Poised to acquire

• Keen interests seen from investors during our conference in New York
• Clear strategies and downside rental protection are key positive attributes, in our view
• Expect acquisitions in near term, capitalizing on debt headroom and low interest rates
• Reiterate Buy, TP: S$1.37 equating to 26% total return upside

Downside rental protection key attribute. We hosted PREIT at our conference in New York earlier this month to good reception with US based fund managers/investors. The downside rental protection and clear strategies presented by management caught on well with investors. Based on the CPI+1% formula, minimum rental for its Singapore Hospitals are set to grow by 4.36% to at least S$52.7m in its third year of lease (23 Aug ‘09 – 22Aug ‘10).

Acquisitions very likely in near term. We expect management to deliver on acquisitions (funded by debt) in the near term for further growth, possibly scale up in Japan, capitalizing on the yield differential between NPI yield and  cost of funds, and the aging population. Management has already put in place a diversified source of funding (S$500 MTN facility, S$126m untapped bank facilities and S$50m 3-year revolving Murabaha facility).

Expect to trade towards NAV, Buy (TP: S$1.37). We like PREIT for its defensive features, and its opportunity for growth via acquisitions coupled with strong fundamentals – high interest cover of 6.9x, fixed 100% interest rate for debt and high gearing headroom (up to S$963m). We think PREIT could trade up towards NAV of S$1.34 as the REIT sector further re-rates. Revised DCF TP up to S$1.37 (WACC 6.6%) as we adjust our terminal growth rate to 2%, based on an assumed CPI rate of 1% over the long term – still below the average 10 year historical CPI rate (1.4%).

VALUE + GROWTH

We met up with the management of Parkway Life REIT (Plife) for an update that bolstered our optimistic view on the REIT.

Value. Parkway Life REIT (Plife) has an underlying stable of properties that commands relatively stable cash flows with a growth component. As a reiteration, approximately 80% of gross revenue is contributed from the Singapore portfolio of hospital which grows at an annual rate of CPI + 1%. During the last revision in August 09, this was set at 4.36%. The Japan properties currently account for 20% of gross revenue. Being exposed to the defensive healthcare industry, its portfolio of properties faces little risk of asset devaluation as they are secured by relatively long leases with stable cash flows.

Growth. Besides organic growth from upward revision of rental, Plife has a growth strategy from asset enhancement and acquisition. Management revealed that it has dedicated personnel who are exploring the possibility of maximizing plot ratio of its assets and also efficient utilization of available spaces. In a recent asset enhancement initiative that was completed on the Matsudo property, incremental return of 19% to its gross revenue was achieved against capital spending on the property of 7%. Management also indicated that it is targeting the Singapore, Malaysia, Japan and Australia markets for potential expansion opportunities given the demographic and infrastructure suitabilities.

The other impetus for growth is the low gearing ratio of the REIT. Current gearing is 23% with total debt of $242 million. Assuming a gearing level of 35%, Plife has the capacity of take on an additional $200 million of debt for its expansion. In terms of funding sources, Plife has in-place a $50 million credit facility of Islamic financing and also a $500 million MTM program. The Islamic financing opens up an avenue of funding sources and also potential investor base.

Recommendation and valuation. We feel that the REIT sector has resolved most of the refinancing debacle that has plagued the sector in the past year. With credit issue out of the way, REIT managers should be turning their attentions to their growth strategy. In our opinion, Plife has satisfied all the criteria in carrying out an expansion.