Keppel Pacific Oak US REIT (SGX: CMOU): 2022 Full Year Result

On 1 February 2023, Keppel Pacific Oak US REIT (“KORE”) have announced their 2022 full year results. Since my last article, the share price of KORE have continued to decrease with the overall negative market sentiments for US Office REITs. Although some of the fundamentals of KORE have deteriorated this quarter, it is not as significant as the decline in share price. KORE is the REIT that have the highest risk to reward ratio that I am holding and covering in my blog with its direct and concentrated exposure to the US office space.

Surprisingly, there were no investment valuation write-downs for KORE this quarter unlike some of their peers. Currently it is still trading at a significant discount from its book value, and there are good reasons for it to be at these levels. Indirectly it also provides a large buffer for the possibility of property valuation write-downs over the short-term, which is covered under the “Key things to note” section.

This is also my last post covering any reporting from 31 December 2022. Had been a busy quarter for me so this post was only completed in April 2023 when people are already looking forward to 2023Q1 results.

Website: Financial Statements And Related Announcement::Full Yearly Results

Photo source: https://www.theedgesingapore.com/news/reits/keppel-pacific-oak-us-reit-esr-reit-and-prime-us-reit-join-ftse-epra-nareit-global


Background

KORE is a distinctive office REIT listed on the main board of the Singapore Exchange Securities Trading Limited (“SGX-ST”) on 9 November 2017.

KORE’s leverages its focus on the fast-growing technology, advertising, media and information (“TAMI”), as well as medical and healthcare sectors across key growth markets in the United States (“US”), and aims to be the first choice US office S-REIT providing sustainable distributions and strong total returns for Unitholders.

KORE invests in a diversified portfolio of income-producing commercial assets and real estate-related assets in key growth markets characterised by positive economic and office fundamentals that generally outpace the US national average and the average of gateway cities. These markets include the Super Sun Belt and 18-Hour Cities, which have and continue to see an accelerated influx of talent as part of The Great American Move.

KORE is managed by Keppel Pacific Oak US REIT Management Pte. Ltd., which is jointly owned by two Sponsors, Keppel Capital and KORE Pacific Advisors (“KPA”).


Key Metrics

Distribution Per Unit (“DPU”)

MetricsCurrentPrevious
Distribution Per Unit-8.5%No Info

It is worth noting that in the presentation slides, management have provided an adjusted DPU comparison. The reason is because the Manager has elected to receive 100% of its base fee for 2022Q1 amounting to USD1,657,009 in the form of Units.

Accordingly, the 2021 comparatives adjusted income available for distribution to Unitholders, adjusted DPU and adjusted distribution yield have been restated to assume 2Q to 4Q 2021 base fees of US$4,758,043 were paid in cash to provide a like-for like comparison to 2H 2022 and FY 2022 actual results.

While there are merits of doing so, I will exclude this adjustment because the issuance of management fee in the form of units is also dilutive to the unitholders. It does not change the fact that an existing unit holder if they were to have held from the previous financial year, they will see the DPU from their holdings decreased by 8.5% to USD0.058 per share in FY2022 from USD0.063 in FY2021.

As at 31 December 2022, this metric is Unfavorable.

Occupancy

MetricsCurrentPrevious
Occupancy92.6%92.5%

Occupancy rate as at 31 December 2022 stands at 92.6%. This is Unfavorable as it is below my expected healthy occupancy rate of 95% and KORE have not been able to fully utilize their assets.

This is part of the high risk to reward ratio that I have mentioned earlier. Unlike Singapore, the US have embraced remote and hybrid work till date, with the larger companies having terminated their leases.

Website: Office property under pressure as U.S. REIT index hits 14-year low

This does not however make excuses for KORE’s 92.6% to be considered favorable. Overall it will still have DPU impact should the environment worsen further. KORE has a Weighted Average Lease Expiry (“WALE”) of 3.4 years which should provide sufficient income visibility. However, it is still possible for leases to be early terminated. For investors that are risk adverse, it may be worth considering other REITs with stable occupancies.

Gearing ratio

MetricsCurrentPrevious
Occupancy38.2%37.5%

Gearing ratio stands at 38.2% as at 31 December 2022 . This to me is Neutral, as although there is sufficient buffer from the MAS limit of 50%, the gearing have increased and may present an issue should there be any valuation write-downs which I am expecting in the short-term. A larger buffer may be needed to prevent any force selling of assets and KORE can also take advantage to raise debt to fund acquisitions if opportunities arose.

Interest coverage

MetricsCurrentPrevious
Interest Coverage4.0x4.4x

The interest coverage stands at 4.0 times as at 31 December 2022. The metric is Unfavorable as the interest coverage is lower than my preference of 5.0 times and seems to be worsening. This is a concern as interest rates continue to rise as the world looks to tackle inflation. The Federal Reserve on 22 March 2023 has hiked the interest rates to a range between 4.75% and 5.00%, the highest level in 15 years.

Website: Fed hikes rates by a quarter percentage point, indicates increases are near an end

As the interest rate may potentially increase further, KORE may be subjected to significant change in their cost of debt in the near future. In their presentation they have mentioned that 77.9% of their debt is also on fixed rates.

I have thus performed a sensitivity analysis using the information as at 31 December 2022:

DescriptionAmount (SGD’000)
Total Debt$580,200
Debt Not Hedged (%)22.1%
Debt at Floating Rate Exposed$128,224
Distributable Income FY2022$60,578

Interest rate sensitivity analysis as below:

Change in Interest RatesDecrease in Distributable Income (SGD’000)Change as % of FY2022 Distribution
+ 50 bps-$641-1.1%
+ 100 bps-$1,282-2.1%
+ 150 bps-$1,923-3.2%
+ 200 bps-$2,564-4.2%
+ 250 bps-$3,206-5.3%
+ 300 bps-$3,847-6.4%

Do note the above is my estimation which may be different from management’s estimation. Nonetheless, if the interest rates were to increase by the basis points above, KORE may experience a fall in DPU accordingly.

Debt maturity profile

MetricsCurrentPrevious
Debt Maturity Profile3.6 years3.9 years

Weighted average term to maturity of their debt stands at 3.6 years as at 31 December 2022. This is Favorable and it allows them sufficient time to refinance their debts as they fall due.

Price to Book Ratio

MetricsCurrentPrevious
Price to Book Ratio0.48No Info

The Price to Book (“P/B”) ratio currently stands at 0.48. This is computed using the closing share price of USD0.385 on 6 April 2023 and the net asset value per share of USD0.810 as at 31 December 2022.

The metric is Favorable as we are paying below book value for its assets. This provides sufficient buffer should there be a significant write-down of valuation for its assets. However, there is a reason for it to be traded at this P/B ratio and is covered under the “Key things to note” section.


Dividend yield

YearYieldTotal
20237.22%USD 0.028
202214.44%USD 0.056
202118.00%USD 0.069
202013.07%USD 0.050
201912.86%USD 0.050
Extracted from Dividends.sg

The current payout of USD0.028 is in line with the payout for 2022. Thus if extrapolated for the full calendar year 2023, the expected dividend payout would be USD0.056 per share. With a closing share price of USD0.385 as at 6 April 2023, this translates to a dividend yield of 14.44%. For my benchmark, a general reasonable range would be around an average of 5.5% to 6.5% in the current environment. KORE’s dividend yield is way above my benchmark.

Website: Reasonable Dividend Yield 2023Q2

The current macro-environment suggest that the US office REITs may be facing significant downward pressure in the short-term which is covered under the “Key things to note” section. As part of the risk to reward ratio assessment, I evaluated a scenario where the valuations and annualized dividend yield were to be halved to 7.22%. As the halved dividend yield is still above my benchmark, the dividend yield metric is Favorable.

Do note that the halving of dividend yield is my expectation should a worst case scenario occur. Management have taken steps to ensure that it does not happen. If the dividend payout is able to be maintained, the dividend yield would be attractive for the long term.


Other metrics

Tenant profile

KORE has an enlarged portfolio covering multiple trade sectors. The high quality and diverse tenant base provides resilience to the KORE portfolio across challenging events. The top-10 tenants accounted for only 24.3% of KORE’s portfolio with no single tenant accounting for more than 3.6% during the period, providing income diversity to the portfolio. Furthermore the WALE of the top 10 tenants is 4.7 years, which provides a strong income visibility as the US rides out the uncertainty.


Key things to note

Risk of property valuation write-down

KORE have surprised me with showing that their office valuations remain relatively unchanged as at 31 December 2022 despite the fall in DPU. As valuations are done on an annual basis, it is unlikely to have any major impact until the end of 2023.

Nonetheless, the US office space have been on a downturn the last few months with occupancy decreasing. As the world continues to increase interest rates to combat inflation, businesses are starting to feel the impact as enter 2023, with sources for cheap funding drying up. Technology companies are shrinking payrolls and downsizing their footprints, especially in gateway markets, adding to the hurdles already facing the office sector.

Website: U.S. Office Market Ends 2022 With Rising Vacancies, Declining Sales

While we may not necessary see a Global Financial Crisis (“GFC”) level kind of crash, in general there are estimates that property prices could drop 20%-30% in 2023, before seeing an uneven recovery after that.

Should the property valuation decrease by 30%, this will bring their total invest properties value as at 31 December 2022 to USD996 million and total assets to USD1,092 million. Assuming the borrowings remain unchanged, this will have implications as the gearing ratio of KORE will increase to approximately 53.1% from the current 38.2%. This will breach the MAS limit and KORE will be forced to raise funding via equity or sale of properties to lower their gearing. Both options may not be desirable given that the share price is trading at a significant discount of its book value or KORE may have to realized losses if they are unable to dispose of their assets at book value.

This is coupled with the fact that this is a foreign investment REIT that is listed on SGX, where these kinds of REIT profile are less appealing to Singapore investors.

Management have actively mitigate this risk, as seen by the recent divestment of Powers Ferry in Atlanta, Georgia. The net divestment prices was 2.5% above its last independent valuation as at 31 December 2021, although it is USD0.2 million less than the book value after taking into consideration the divestment costs.

Website: Asset Acquisitions And Disposals::Completion Of Divestment Of Powers Ferry In Atlanta, Georgia


Summary

MetricsFinancialsRating
Distribution Per Unit-8.5%Unfavorable
Occupancy92.6%Unfavorable
Gearing Ratio38.2%Neutral
Interest Coverage4.0xUnfavorable
Debt Maturity Profile3.6 yearsFavorable
Price to Book Ratio0.48Favorable
OverallNeutral

Overall, the metrics indicate that it is neutral to invest in KORE. The recent market conditions present opportunities for entry as the share price continues to face downward pressure and trade at a significant discount from its book value.

Despite the relatively stable results, investors need to take note that of their risk appetite as KORE may not necessary be worth the risk. Especially as safe assets have seen their yield rise considerably with rising interest rates, the appeal of KORE may take a turn for the worse and further downside may happen.

Disclaimer: Not financial advice. All data and information provided on this site is for informational purposes only.


Previous Post

Website: Keppel Pacific Oak US REIT (SGX: CMOU): 2022 Third Quarter Business Update