Brokers’ take: RHB cuts Kore’s target to US$0.48 on higher risk premium

RHB Research has trimmed its target price for Keppel Pacific Oak US Reit (Kore) to US$0.48 from US$0.56, after factoring in sector headwinds via higher risk premium.

The research house on Thursday (Oct 19) raised concerns over Kore’s potential valuation decline and gearing breach in a highly volatile US market, and hiked the equity risk premium by 120 basis points.

It also noted that Kore’s manager expects the risks to be constrained, given the real estate investment trust’s (Reit) differentiated market portfolio and healthy operational numbers.

Nonetheless, RHB maintained a “buy” call for the office-focused Reit, based on the Reit’s Q3 updates released the day before slightly exceeding expectations, as well as its relatively safe valuation and debt positions.

RHB analyst Vijay Natarajan highlighted that the increase in demand for Kore’s offices – driven by sectors such as technology, advertising and professional services, had outpaced downsizing requests, as more tenants implemented return-to-office mandates.

He added that, for now, a gearing breach is unlikely because Kore faces minimal risks from tenant concentration. None of its top 10 leases are expiring in the next two years.

The Reit’s portfolio also focuses on non-gateway key growth markets, which fared better, mitigating the valuation risks from the US office market.

Natarajan added that Kore’s valuation had to decline by more than 23 per cent for it to breach the regulatory 50 per cent gearing threshold.

“Our base case expectation is for a 10 per cent decline in valuation by the end of 2023, with the worst case at 15 per cent, which should still keep gearing at 42 per cent to 46 per cent levels.”

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He also favours Kore’s relatively safe debt profile even during interest rate hikes.

While Kore’s debt is fully unsecured and from non-US local banks, its interest cover, measured by the debt service coverage ratio, remains healthy at 3.3 times, which is way above the loan covenant’s requirement of 1.5 times.

He expects the ratio to stay above 2.5 times, despite rising interest rates, given that about 76 per cent of the debt is hedged.

Units of Kore rose 2.4 per cent, or US$0.005, to US$0.21 as at 10.43 am on Thursday.