Daniel Lee

Jun 1, 20236 min read

A Fundamental Look At Keppel REIT [Is It Worth Investing In?]

Updated: Jun 4, 2023

Best Viewed On Desktop (As of May 2023)

In this article, we'll be conducting a fundamental analysis of Keppel REIT and its suitability to achieve the following investment objective: To deliver a stable dividend yield of 5% to 6% per year while having a high degree of capital preservation ability.

This article will be split into 6 sections:

Summary of the Analysis
Personal Opinion
Scenario Analysis: Price Target & Expected Return
First filter: Income & Distribution Statements & Valuation Ratios
Second filter: Balance Sheet Health
Third filter: Underlying Property & Tenants

For those looking for a quick analysis, you can just focus on sections 1 & 2 - summary of the analysis and personal opinion. For those who would prefer to have a deeper look into the financials, you can explore the findings in the other sections.

1. Summary of Analysis

Personal Opinion on:

Business Model: Keppel REIT is a well-managed office REIT with a resilient occupancy rate and weighted average lease of expiry mainly due to the quality of their properties. The managers do seem to exhibit consistency and competency in managing property expenses and borrowing costs.

General Outlook: While the economic headwinds are strong, I expect Keppel REIT to weather through the slowdown in economic activity thanks to the resilience of their properties. However, their net income and hence dividend per unit will be negatively affected by the high-interest rate environment which is inevitable across the industry.

Valuation & Expected Return: Based on historical performance, fundamentals and prevailing dividend yield, I believe Keppel REIT is currently undervalued. At the current price of $0.865, long-term investors (>10 years) can expect to receive a compounded annual capital return of 1% to 2% and a 5.5% to 6.5% annual dividend yield.

What My Actions Will Be: I have invested in Keppel REIT in May and would be adding more positions in the future (need to save up more capital and perhaps average down if short-term headwinds exert further downward price pressure) as I feel that the valuation and nature of the properties fit the investment objective of having a stable distribution yield while preserving the capital.

What to watch out for:

How the recent Japan acquisition would pan out and their future acquisition/disposal

What I like about the REIT:

The company’s performance has been very stable and consistent over the years despite economic ups and downs.
The underlying leases of property are long and hence not subjected to the risk of lease decay Local: 99 years (oldest property: 1997) Foreign: Freehold
Underlying properties are located in prime areas (OFC, MBFC, ORQ) and are high quality in nature which makes them resilient from recessions and WFH trends given the nature of the tenants (have a prime office to “show off/signal confidence”)

What I don’t like about the REIT:

Financial statements are hard to discern in terms of how the group expenses will pan out to be as a high degree of effort is needed to integrate the company’s financials with the company’s share in the joint venture and associate’s financials.

2. Personal Opinion

Given the historical valuation, group performances and dividend yield, I would consider Keppel REIT to be undervalued (especially now that it is trading 1 standard deviation below the long-term average).

Moving forward, at the current price of $0.865, long-term investors (>10 years) can expect a:

1) Capital return: 1% to 2% per year

Undervalue: $0.85 and below
Fair Value: $1.00 to $1.13
Overvalue: $1.25 to $1.40

2) Dividend return: 5.5% to 6.5% a year

While I am confident in the group’s ability to deliver stable dividends over the years, investors will have to deal with the uncertainty revolving around the capital return as the plausible main driver of capital returns in the future can only be found in valuations revision from where we are at today 14.65 back to its long term average of around 18.68.

3. Scenario Analysis

Cells within the blue box represent the most realistic scenario that has the highest probability of materialising. To read the table, the horizontals represent a change in the distribution income over time while the verticals represent changes in the investor's willingness to pay.

Boxes highlighted in red represents a loss while boxes highlighted in green represent a gain based on the current price level.

Projected Target Price

Projected Target Return

4. First Filter

For this, we will be examining key metrics revolving around the financial statements, namely:

Income Statement - to examine the performance of the group as a whole
Distribution Statement - to examine the behaviour of the total distribution over time
Valuation metrics - examine the “expensiveness” of the stock relative to its intrinsic value

The purpose of the first filter is to remove companies that are either:

Not profitable - which reflects either poor management or quality of assets
Inconsistent distribution - Pays out dividends from capital instead of rental revenue
Too expensive - in terms of valuation (as viewed from the lens of distributions)

Income Statement

Note: Net income includes income from JV which includes changes in fair value.

Findings:

From the gross income perspective, the group has posted healthy growth levels over the years.
From the property expense perspective, the management has displayed proficiency and consistency in managing expenses at around 20% of gross income
From a net income perspective, while inaccurate as a result of changes in fair valuation, had been pretty stable over the years which had shown signs that the increase in top-line revenue is mainly used to offset bottom-line costs.

Overall, the behaviour from the income statement displayed signs of stability in the bottom line revenue which fits the investment objective for a dividend investment.

Distribution Statement

Overall, distribution per unit has remained relatively stable over the years despite the sudden spike in units issued in 2021. Moving forward, I expect the distribution per unit to come back down slightly as a result of a higher cost of borrowing.

Valuation Ratios

While the business model and performance of Keppel REIT have been stable over the years, the valuation and dividend yield has not been that attractive, especially from 2017 to 2021 where the dividend yield has been pushed to around 5% as a result of rich valuations.

At the current price range of around $0.865 to $0.90, the valuation of Keppel REIT would make sense for our consideration given the prevailing distribution yield as there is an ample margin of safety even if the distribution per unit is expected to come down.

5. Second Filter

Now that we’ve established that the REIT is worth considering, let us examine the health of the business - namely balance sheet health and financing details.

Balance Sheet

Overall, Keppel REIT’s balance sheet is very healthy and had remained very consistent over the years.

Financing Details

Given that a good chunk of the borrowing is expiring between 2023 and 2024, we can expect the all-in financing cost to increase beyond 2.5% moving forward and remain at that level for a good amount of time until the interest rate comes back down (Beyond 2024).

Even though a good chunk of the borrowings is hedged, the need to refinance during the high-interest rate environment will still put significant upwards pressure towards the all-in financing cost of the group.

As a result, ceteris paribus, we can expect the distribution amount per share to continue to decline as a result of higher financing costs which will eat into the net profits.

6. Third Filter

The last consideration that we will be examining would be the nature of the underlying properties and their tenants.

Underlying Properties

Findings:

Offices have exhibited strong and resilient occupancy rates over the years (with the exception of Japan 2022 – which just finished acquisition in Nov 2022)
From the acquisition/disposal record, the management had displayed a decent level of competency in liquidating losers and retaining winners.
Acquisition and move into Japan are questionable but exposure is relatively small to make a material impact on financials.

Tenant Profile

Findings:

Tenants are largely concentrated in Finance, Government Agency and Tech which are also firms that have the purchasing power and demand for prime offices
Weighted average lease expiry had remained consistent over the years despite the ups and down in the economy
Lease expiry profiles are evenly distributed over the years which provides greater stability to the group’s revenue
The group had historically achieved a high level of lease renewal which provides stability to the group’s revenue. This can be attributed to the nature of the tenants as well as the quality of the properties

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