SREIT – CIMB

Feedback from investors

We held meetings with 58 investors during an 8-day roadshow to the UK, Europe, Singapore and Kuala Lumpur in November. Themes discussed included REITs’ refinancing issues, the implications of breaching the 60% gearing limit as well as the degree of occupancy and rental declines that could be expected in a downturn.

While most REITs seem able to maintain general debt covenants with their bankers with safe gearing levels of under 45% (vs. the regulatory 60% limit) and interest cover exceeding 3x, short-term refinancing looks daunting for a number of them. From the refinancing deals announced over October-November, we conclude that REITs with strong sponsors, particularly government-linked sponsors, low leverage and quality portfolios are more likely to secure bank loans, which are the preferred refinancing option.

While some sceptical investors felt that there was more room for rents and occupancy to fall, most agreed that REITs have been oversold and even if yields deteriorate moderately from here, the REITs remain highly attractive, by any measure.

Our top pick #1: CCT

Will it get cheaper? Most clients agreed that at 0.2x P/BV, falling rents and occupancy levels have been priced in and yields of 18% certainly look attractive. We contend that CCT’s low average rent base (under S$8psf/month), long leases, rental caps for some of its leases, rental support from CapitaLand for One George Street and a master lease structure with the hotel operator RC Hotels within Raffles City would provide buffers despite falling office spot rents and occupancy levels. Investors’ apprehensions about a falling topline were somewhat assuaged. However, refinancing issues remain the main worry and three possibilities were discussed:

(1) Bank loans secured but at a high cost. Refinancing via bank loans is the most preferred solution for CCT at this point. On 28 Nov, Reuters reported that CCT verbally mandated four banks (Bank of Tokyo-Mitsubishi UFJ, DBS Bank, Standard Chartered Bank and UOB) to handle a S$580m 3-year bullet refinancing deal, which is equivalent to its short-term debt coming due in Mar 09. Interest cost, which was reported at 250bp above LIBOR, is in line with the 3-year cost of debt in Singapore (we earlier estimated at 200-300bp above SIBOR or SOR). However some investors are concerned that the indicative rate is significantly higher than CCT’s portfolio property yield, which is below 4%. Even though the cost of debt has yet to be finalised, we have assumed a cost of debt of 5% for CCT in 2009. Most investors conceded that an increase in cost of debt would still be preferable to a dilutive rights issue. We are of the view that banks remain willing to extend credit to CCT, given its quality portfolio and strong sponsor CapitaLand (CAPL SP, S$2.49, Underperform, target price S$2.30). A direct bank loan remains the most possible and positive outcome for CCT.

(2) Bank loans not secured; rights issue forced. More sceptical clients were worried that CCT may resort to a rights issue if bank loans cannot be secured, causing dilution for existing unitholders. Additionally, if take-up is poor, sponsor CapitaLand could end up absorbing the bulk of the issue, resulting in a highly illiquid REIT. This would be negative for both CCT and the REIT sector. We are of the view that this option would be given low priority, and that bank financing would eventually be made available to CCT. Before deciding on a rights issue, a loan from the parent might be an alternative, and would be received more positively than rights.

(3) Convertible bonds redeemed at put date. Short-term financing woes aside, Singapore-based investors were particularly concerned that CCT’s S$370m convertible bond due to mature in 2013 would be redeemed earlier at its put date in May 2011. This would cause a spike in CCT’s debt profile in 2011 and increase its allin cost of debt.

Our top pick #2: PLife

Positive on existing model, negative on Novena. While investors like the downside protection of PLife with a CPI-pegged revenue base and interest locked in for three years, they are apprehensive about the Novena hospital site, which is currently under development by the sponsor Parkway Holdings (PWAY SP, S$1.11, Outperform, target price S$2.45). It is widely anticipated that the completed development would be injected into PLife upon completion. The 17,266 sq m site was acquired by PWAY in Feb 08 for S$1.25bn or S$1,600/sf/gross plot ratio under the Government Land Sales programme. The acquisition price of the land was more than double the secondhighest bid of S$695/psf/gross plot ratio. We assured investors that while PLife has the first right of refusal to the sponsor’s assets put up for sale, it is not obliged to acquire assets that are not accretive. Additionally, any related party transaction that crosses 5% of the NAV threshold will require unitholders’ approval, and the related party (PWAY in this case) will have to abstain from voting. Completion of the hospital is expected in 2011.

Where’s the growth? Investors also queried about PLife’s growth avenues. Management earlier indicated that the company still has capacity to grow via acquisitions given a low leverage of under 20% and access to more than S$350m of funds. While investors remained open to further acquisitions, they also hoped that management will be cautious and secure truly accretive deals.

Tenant concentration risk. Some investors pointed out that PLife is highly dependent on its sponsor, PWAY, as its major tenant/operator, contributing about 80% of its gross revenue. We draw comfort that PWAY, the leading integrated healthcare provider in Asia, had remained profitable throughout the last two recessions, in 1998 and 2002. Furthermore, PWAY was among the earliest to recover, boosted by pent-up demand during the recessions. We also expect PWAY’s enlarged regional network to cushion its revenue in the coming recession. In PWAY’s
Singapore hospitals, higher-paying patients from new venues such as Russia and the Middle East have increased, resulting in an overall improvement in revenue.

Wish list for the sector

Securing refinancing that is not detrimental to unitholders. Top of the wish list is the ability to secure refinancing that would be non-detrimental to unitholders. Several investors were concerned that REITs would have to resort to: 1) dilutive rights issues; 2) distressed sales of assets to repay debt; or 3) the declaration of bankruptcy / liquidation, should banks be unwilling to extend credit at reasonable costs.

Truly accretive acquisitions. Also top of the list are truly DPU-accretive future acquisitions, untainted by financial engineering. While a number of acquisitions had “proven” accretive due to the spread between property yields and low borrowing costs, the credit crunch throws up the possibility that spreads may not be sustainable if refinancing is not available or obtained at much higher costs.

REITs in favour. Long funds remain fundamentally focused on asset quality, prudent REIT managers and more resilient property segments. REITs with a core Singaporebased portfolio are also preferred. FCT, A-REIT and PLife are three of the more preferred stocks. Strong interest was also expressed in CCT which remains the cheapest stock under our coverage at 0.2x P/BV, although doubts about refinancing were equally strong. Despite the hostile macro environment for the hospitality industry, some investors were beginning to show interest in CDLHT, citing its low asset leverage and prudent management.

Link – Table