Paragon REIT - Softer retail sales limit income growth

Initiate Coverage of Paragon REIT with NEUTRAL

Paragon REIT's asset under management comprises 4 retail malls in Singapore and Australia. Paragon, the largest asset in the portfolio, contributed 62% of net property income in FY23 and accounts for 68% of total portfolio value. 

The sponsor is Cuscaden Peak Investments Pte Ltd, a consortium that includes Hotel Properties Ltd, Mapletree Investments Pte Ltd, and CLA Real Estate Holdings Pte Ltd, a member of Capitaland Group.

Total portfolio value of Paragon REIT grew 2.0% in 1H24

The Singapore assets saw a 3.5% uplift in value, driven by positive rental reversions and full occupancy. On the other hand, value of the Australian assets fell 3.8%, impacted by higher cap rate. The sale of the Rail Mall for S$78.5m was completed in August 2024. The REIT has declared a special distribution of 1.85 cents/share from the sales proceeds. 

Higher debt and interest cost

Gearing ratio remained healthy at 29% as at end-Jun, and adjusted interest coverage was 2.8 times. Total debt, however, could rise to S$1.56bn after the redemption of the S$300m 4.1% perpetual securities in Aug, funded by debt. 

We estimate gearing to rise to 36%, still below the regulatory threshold of 50%. We expect average cost of debt at 4.6% for FY24E (FY23: 4.3%) and FY25E. With 85% of debt on fixed rates, any rate cut will take longer to flow through positively.

Retail sector has softened from 4Q23

We are cautious on the retail sector in Singapore and Australia, which have softened from 4Q23. Weak retail sales could weigh on tenants’ sales and increase occupancy costs. This, in turn, impact the malls’ occupancy level and the rents it can command. 

Singapore’s June retail sales excluding motor vehicles slipped to -3.1% year-on-year. July tourist arrivals growth also moderated to 12.9% year-on-year. Retail rents have eased since 3Q23. Vacancy rates in Orchard area crept up by 0.3%-point to 7.1% in 2Q24. Still, with small percentage of leases up for renewal this year and next, occupancy rates at Paragon and The Clementi Mall are likely to remain resilient, but rents could stay flat.

In Australia, elevated bank lending rates have curtailed spending and retail sales growth. The rise in unemployment rate to 4.2% in July could further dampen consumer demand. Inflation rate ticked higher to 3.8% in 2Q24, after 5 straight quarters of decline. This is beyond RBA’s target range of 2 to 3%, hence diminishes the prospect of a rate cut in the near term. Rental reversions were negative in 1H24 at the two malls.

Our 12-month target price for Paragon REIT is S$0.85

Our target price is derived from dividend discount model based on weighted average cost of capital of 9.1% and terminal growth rate of 2.0%. The potential 12-month total return is 1.6%, hence our NEUTRAL rating. 

Including the 1.85 cent/unit special distribution, we expect higher DPU of 5.87 cents in FY24E, but moderate to 4.10 cents in FY25E. Our target price translates into yield of 6.9% and 4.9%, for FY24E and FY25E, respectively. 

There is upside risk to our rating in the event of a buyout of Paragon REIT at higher price, or asset divestment at above valuation. 

Downside risks are tenants’ rental default and lease cancellations, and a weaker Australian dollar vs Singapore dollar.

To read our analysis in more detail, download the full report here. 

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To learn more about our outlook on Singapore REITs, read our detailed report on "Singapore REITs - Distributions may remain under pressure"

Related links:

• Paragon REIT share price and share price target 
• Paragon REIT dividend history and forecast

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