TCT – OCBC

Diversification into China’s tier-2 cities

Betting on China. We recently visited TCT’s commercial assets in Shanghai and Qingdao, including the newly acquired Central Avenue Mall and pending Huai Hai Mall (midst of acquisition with settlement no later than 30 Jun). We observe that TCT has over time evolved its strategy in China, which used to focus on commercial assets and development projects in tier-1 cities such as Beijing and Shanghai . Recently, it has concentrated on regional expansion into tier-2 cities, including developing a large-scale retail property at the Laoshan district of Qingdao with the Trio group. TCT is also actively looking at deals in Xi’an in Shangxi province, forming a strategic partnership with the Ginwa Group to tap the emerging retail market in central and west China.

Three key advantages. We observed that TCT has three key advantages in China. First, TCT is listed as a business trust instead of a REIT, with the more flexible structure of 30% development cap and 45% gearing limit, as stipulated in its trust deed. The development component sets TCT apart from REITs which have little development exposure (10% deposited property max). TCT is thus better positioned to achieve accretive-yields due to cost savings from vertical integration. It is also not bounded by investment constraints, such as at least 75% of assets must be invested in income-producing properties. Secondly, TCT is upscaling its tenant mix from mostly low-mid tier to mid-high end retailers, which provide income uplift. Presently, some of its existing leases are well below prevailing market rates. For example, the anchor tenant Parkson, at City Centre, is paying only RMB1.73 psqm/day (average rate is RMB6 psqm/day). With the completion of the City Centre extension, Parkson will be vacating the property in 2012, while Marks and Spencer was roped in as the replacing tenant on a 10+5 years lease. On TCT’s debt portfolio, 85% is USD-denominated but 100% of its revenue is in RMB. TCT thus enjoys low borrowing costs, while the likely RMB appreciation in the mid to long term provides further forex upside.

Supply overhang remains. According to DTZ, there is an anticipated supply of new office space in Shanghai, amounting to about 100% of existing stock in 2011-2014. Likewise, highend retail space is expected to increase by another 50% from 2011 to 2013. The large new supply is expected to drag down overall occupancy rates and intensify the “winners/losers” divide among the Shanghai properties. Oversupply and inflation risks (dampening demand) remain our top concerns for the trust and we expect management to consciously address these as the trust grows in asset size. We do NOT have a rating for TCT presently.