Allco Reit gets BB long-term rating from S&P

Agency also places rating on CreditWatch with positive implications

STANDARD & Poor’s Ratings Services yesterday said it has assigned its ‘BB’ long-term corporate credit rating to Allco Commercial Real Estate Investment Trust (Allco Reit).

At the same time, it placed the rating on CreditWatch with positive implications.

The rating on Allco Reit reflects the trust’s smaller asset base compared with its global peers’.

It has nine properties (excluding units in unlisted property fund Allco Wholesale Property Fund).

‘Allco Reit also has high tenant concentration, with its top two tenants representing about 30 per cent of the gross revenue of its portfolio,’ said Standard & Poor’s credit analyst Wee Khim Loy.

‘In addition, the trust’s market and tenant diversity could decline. Should Allco Reit’s manager, Frasers Centrepoint Asset Management (Commercial) Ltd, continue the previous manager’s strategy to exit the Australian market and focus on properties in Singapore and Asia, the trust’s asset portfolio and cash flow stability would be negatively affected.’

The above weaknesses are partly offset by the quality of Allco Reit’s investment portfolio.

The Asian properties, which require minimal capital expenditure, are mostly strategically located in central business districts.

These benefits are complemented by the stable rental cash flow of Australian properties, which are backed by longer term leases.

In addition, the weighted average lease term of 4.8 years for Allco Reit’s combined diversified portfolio is higher than the average for comparable real estate investment trusts focusing on Asian office commercial properties.

Allco Reit’s nine properties have more than 400 tenants in total, spanning five markets in three countries.

The diversification strength of the investment portfolio provides cash flow stability to the business.

The rating is also supported by the enhanced financial flexibility of Allco Reit following the change in the ownership of its manager.

Impending refinancing risk declined after Allco Reit was ‘de-linked’ from Allco Finance Group (AFG). Frasers Centrepoint Ltd (FCL) acquired 17.6 per cent of Allco Reit and 100 per cent of its previous manager, Allco Singapore Ltd, from AFG on Aug 14, 2008.

Allco Reit will be eventually renamed Frasers Commercial Trust. FCL is the wholly owned property arm of Fraser and Neave Ltd, a leading consumer group with a satisfactory credit profile.

First look

Allco’s 2Q08 results were in line, with the positive reversionary profile in Singapore over FY08-09F underpinning valuations. We see the acquisition of a 17.7% stake in the REIT by FNN as positive, enabling the REIT to leverage off a pipeline of assets (circa S$640mn), with DPU potentially seeing a fillip on lower funding costs consequent to a review of the REIT’s credit rating and a realised gain on a derivative financial instrument of S$3.9mn. Our STRONG BUY and FV stand.

2Q08: in line with expectations

Strong 2Q 08 earnings

Story: 2Q08 results were within expectation. Gross revenue grew 57.9% y-o-y to S$27.6m, while NPI grew 37.6% to S$20.9m. Distributable income grew 61.4% to S$17.2m, translating into 2.4cts DPU in 2Q08. For 1H08, unitholders are getting 3.99 cts DPU. Allco also recorded a write-down for its investment properties, mainly from Cosmo and Centerlink, of S$29.7m, resulting in NAV falling to S$1.39 per share on 30 Jun 2008 (1Q08: S$1.45).

Point: The better 2Q08 performance was driven by higher rents achieved at Central Park and contributions from properties purchased after 2H07, i.e. Centerlink, the Japanese assets and Keypoint. Moving forward, there are several issues to look at: (i) expiry of S$70m loan in Nov08 that is expected to be repaid from proceeds from the divestment of AWPF, and (ii) strategic review of its Australian assets. Proceeds will be used to pare down existing facilities and for capital re-cycling for asset acquisitions lined up by Frasers Centrepoint Ltd (FCL). In this respect, we remain optimistic about opportunities in the medium term with its new parentage. Allco should benefit given FCL’s established presence in Asia Pacific and a ready pipeline of assets worth S$700m.

Relevance: We have adjusted FY08F and FY09F DPU to 6.9 and 7.0cts, respectively. Our DCF-backed target price is reduced to S$0.93 after imputing higher risk free rate of 3.9%, beta of 0.8 and a lower terminal growth rate of 0.5%. The share price could underperform in the near term, given the uncertainty in terms of the structure and direction of the REIT following the change in parentage. But valuation wise, Allco is trading at attractive 0.6x P/BV and offers FY08-FY09F DPU yields of 8.9% – 9.0%.

Maintain Buy

A Fresh Start

Allco Commercial REIT (Allco) announced that Fraser Centrepoint Limited (FCL) has bought over Allco Finance Group’s (AFG) stake of 17.7% in the REIT and also 100% of the REIT manager Allco (Singapore) Limited for a total consideration of S$180 million. The sale is expected to complete by 6 August 2008. Allco will be renamed Frasers Commercial Trust upon completion.

In addition, Allco recorded valuation loses from its Cosmo Plaza and Centrelink Headquarters properties after valuations were done on 30 Jun 2008. Currently Allco has a property portfolio size of S$1.9 billion.

Strategic review. Following the acquisition by FCL, there is no formal announcement on the intended divestment of the Australian assets. This is dependent on the strategic direction of FCL. However looking at the Centrelink Headquarters revaluation, the divestment may net proceeds 10% lower than originally intended.

A quick recap on Allco debt profile. Allco has S$70 million of debt maturing in Nov 2008, which will be repaid with the redemption proceeds from AWPF. Another S$550 million is expiring in Dec 2009 and another S$268 million of Yen denominated debt in 2012. With the Fraser and Neave Group as the sponsor now, we believe this would strengthen Allco financial credibility.

Allco’s current gearing is 47.3%. Following the full redemption of AWPF and assuming all 3 proposed properties injected into the REIT are fully funded by debt, gearing would increase to 57.9%.

Analysis. We view some synergistic benefits to the acquisition by FCL, however there are also some issues that linger in our minds. First up, Allco gain a reputable sponsor that could act as a catalyst to close up the gap between the trading price and NAV. Under the agreement, FCL will pay S$104 million to acquire 17.7% stake from AFG and $76 million to acquire 100% of the manager. The manager currently holds 1.48% (10,491,300) of the outstanding units. There is a termination fee of $20 million if the manger is removed from its capacity. Therefore we reckon the implicit price paid by FCL to gain a controlling stake is actually $1.17 per unit, assuming FCL’s purchase price of the manager includes this termination fee. This would then represent an 18.7% discount from the NAV.

One of the uncertainties associated with non-developer sponsored REITs and independent REITs is the lack of acquisition opportunities. With FCL as the sponsor, there is more visibility to the expansion pipeline now. Secondly, we feel Allco will be in a better financial standing when it comes to funding negotiations. It will also have more funding options being part of the Fraser and Neave Group.

With this initial announcement of acquisition, there are a few doubts that we would like to seek clarity. The foremost question would be the future direction of the REIT. Allco started out as a commercial REIT focusing on the office sector. With the purchase of Keypoint building, it added retail spaces to its portfolio. And recently, it gained provisional permission from URA to develop a hotel tower at the China Square property. So we are seeing a shift in investment policy of the REIT. Secondly, it would be the probability of the divestment of the Australian properties.

Valuation and reccomendation. For our valuation, we took the conservative stance of impairing the potential A$6.4 miilion income support from AFGL. We also apply stringent parameters in our valuation model to reflect the bad market condition. Our revised valuation gives us a FY08F DPU of 6.41 cents. We lowered our fair value from $1.05 to $0.86. We believe Allco is a long term value play and keep our buy recommendation at the current price.

Risks to our valuation. The macro risk affecting Allco is the sustained economic slowdown leading to a drop in rental revenue. Poor credit environment couple with rising interest rates will increase the borrowing cost and interest expense. Current gearing of Allco is 47.3%. Concern exists over the leverage if Allco is to acquire using debt. Therefore in our view, Allco will need to raise equity at some point in time or divest the Australian properties to lower gearing.

Forum takeaways
From the Nomura Asia Equity Forum: we view the recent acquisition by Frasers Centrepoint as positive for Allco REIT unit-holders, providing the REIT with a clear asset pipeline and potential for lower funding costs. The core portfolio is exceeding expectations, with the enhancement of Keypoint on track. STRONG BUY.

Anchor themes
While office supply will remain tight over 2008F, we expect office rents to peak in 2H08-1H09F, before encountering cyclical declines of 13.7% in 2010F and 19.0% in 2011F, in light of the increased office supply.

Strong rental reversions are likely to underpin REIT cashflows. That said, increased concerns over the ability to refinance debt have seen REITs trade below book. In such an environment, investors need to focus on underlying asset values, with REITs with well-located assets beneficiaries of rising expectations of M&A activity.

Tiger REIT