Broker's take: DBS ups OUE Commercial Reit to 'buy' on upturn in office market

DBS Equity Research has upgraded its call on OUE Commercial Reit (OUE C-Reit) to "buy", citing an expected upturn in spot office rents among factors to look past any overhangs.

Analysts Mervin Song and Derek Tan also raised their target price (based on discounted cash flow) for the real estate investment trust to S$0.60 from S$0.47. As at 11.55am, the Reit was trading 1.02 per cent higher at S$0.495.

Consensus has a "hold" call on OUE C-Reit due to the overhang from the potential roughly 18 per cent dilution from the conversion of the convertible perpetual preferred units (CPPUs).

The DBS analysts acknowledged that this is a valid concern as the conversion price for the CPPU is S$0.71. However, they believe it is unlikely that the Reit's sponsor, OUE Limited, will convert them into equity as the CPPUs are out of the money.

Therefore, "investors will likely ignore the potential overhang from the conversion of the CPPUs", they wrote.

The analysts also allayed investors' concerns about the Reit conducting an equity placement - similar to the exercise undertaken in March 2017 - to help with the redemption of the CPPUs. They said that it is unlikely due to the dilution to the Reit's distribution per unit (DPU) from the recent rights issue.

Instead, the analysts are looking to an expected multi-year upturn in office rents, a recovery in 2019 DPU, and the Reit's high yield to drive its share price.

They noted that large cap office Reits are approaching mid-4 per cent yield. DBS's target price implies a yield of 5 per cent (adjusting for the impact of a conversion of the CPPUs) - about 0.50 basis point higher than the large cap office Reits.

But the analysts consider the yield spread to be fair as OUE C-Reit owns Grade A office buildings in prime CBD (central business district) locations in Singapore and Shanghai.

Therefore, the Reit will be an "attractive laggard play" for investors seeking exposure to the upturn in the Singapore office market, they said.