CGS-CIMB lowers target price for Paragon REIT to 88 cents after limited upside potential

Paragon REIT has made an improvement in operating metrics, but higher cost of equity and slowdown in consumer spending loom.

CGS-CIMB Research has lowered its target price for Paragon REIT to 88 cents from $1.01 previously, following its 3QFY2023 results. For the three months ended September, the REIT reported a gross revenue of $215.6 million, which stood in line at 72.1% of analysts Natalie Ong’s and Lock Mun Yee’s FY2023 forecasts.

Despite that, the analysts have lowered their target price on the basis of lower distribution per unit (DPU) forecasts and higher cost of equity, as they factor in a risk of slowdown in consumer spending.

Ong and Lock have reiterated their “hold” on the REIT.

For this quarter, the analysts note that the REIT has made an improvement in operating metrics. Paragon REIT’s revenue grew 1.2% y-o-y, in line at 72.1% of their FY2023.

They note that gross revenue for the REIT’s Singapore and Australia assets increased 2.4% y-o-y and 5.4% y-o-y respectively, and portfolio occupancy improved q-o-q from 97.8% to 98.1%, driven by higher occupancy at Westfield Marion (96.1% to 97.1%). However, this was partially offset by lower occupancy at Figtree 5f4 Grove (99.2% to 96.4%) while occupancy for the Singapore assets was unchanged q-o-q at 100%.

The REIT’s 3QFY2023 tenant sales grew 1%/9% y-o-y in Singapore/Australia, while its 1HFY2023 portfolio reversion turned positive at 6.9% with approximately 4% of leases by rental income anticipated to expire in FY2023, attributed to the Australia portfolio.

“During the 3QFY2023 analyst briefing, management shared that reversions for its Australian lease renewals since 1HFY2023, while negative, were narrowing,” they note.

Ong and Lock note that there is a “slight deterioration of balance sheet” for the REIT. While gearing remained low at 30.1% with fixed debt of 85%, the cost of debt increased q-o-q from 4.05% to 4.21% while adjusted interest coverage ratio fell from 3.4x to 3.1x.

The analysts say that the REIT has $300 million in perpetuals with a call/reset date of Aug 30, 2024. Assuming interest rates remain at present levels, the coupon rate will increase from 4.1% to about 6%.

Should the REIT redeem the perpetuals by drawing on bank loans, Ong and Lock estimate that at present interest rate levels, interest on new loans will be about 5% and gearing will increase to about 37%, which is “still healthy”.

The REIT has conducted a half-year asset valuation, during which it recognised S$31m
fair value loss on its Australian assets, according to the analysts. This valuation decline was partly attributed to a 25 basis points (bps) cap rate expansion for both Westfield Marion and Figtree Grove.

“While we could still see some devaluation from the Australian assets, management thinks that any devaluations will be lower given that Paragon REIT revalued and recognised fair value losses in 1HFY2023,” they note. “Management expects valuation for the Singapore assets to be stable.”

As such, Ong and Lock have cut their FY2023-FY2025 DPU by 8.1%-11.7% as they factor in higher cost of debt and the redemption of perpetuals, financed by bank loans, while rolling over their five-year dividend discount model-based target price to FY2028.

“While we expect to see more positive reversions from Paragon in FY2024 as its lease was signed during the pandemic, reversions at Clementi Mall and Rail Mall could decline, in our view,” they say.

The analysts have a lower target price of 88 cents, on lower DPU forecasts and higher cost of equity as they factor in risk of a slowdown in consumer spending.

As at 1.02pm, units in Paragon REIT are trading 0.5 cents higher or 0.61% up at 82 cents.

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