mixed on the REIT’s prospects. Their views come after the REIT said that it plans to suspend its distributions from the 2HFY2023 ended Dec 31, 2023, through to 2HFY2025. The REIT is also looking at recapitalisation options, which it said was “necessary”.

The announcement was made on Feb 15 after KORE postponed its initial results release date from the morning of Jan 31.

For FY2023, KORE’s leverage rose to 43.2% after its year-end valuation, remaining within the Monetary Authority of Singapore’s (MAS) regulatory limit of 50%. Income available for distribution fell by 13.8% y-o-y to US$52.2 million ($70.2 million) for the full year as gross revenue and net property income (NPI) improved slightly.

DBS Group Research analysts Rachel Tan and Derek Tan have downgraded their call on KORE to “fully valued” with a lower target price of 10 US cents, down from 48 US cents previously.

In their Feb 16 report, the analysts said that the REIT’s decision to suspend distributions to build up liquidity came as a surprise even though its operational and financial metrics stood in line with their estimates.

“We see [the move] as a conservative and proactive stance taken to manage its financial liquidity situation. We believe that the manager is probably proactively building up further liquidity to refinance its near-term debt expiry in case there is a ‘funding gap’ when refinancing discussions start sometime in the coming quarters. However, this will cause an overhang on the stock in the interim,” they write.

The analysts were right. Units in KORE plunged when markets opened after the news on Feb 15 by more than 39% to as low as 15.2 US cents in reaction, down from 25 US cents at the close of Feb 14. Units closed at 14.8 US cents on Feb 16.

The analysts’ new target price is pegged to 0.15 times P/B to factor in the suspension of distribution and higher capital management risks.

That said, they remain somewhat positive in the REIT’s portfolio, noting that its assets in the tech hubs of Seattle, Austin and Denver, which contribute over 60% to KORE’s NPI, remain office growth markets in the US.

Furthermore, KORE has delivered a stable performance and resilient distributions per unit (DPU) in the past few years despite a volatile market during the pandemic and amid the high inflationary environment in the US.

“Operationally, KORE has also kept its portfolio at above 90% thus far, a commendable effort given the headwinds impacting the sector. However, unfortunately, the sector’s structural concerns have subsequently impacted its funding,” they write.

RHB Bank Singapore analyst Vijay Natarajan kept his “buy” call on KORE in his Feb 16 report as he sees the distribution suspensions as a “short-term pain” to better preserve long-term value, especially with the REIT’s resilient operational income.

The shock announcement, which resulted in a knee-jerk share price correction is “overdone”, says the analyst, who expects “value-driven investors to enter once the dust settles”. At its current share price, KORE is trading at 0.2 times FY2024 P/B.

Despite the positivity, Natarajan has lowered his target price to 29 US cents from 48 US cents previously. His new target price has buffered in a further 30% decline in KORE’s asset valuations.

UOB Kay Hian analyst Jonathan Koh has kept his “buy” call on KORE, as he sees the distribution suspensions as the REIT’s “best endeavour” to avoid divestments, equity fundraising (EFR) and a potential default.

KORE’s distributable income of US$26.1 million for the 2HFY2023, 10.1% lower y-o-y, stood in line with his expectations.

“KORE will recapitalise its balance sheet by suspending distributions for 2HFY2023, FY2024 and FY2025. It intends to resume distribution in 1HFY2026. Investors are rightfully shocked as aggregate leverage of 43.2% as of December 2023 remains within MAS’s regulatory limit of 50%,” notes Koh.

Like RHB’s Natarajan, Koh sees investors’ “thunderous response” to the temporary suspension of distributions as “misread” by the market.

“The correction of 39.6% yesterday was overly harsh, especially after the drop of 12.5% on Jan 31 when KORE delayed the announcement of its 2023 financial results. KORE provides FY2026 distribution yield of 28.4% and trades at P/NAV (or price to net asset value) of 0.22 times (78% discount to NAV per unit),” he writes in his Feb 16 report.

For FY2026, Koh estimates that KORE will report a DPU of 4.3 US cents.

That said, he has also lowered his target price to 35 US cents from 59 US cents previously, based on a dividend discount model (DDM), which factors a cost of equity (COE) of 10% from 9% previously and a terminal growth of 0% from 1% previously. —