Frasers Logistics & Commercial Trust: Optimising balance sheet through L&I expansion
- Slight miss in earnings as a result of FX and rising borrowing costs
- Rental growth has significantly offset the impact of cap rate expansion on valuations
- FLCT to be more active in optimising gearing in FY24; focusing on L&I assets in Singapore and Japan
- Maintain BUY with a slightly lower TP of S$1.44
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- Frasers Logistics & Commercial Trust: Results First Take: Sustained double-digit positive rental reversions31 Jan 2024
- Frasers Logistics & Commercial Trust: Results First Take: 3Q23 Business Updates - Robust leasing momentum with strong positive rental reversions02 Aug 2023
Rental reversions in 4Q23 continued to be positive, with the L&I portfolio witnessing an impressive 33.5% increase in rents, while the commercial portfolio saw a 9.2% uptick in rents. On a full-year basis, FLCT reported an overall positive rental reversion of 18.9% for its entire portfolio. This growth was primarily driven by leases signed in Australia, both for L&I and commercial properties, as well as the commercial leases in Singapore.
Stable occupancy rates and minimal lease expiries. FLCT managed to maintain a commendable overall portfolio occupancy rate of 96.0%. While the L&I portfolio remained fully occupied, there was a marginal 0.2ppt decline in overall occupancy, mainly attributable to vacancies at Central Park, 357 Collins Street, Farnborough Business Park, and Maxis Business Park.
Lease renewals for FY24 have already begun. During the quarter, FLCT also concluded leases that were set to expire in FY24, leaving only 8.7% of its portfolio leases to be renewed next year. With rents remaining stable and even showing an upward trend, we anticipate that FLCT will continue to report positive rental reversions in the coming year. It's worth noting that leasing inquiries have picked up, but tenants might be taking more time to commit to leases.
Upcoming challenges with Google’s space. We will closely monitor the impending vacancy of Google's space at ATP in February 2024 and the potential for the non-renewal of their remaining lease that will expire in December 2024. The first lease expiry covers approximately 150,000sqft of space, and we understand that FLCT is already in advanced negotiations to backfill it. However, there may be some downtime for the space once Google's lease expires in February 2024.
FY23 DPU of 7.04Scts was slightly below our estimates. FLCT's FY23 DPU of 7.04Scts. was slightly below our estimates. Despite the strong leasing momentum and positive rental reversions, FLCT's FY23 DPU was c.1.5% lower than our projections. This was primarily due to the weaker AUD and higher financing costs. Looking ahead, we believe that the recent developments in Worchester and Blythe Valley Park will contribute to earnings growth. Additionally, the development at Ellesmere is expected to be completed in December 2023, and FLCT has just announced another forward-funded development project in the Netherlands. While this is a smaller project (around S$20.9m), it offers an attractive yield of about 6% and will be completed in November 2024.
Cap rates have expanded, but valuations supported by rental growth. Although there have been cap rate expansions of 50-175bps across Australia and Europe, FLCT reported a manageable decline of c.4.7% in portfolio valuations. Excluding the effects of FX, portfolio valuations would only have declined by c.3%. The most significant cap rate expansion occurred in the UK, with the L&I portfolio witnessing a 140bps expansion and the business parks reporting a 175bps expansion. In Australia, the L&I portfolio experienced a slightly larger cap rate expansion of 89 bps (compared to 78bps for commercial properties), but valuations increased by approximately 1.4% due to strong rental growth.
However, negative fair value adjustments amounting to S$359m, combined with divestments and a weaker AUD, led to a 10.0% y-o-y decline in NAV to S$1.17.
One of the strongest balance sheets. FLCT boasts one of the most robust balance sheets in the industry. Despite the recent valuation declines, the REIT has managed to maintain a remarkably healthy financial position. Gearing increased by 1.6ppt q-o-q, reaching 30.2%, and financing costs inched up by 0.3ppt during the quarter, now standing at 2.4%. With approximately S$522m in loans due for refinancing in FY24, we anticipate a gradual rise in FLCT's borrowing costs, which are likely to remain well within the estimated range of 3%. It's noteworthy that the bulk of loans maturing in FY24 will occur in the second half of the year, ensuring that FLCT's borrowing costs should remain relatively stable throughout the first half of 2024. At present, FLCT maintains a substantial debt headroom of more than S$1.1bn before gearing reaches the 40% threshold.
CEO’s strategic direction. FLCT’s CEO Anthea Lee, who assumed the role in August 2023, has communicated her intention to increase the portfolio’s exposure to the L&I segment. Her primary goal is to optimise FLCT’s gearing by acquiring L&I assets in Singapore and Japan. Additionally, she plans to actively explore opportunities in the data centre sector, including assets in Europe and Japan.
Our views
Considering the current high interest rate environment and relatively tight cap rates for L&I assets, FLCT has understandably taken longer than expected to redeploy funds for acquisitions. However, with more opportunities emerging, we are excited about the prospects of FLCT intensifying its gearing optimisation in the upcoming year. Of significant note is the management has outlined its focus on L&I assets in the near term, particularly in developed and well-established markets like Singapore and Japan. Moreover, the management intends to consider data centre assets, which continue to benefit from structural tailwinds.
We have rolled forward our valuations to FY24 and adjusted certain assumptions regarding financing costs and foreign exchange. Although we have already accounted for higher borrowing costs in FY24, we are now assuming a further 20bp increase over the next two years, given the expectation of prolonged high interest rates. Additionally, we have modified our assumptions for the AUD/SGD exchange rates to reflect the current weakness in the AUD. Our new estimates assume the AUD/SGD at the current spot rates, and any appreciation in the AUD would result in upside potential for our revised estimates.
Importantly, while management has clearly expressed its intent to optimise the balance sheet for L&I asset acquisitions, our revised projections do not factor in specific assumptions for such acquisitions. We have also taken a conservative approach, assuming it will take 12 months for the space vacated by Google at ATP to be gradually backfilled. Any faster-than-anticipated backfilling of the space and accretive acquisitions in FY24 would represent upside potential to our revised projections.
As a result, we have slightly lowered our TP slightly to S$1.44, while maintaining our BUY recommendation for FLCT due to its highly attractive forward yield of more than 6.7%.
Interim Income Statement (S$m)
FY Sep | 2H2022 | 1H2023 | 2H2023 | % chg yoy | % chg hoh |
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Gross revenue | 215 | 208 | 213 | (0.8) | 2.3 |
Property expenses | (49.3) | (50.1) | (55.7) | 13.0 | 11.3 |
Net Property Income | 165 | 158 | 157 | (4.9) | (0.5) |
Other Operating expenses | (21.9) | (4.8) | (22.5) | 2.6 | 364.6 |
Other Non Opg (Exp)/Inc | 2.25 | 2.02 | 2.52 | 12.0 | 24.8 |
Associates & JV Inc | 0.0 | 0.0 | 0.0 | - | - |
Net Interest (Exp)/Inc | (18.6) | (20.9) | (24.2) | (30.4) | (15.8) |
Exceptional Gain/(Loss) | 0.0 | 0.0 | 0.0 | - | - |
Net Income | 127 | 134 | 113 | (11.1) | (15.9) |
Tax | (101) | (14.9) | 21.5 | (121.2) | (244.2) |
Minority Interest | (9.0) | (1.2) | 3.54 | nm | nm |
Net Income after Tax | 16.8 | 118 | 138 | 722.7 | 16.7 |
Total Return | 442 | 118 | (221) | nm | (287.3) |
Non-tax deductible Items | (311) | 3.13 | 337 | (208.3) | nm |
Net Inc available for Dist. | 140 | 131 | 132 | (5.8) | 0.6 |
Ratio (%) |
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Net Prop Inc Margin | 77.0 | 75.9 | 73.8 |
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Dist. Payout Ratio | 100.0 | 100.0 | 100.0 |
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Source of all data: Company, DBS Bank
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