ANOTHER QUARTER OF STEADY EXECUTION

• 3Q12 DPU of 1.68 S cents
  
• Maintain core focus on Indonesia
  
• Positives likely priced in
  

3Q12 results were within expectations

First REIT (FREIT) reported 3Q12 results which were in line with our expectations. Gross revenue increased 3.7% YoY to S$14.2m, driven by a full quarter of contribution from its Sarang Hospital (acquired in Aug 2011) and higher rental income from its other assets. Distributable amount to unitholders and DPU slipped 12.1% and 12.5%YoY to S$10.6m and 1.68 S cents, respectively. This is unsurprising given the absence of a special distribution of S$2.2m (S$0.34 per unit) in 3Q11 which arose from a gain from the sale of the Adam Road property (four equal tranches paid from 3Q11 to 2Q12). For 9M12, gross revenue climbed 5.4% to S$42.2m and formed 71.4% of our full-year forecast which includes our assumptions on the contribution from its proposed new acquisitions. Distributable amount to unitholders rose 9.6% to S$34.9m, or 74.8% of our FY12 estimate.

Abundant opportunities in Indonesia’s healthcare market

FREIT continues to see ample growth opportunities in Indonesia’s underserved healthcare market. Demand for higher quality private healthcare services would likely gain traction moving forward, underpinned by a growing population, rising affluence and urbanization rate. Hence we expect Indonesia to remain as FREIT’s core focus, especially since it has a right-of-first-refusal on its sponsor Lippo Karawaci’s (Lippo) Indonesian healthcare assets.

Maintain our HOLD rating

FREIT has lodged its Circular regarding its recent proposal to acquire two Indonesian properties from Lippo. An EGM will be held on 9 Nov to obtain unitholders’ approval. While we like FREIT for its visible and defensive income streams which would provide stability to unitholders, we believe that this has been factored in its share price, as reflected by its FY13F P/B ratio of 1.3x. Although this represents a 7.2% discount to its closest comparable peer Parkway Life REIT (1.4x), it is still a 20.8% premium to the S-REIT universe average of 1.1x. Maintain HOLD with an unchanged fair value estimate of S$0.98.

ENTRENCHING ITS INDONESIAN FOOTPRINT

• Total purchase consideration of S$142.9m
  
• Slight disappointment in lease terms
  
• Raise FV to S$0.98 but maintain HOLD
  

Plan for new acquisitions from sponsor

First REIT (FREIT) recently announced that it has entered into two conditional sale and purchase agreements with its sponsor Lippo Karawaci (Lippo). This entails the proposed acquisition of Siloam Hospitals Manado & Hotel Aryaduta Manado (MD) which are located in the same building in North Sulawesi, and Siloam Hospitals Makassar (SHMK) in the South Sulawesi Province. The purchase consideration for MD is ~S$83.6m, while that of SHMK is ~S$59.3m. The purchase of MD would be funded by a combination of debt and a private placement exercise (proportion not finalised), while SHMK would be financed wholly by a drawdown from its committed debt facility.

Lease terms largely similar to existing Indonesian portfolio

Similar to its existing Indonesian asset portfolio, these two proposed acquisitions are structured on a triple net master lease for 15 years (option to renew for a further 15 years thereafter) with 100% committed occupancy and downside base rental protection. Exchange rate risk for FREIT is also eliminated as the base rental is structured in SGD while the variable rental component is based on a fixed SGD/IDR rate (1 SGD = IDR 7,000) throughout the entire lease term. This provides greater stability and visibility to FREIT’s unitholders. However, the initial base rental yield of 9.7-10.0% for the two assets is a tad below our expectations. The base rental component for the leases would also be stagnant for the first three years of the lease, with rental escalation only possible in the fourth year.

Valuations still rich, reiterate HOLD

We had previously assumed new acquisitions in our 29 Jun 2012 report. Hence we finetune our assumptions in accordance with the updated asset details and also roll forward our valuations to FY13. This is partially mitigated by an enlarged unit base from its impending private placement exercise. Our RNAV-derived fair value estimate increases from S$0.96 to S$0.98. But we maintain HOLD on FREIT as valuations still appear rich, in our view, with the stock trading at 1.3x FY13F P/B.

Favorable Yield Likely To Sustain

Investment Highlights

• An attractive and sustainable yield. Underpinned by the defensiveness of the healthcare sector and its long‐term lease structure, we are confident about the sustainability of First REIT’s FY2012 forward dividend yield of 7.38%. First REIT’s lease terms range from 10‐15 years, which factors in step‐up escalation rates, thus providing long‐term visibility in its income stream. Moreover, we note that First REIT’s lease agreements for its Indonesian properties include a variable component that is a function of turnover growth, thereby allowing it to capture upside potential in favourable market conditions.
  
• Poised to leverage on demographic shifts. With its assets based in Indonesia, Singapore and South Korea, First REIT is in a strong position to leverage on the growing healthcare needs of a burgeoning population in Indonesia as well as an ageing population in Singapore and South Korea. Demonstrating the surging demand for nursing home services in Singapore, the government plans to build 10 new nursing homes between 2012 and 2016.
  
• Boasts financial firepower to support its acquisition appetite. First REIT recently entered into conditional agreements for the acquisition of Siloam Hospitals Manado & Hotel Aryaduta Manado, which is an integrated hospital and hotel, and Siloam Hospitals Makassar for S$142.9mil. Assuming that the acquisition of the former is to be financed by a debt‐to‐equity ratio of 30%, First REIT’s asset leverage ratio will increase to 24.0%, which is still much lower than the regulatory limit. With a right‐of‐first refusal to seven hospitals under its sponsor, First REIT has a healthy pipeline of assets to bolster its growth plans.
  
• A steady generation of operating cash flows. First REIT has consistently generated sufficient operating cash flows to cover its distribution payments over the past fiscal years. Given its sturdy fundamentals and the quality of its earnings, this should support the sustainability of its yield .
  
• Forex exposure mitigated. First REIT’s rental income from its Indonesian assets are based on a fixed SGD‐IDR exchange rate of IDR/SGD5,623.50 over the entire lease term, providing greater visibility over its earnings stream.
  

Key Risks

• First REIT’s overreliance on the Indonesian market and its two master lessees Pacific Healthcare as well as Siloam Hospitals (a subsidiary of Lippo Karawaci) for rental income are key risks. However, we are not particularly concerned about the latter given the master lessees’ reputation and Lippo Karawaci’s vested interest as a shareholder and sponsor.
  

First REIT has entered into conditional sale and purchase agreements for the proposed acquisition of two new properties in Indonesia. The proposed acquisitions comprise an integrated hospital and hotel in Manado, and another hospital in Makassar in Indonesia's southern province of Sulawesi, both of which will be purchased from two wholly‐owned units of PT Lippo Karawaci Tbk (First REIT's sponsor) for a combined purchase consideration of approximately S$142.9 million.

The acquisition of Siloam Hospitals Manado & Hotel Aryaduta Manado at a consideration of S$83.6 million will be funded by a combination of committed debt and proceeds from a proposed private placement exercise while the purchase of the S$59.3 million Siloam Hospitals Makassar will be financed entirely by a drawdown of committed debt.

PT Lippo Karawaci Tbk, First REIT's sponsor and Master Lessee of the two properties, has signed conditional master lease agreements for lease terms of 15 years, with an option to renew for a further term of 15 years. The two properties are estimated to earn a total of $14.1mil in net rental income, or 26% of First REIT's $53.4mil net profit in 2011.

We view this as a positive development for First REIT (UNRATED, S$1.03). The acquisition of two hospitals in Indonesia not only improves its portfolio diversification in terms of locations and medical specializations but also enhances its weighted average lease expiry profile (WALE). The acquisitions are expected to improve its WALE from 10.8 years to 11.7 years. More importantly, the acquisitions would strengthen First REIT's reach in Indonesia, a market we perceive to be highly attractive on the back of strong underlying demographics and the government's aim of improving healthcare access to the public. Given that the acquisition of Siloam Hospitals Manado & Hotel Aryaduta Manado is to be funded by a mix of committed debt and cash from private placement exercise, we expect First REIT's aggregate leverage to remain below 30% (lower than the regulatory limit of 35%), which should provide comfortable headroom to support its future acquisitions.

STEADY QUARTER, NO SURPRISES

•2Q12 DPU of 1.93 S cents (+22% YoY)

•Acquisitions possible in 2H12

•Yield still decent, but valuations rich

2Q12 results were within expectations

First REIT’s (FREIT) 2Q12 results were within our expectations. Gross revenue increased 6.1% YoY to S$14.0m. This was driven by contribution from its Sarang Hospital which was acquired in Aug 2011 and higher rental income from its remaining portfolio. Distributable amount to unitholders and DPU jumped 23.1% and 22.2% YoY to S$12.2m and 1.93 S cents, respectively. This is payable on 29 Aug 2012 (ex-div: 30 Jul). The hike in DPU was boosted by a special distribution of S$2.2m (S$0.34 per unit) which arose from a gain from the sale of the Adam Road property. This is the last tranche of special distribution arising from this divestment gain. Sequentially, revenue and DPU were both flat. For 1H12, gross revenue rose 6.2% YoY to S$28.0m and constituted 47.4% of our full-year projection. DPU increased 22.2% to 3.86 S cents. Excluding the special distribution highlighted earlier, DPU would have formed 50.1% of our FY12 forecast.

Acquisitions likely to complement organic growth

Looking ahead, we believe that acquisitions could possibly take place in 2H12, given FREIT’s low leverage ratio of 15.1% and ongoing negotiations with its sponsor Lippo Karawaci over the past several months. We had previously factored in acquisitions amounting to S$88.9m in our model assumptions, with details delineated in our 29 Jun 2012 report.

Downgrade to HOLD on valuation grounds

Following our last upgrade on FREIT to Buy on 29 Jun 2012, the stock has since appreciated 6.0%, outperforming both the STI and FTSE ST RE Invest Trust Index. Although FREIT offers an FY12F yield of 7.6% (6.9% if we strip out the special gain distributions), while providing income streams that are largely resilient in nature given its long-term master leases, valuations appear rich at current price level, in our opinion. The stock trades at FY12F P/B of 1.23x, a significant 26% premium to the S-REIT universes’ average P/B of 0.98x. Hence we downgrade FREIT from Buy to HOLD on valuation grounds, with an unchanged fair value estimate of S$0.96. We believe that it is also possible for FREIT to fund its next acquisitions via a combination of debt and equity given its current rich valuations.