Subdued organic growth, rental reversions

What has changed?

• CapitaRetail China Trust (CRCT) announced its 1Q10 results on 23 April 2010. Distribution per unit (DPU) of 2.14¢ was 1.9% above our forecast.

Impact

• Net-property income (NPI) was 1.6% above our forecast. In local currency terms, gross revenue dipped by 0.8% QoQ due to an 11% QoQ drop for the Qibao Mall. NPI (in local currency) was 1.5% above our forecast, with Xizhimen Mall, Anzhen Mall and Wangjing Mall exceeding our forecasts, while Qibao Mall fell short.

• Rental reversions for 1Q10 (involving 52 leases) were subdued at an average of 2.4% above preceding rents. Only Wangjing Mall (21 leases) recorded a positive average rental reversion (of 9.2%). CRCT’s portfolio occupancy improved slightly over the previous quarter to 95.2% from 95.0%. The overall leasing environment appears stable, but still delicate, in our opinion.

• We have revised up our FY10 DPU forecast by 0.5% after revising up our NPI forecast by 0.9%. However, we have revised down our DPU forecast for FY11 by 14.1%. We assumed previously that CRCT would acquire about S$1bn of China-mall properties annually from its sponsor’s private equity funds from the start of FY11. We assume now that these acquisitions will begin from FY12.

Valuation

• We maintain our six-month target price, based on parity to our RNG (a finitelife Gordon Growth model) valuation, of S$1.11. We have assumed an effective cap rate of 6% (consisting of a discount rate of 11% and an internal growth rate of 5% p.a. over the portfolio’s remaining leasehold of 34 years). Our valuation also assumes the inclusion of about S$966m of acquisitions at a yield of 7.5%.

Catalysts and action

• We maintain our 4 (Underperform) rating for CRCT and believe it is on track to record a year-on-year decline in DPU for FY10. Moreover, FY11 could be another listless year for DPU growth, by our estimates, unless CRCT makes a major accretive acquisition.

1Q10 results review

• 1Q10 results slightly ahead of expectation, with trust announcing DPU of S$0.0214/unit, annualizing 7% yield based on Friday’s closing price. The better than expected earnings was a result of lower than expected interest expenses. Note that the trust pays dividend on a semi-annual basis.

• Capital management a big focus this year. Whilst the trust has extended S$88million term loan for another two years to 2012, CRCT has yet to refinance S$283.5million worth of debt (68.2% of total borrowings), comprising S$200.5million term loan due Dec-10 and S$83million short-term money market line. With expectation of RMB appreciation at high level, we see upside risk for the trust to refinance at a better than expected rate. Current gearing for CRCT is 33.8% with average cost of debt at 2.4%.

• Operating performance to turn around in 2H10, in our view. Whilst net property income grew 7.5% in RMB term, the increase is largely a result of new contributions from Xizhimen Phase 2. Net property income for initial portfolio grew only 1% Y/Y due to still challenging Beijing retail market as well as the repositioning of Qibao Mall in Shanghai. That said, as tenant sales started to increase with 9% sequential growth and the new commitment at Qibao Mall to be started in July, we see potential turn around in underlying performance in 2nd half this year.

• We retain our Neutral rating, with Dec-10 DDM based price target at S$1.25/unit. Key risks to our rating and price target include surprises on operating fundamentals both on the upside or downside, and the uncertain timing of the introduction of China REIT code, which is likely to support or even lift up the valuation of the trust.

CRCT maintains Q1 DPU at 2.14 cents

CAPITARETAIL China Trust (CRCT) has maintained its distribution per unit (DPU) for the first quarter ended March 31 at the year-ago level of 2.14 cents.

This translates to an annualised DPU of 8.68 cents or a yield of 7 per cent based on the trust’s closing price of $1.24 on April 23.

CRCT is managed by CapitaRetail China Trust Management Limited (CRCTML), which is an indirect wholly owned subsidiary of CapitaMalls Asia.

Income available for distribution was marginally up at $13.34 million. Due to a 6.2 per cent depreciation of the renminbi against the Singapore dollar in 1Q10 from 1Q09, gross revenue was 2.9 per cent lower at $29.5 million, while net property income (NPI) was slightly higher by 1.2 per cent at $19.34 million compared to $19.17 million.

Earnings per unit were 1.86 cents compared to 1.78 cents previously.

Wee Hui Kan, chief executive officer of CRCTML, said: ‘Our strategy of refining mall-positioning and tenancy mix to meet changing consumer demands continues to show results. Our committed occupancy rates stayed high at about 95.2 per cent.’

CRCT, which is the first China shopping mall real estate investment trust (Reit) in Singapore, has a portfolio of eight retail mall properties in five cities in China. As at Dec 31, 2009, CRCT’s total assets equalled $1.2 billion.

Separately, CRCTML also announced yesterday the appointment of Tan Tee Hieong as deputy chief executive officer of the company with immediate effect. Mr Tan, who joined the company in 2007, will continue to hold his current position as head of finance. Prior to joining CRCTML, Mr Tan was with Ikea for over nine years, where he held positions as treasurer and finance manager for the Asia-Pacific region.

Steady yield and attractive theme priced in

Exposure to China theme remains attractive

We continue to like CRCT for its exposure to the China consumption and urbanization theme. However at 6.5% 2010 DPU yield, it is trading near our DCF derived price target. Our estimates are unchanged. We downgrade our rating from Buy to Neutral.

Acquisition only like towards end 2010/2011 and hinges on cost of capital

As the majority of CMA's pipeline of malls is still in the stabilization phase, we think acquisitions are only likely to happen towards end 2010/2011. Cost of capital is likely to be a key determinant as the gearing is 34% and capped at 35% given no credit rating. Assuming 35%/65% debt/equity funding, we estimate accretion from new deal flow would make sense when CRCT is at S$1.70. In the past, CRCT's share price had outperformed strongly when the market was willing to price in the option of acquisition.

Credit rating could lift debt headroom

The key risk, in our view, is that CRCT obtains a credit rating which would lift the debt headroom for acquisitions. Speaking with management, it does not appear that this is likely to occur in the near term. The implementation of a formal REIT legislation in China could potentially facilitate this process but the actual timing is hard to determine.

Valuation: Downgrade to Neutral

Our price target uses 2.6% risk-free, 1.1x beta, 5% ERP and 2.5% terminal growth.