Cromwell European REIT - DBS Research 2022-11-11: Early Refinancing At A Cost

• See Cromwell REIT's announcement dated 10 Nov 2022 for its 3Q22 business updates.

Improvement in revenues and NPI

• Cromwell European REIT (SGX:CWBU)'s 3Q22 revenues and NPI were 10.4% and 4.1% higher y-o-y, mainly driven by recent acquisitions and organic growth in portfolio occupancy and rents. Light industrial/logistics portfolio reported higher occupancies and higher underlying rents.
• Earnings from office portfolio were flat y-o-y. Higher revenues from the Netherlands were offset by declines in Italy, France, and Finland. On a like-for-like basis (excluding redevelopment and one-offs), office portfolio reported a 8.6% decline
• Cromwell European REIT's 3Q22’s distributable income of EUR 24.2m was slightly lower by 0.4% y-o-y (would have been flat if income from Via Nervesa 21 was excluded. Via Nervesa 21 is currently undergoing redevelopment).

Pivot to logistics leading to improvement in occupancy rate

• Occupancy rate for the light industrial/logistics portfolio inched up 0.4% q-o-q to 97.5%. Almost all markets reported improved occupancy q-o-q. Positive rental reversions of +7.6%.
• Office portfolio occupancy inched down slightly by q-o-q to 89.9%. However, dip in occupancy in the Netherlands and France is reported.
• A new lease for 10 years was signed in Haagse Poort (Netherlands), but will only commence in August 2023, bringing committed occupancy to ~94%. However, rental reversions were still positive for leases renewed (+6.1%).
• Only ~4.9% of portfolio leases remain to expire in 4Q22. A further ~14.2% of leases are due to expire in FY23; bulk of it from the light industrial/logistics portfolio.

Financing costs have crept up to 2.28%

• Cromwell European REIT's all-in financing costs inched up by ~ 60 bps q-o-q mainly due to the signing of a new EUR 180m loan to refinance expiring loans. Following the refinancing, only EUR 51m in loans will mature in November 2023. 76.4% of loans will be hedged to fixed rates.
• Cromwell European REIT's gearing is maintained at 38.9%

Portfolio recalibration ongoing

• Redevelopment of Via Nervesa 21 in Milan is on track for completion by the end of FY23. Extension of Lovosice One Industrial Park ongoing.
• Overall target of ~EUR 250m in redevelopments and AEIs. Redevelopment plans for Amba Aradam (office property in Rome) progressing well, commencement expected in FY23 when existing tenant’s lease expires.

Our thoughts on Cromwell European REIT

• Operationally, Cromwell European REIT continues to perform well with a strong portfolio occupancy and higher revenues driven by recent acquisitions. CPI-linked rental escalations and continued positive rental reversions are expected to drive earnings growth going forward. In the longer term, the ongoing redevelopment of Via Nervesa 21 and expansion of Lovosice One Industrial Park will continue to support higher revenues.
• However, Cromwell European REIT will also be subjected to higher financing costs due to rising interest rates. Although Cromwell European REIT has 76.4% of its loans hedged to fixed rates, the spike in interest rates will impact the portion of loans that have not been hedged. Furthermore, it has ~EUR 51m in borrowings that will be due for refinancing in FY23, and we expect the refinanced rates to be significantly higher. We have thus taken the conservative approach to assume that Cromwell European REIT’s all-in financing costs will increase gradually over the next three years, putting downward pressure on DPUs going forward.
• We will also be watching for Cromwell European REIT’s portfolio revaluation exercise in December 2022. Although the valuation of its light industrial/logistics portfolio is expected to report further improvements due to higher occupancies and higher underlying rents, its office portfolio could potentially see some downside risks. It remains to be seen if the uptick in valuation for its light industrial/logistics portfolio will be sufficient to offset the decline in valuations of its office portfolio. Especially with the economic uncertainty and geo-political instability Europe currently faces, demand for office space is expected to remain challenged.
• With that, we have revised our target price for Cromwell European REIT to EUR 2.10, but will be maintaining our BUY recommendation on a valuation basis. Our revised target price implies a ~40% upside to the current Cromwell REIT's share price, and we feel that the correction in Cromwell REIT's share price has been overdone.