Acquisition driven performance

Comment on Results

Allco’s results were within expectation. Gross revenue and net property income growing 76.4% and 62.3% y-o-y, respectively, to S$28.4m and S$22.1m led by contributions from new acquisitions such as the 3 Japanese properties and Keypoint, completed in 2H07. Contributions from these assets made up c80% of revenue and NPI.

However, DPU was flat y-o-y at 1.6cts due to i) dilutive impact from a higher unit base following its equity raising in July 2007, ii) increased interest expense from larger borrowings and higher interest cost (+141% to S$9m in 1Q08), and (iii) reversal of allowance of impairment of receivables from API of S$2.0m.

Moving forward, we expect bottomline growth to be fueled be organic drivers coming from positive office rental reversions and planned AEI at Keypoint. An estimated 45% of its portfolio NLA is up for renewal over FY08-09F. In addition, parent, Allco Finance Group (AFG) had recently indicated it will guarantee the payment of outstanding receivables and obligations amounting to A$7.98m (S$9m). This has not been factored into our current forecast and could raise our earnings projections by c.5%.

In terms of acquisition growth, we believe this strategy would materialize only when Allco further de-gears it balance sheet. Current gearing is at 45%. Meanwhile management’s strategic review to divest its Australian properties, are still ongoing and proceeds from these activities could potentially be utilized to strengthen its balance sheet.

Recommendation

Maintain FY08 and FY09 DPU estimates of 6.6cts and 6.7cts, translating to FY08-FY09F yields of c8%. Our price target of $1.23 offers potential 45% upside. However, we believe the share price is likely to be re-rated only when it demonstrates successful execution of its growth strategies and provide better clarity on Allco REIT’s position following API and AFG’s restructuring activities.

Debt reprieve for Allco Reit – but at a much higher cost

Market cheers news the firm has secured extension of loans

Allco Commercial Real Estate Investment Trust (Allco Reit) earned a reprieve in its debt repayment obligations last week – but at a much higher cost.

Allco (Singapore) Limited, the manager of Allco Reit, had announced last Thursday that the trust had received in-principle approval to extend the due date of S$550 million in debt from July 31, 2008 to Dec 31, 2009. It had not detailed the terms and conditions of the extension, saying only that it was currently reviewing them.

When asked by BT yesterday about the terms of the refinancing, Nicholas McGrath – CEO and managing director of Allco (Singapore) Limited – did reveal that, while the terms were largely the same, the refinancing was ‘a lot more expensive’.

He declined to state the exact quantum of the increase in the cost of refinancing, that is the change in interest rate charged by creditors for the extension of the loan – explaining that such matters are confidential.

Refinancing of loans is typically a pricier matter for most debtors, with creditors choosing to charge more for the extension or relief in debt obligations.

Mr McGrath could, however, reveal to BT the blended margins for Allco Reit’s total debt obligations. The trust currently has S$620 million in Sing-dollar debt and another S$260 million in debt denominated in Japanese yen. The blended interest rate for its total is 3.8 per cent for 2008 and 3.95 per cent for 2009 – with the interest rate being higher for the Sing-dollar debt than the Japanese-yen portion.

‘But the margins are still lower than what our properties are yielding,’ Mr McGrath explained.

Allco Reit’s key properties include China Square Central and 55 Market Street in Singapore, and Central Park in Perth, Australia.

S$70 million of its Sing-dollar debt will mature in November 2008, which Allco Reit will repay in full with the proceeds from the sale of the assets of Allco Wholesale Property Fund. The rest of its debt obligations are long-term ones.

Mr McGrath also told BT that the trust intends to decrease its leverage over the next 12 months – from 43 per cent currently, to about 30 per cent in a year’s time.

Allco Reit’s debt repayment concerns had been the subject of a fierce legal tussle last week. The trust had sought a court injunction to head off a credit ratings downgrade by Moody’s Investors Service, concerned that the downgrade would hurt its attempts to refinance its debt. But Moody’s had battled the injunction, saying it should not be stopped from going ahead with its independent credit reviews.

The injunction was set aside by the High Court last week, and Moody’s had gone ahead with the ratings downgrade – lowering the trust’s corporate family rating to ‘Ba2’ from ‘Ba1’ and retaining the ratings on review for further possible downgrade.

Despite the downgrade, Allco Reit still succeeded in refinancing its debt – announcing a day after Moody’s ratings revision that it had managed to secure an extension of its loan obligations.

And the market has reacted favourably to Allco Reit’s announcement, with its share price having climbed steadily since. Allco Reit shares closed at 80.5 cents yesterday – up 11 per cent from its close of 72.5 cent last Thursday, after the ratings downgrade.

Re-financing issues laid to rest

Story: Allco REIT (Allco) share price was hit recently by a spate of negative news ranging from a Moody’s ratings downgrade to ‘Ba2’ in view of its high debt expiry and strategic review to a potential fire sale situation given its inability to obtain refinancing. However, Allco has allayed such unfounded fears by securing an in-principal approval for the extension of its S$550m loan facility expiring in July’08 to end Dec’09. In addition, the proposed strategic review raised concerns of a possible dilutive impact on earnings in the near term.

Point: We have previously maintained that re-financing should not pose much of a problem for Allco given its strong asset base of S$2bn, (of which c. 50% is made up of its Singapore properties) but at a higher price of c. 200 bps above its current rates. The group is in the process of divesting its stake in AWPF and is looking to unlock gains from its Central Park in Perth. As such, we have further adjusted FY08 and FY09 DPU to 6.6cts and 6.8cts to reflect the absence of AWPF. A recent re-composition of its board to include a majority of independent directors is a positive signal to investors as a step in the right direction for good corporate governance and should be viewed positively on a operational, asset divestment and future reinvestment standpoint.

Relevance: With re-financing issues put to rest, a re-rating of Allco would hinge on further newsflow with regards to i) the successful execution of its re-investment plans and organic growth strategies to drive DPU growth which will be partially driven by strong rental reversions from Keypoint offsetting the loss of the income from API and distribution income from AWPF, ii) clarity on the positioning of Allco REIT given API and AFG’s restructuring activities. We maintain BUY on Allco with revised TP of S$1.23 based on a 20% discount to its DCF backed price of S$1.54 on the premise of uncertainties arising from the ongoing restructuring activities at its parent level.

Our view

Allco REIT has successfully refinanced its S$550mn debt due in July 2008. With the market’s misplaced view of refinancing risk and expectations of a “fire sale” of its Australian assets expunged, we see Allco REIT pursuing an orderly review of its portfolio while the market re-focuses on the REIT’s inherent value. STRONG BUY.

Anchor themes

While office supply will remain tight over 2008F, we expect office rents to peak in 1H09F, before seeing cyclical declines of 15.2% in 2010F and 18.0% in 2011F, given increased new office supply.

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

Refinancing Concern Addressed

Allco REIT announced it had received extension on the maturity date of S$550 million of its debt, which was due in July 2008 to 31 Dec 2009. The balance of S$70 million will be repaid with the proceeds from the redemption of AWPF. With the announcement, we believe the clout over refinancing worries has been dispelled and thus will not lead to any force-sale of its properties.

Earlier, Moody’s downgraded Allco’s credit rating for the second time within a span of two months. Allco’s credit rating was downgraded from Baa3 to Ba1 on 31st Jan 2008 and was further downgraded one level to Ba2 on 18 Mar 2008. The latest revision centers on concerns of Allco refinancing progress as well as outcome of the possible divestment undertaken by Allco REIT of its Australian properties.

With regard to the strategic review, the manager of Allco Commercial REIT announced that it is investigating a potential divestment of its Australian properties. The decision stems from the strong Australian property market that has resulted in substantial capital gains as well as to redeploy capital to higher growth assets.

AWPF has stated its intention to dispose of its entire portfolio and Allco REIT expects to receive its proportionate share in AWPF in the 3rd quarter of 2008.

With the latest guidance from Allco, we believe a likely scenario would be Allco manages to refinance at a cost of 4%., while keeping both the Central Park and Centrelink properties and AWPF will be fully redeemed.

Scenario Analysis

We conducted a scenario analysis study of possible outcomes from Allco’s refinancing talk as well as the strategic review on the impact of DPU.

Scenario 1: AWPF fully redeemed, sold off Central Park to realise capital gain. Proceeds from sale used to reduce debt, gearing reduced to 26%.

Scenario 2: Proceeds from AWPF redemption reduces debt marginally to 42%

Valuation and recommendation. The downgrading of Allco’s credit rating has hurt the dividend payout, although fundamentally we believe Allco’s portfolio will continue to do well. Allco is a victim of bad sentiment surrounding the sector that resulted in a tight credit market making refinancing more difficult and most costly. The double credit rating downgrade stems from rating agencies taking a more cautious stance in their methodology after the sub-prime fiasco. Our analysis study indicates that under different assumptions, FY08F DPU ranges from 5.44 cents to 7.35 cents. This translates to a yield range of 7.8%-8.7%. We note the contrast to the 6.73 cents paid out in FY07 and represents a yield erosion of 19.1% in the worst case while a yield accretion of 9.2% in the best case. Fair value estimation ranges from S$1.00 to S$1.14. Our base case valuation is premised on the assumptions that Allco will refinance at 4%, which represents a margin of 200 basis points over SIBOR and Allco will retain the Central Park and Centrelink buildings. Fair value is lowered from S$1.21 to S$1.07. Maintain Buy.