• Perennial China Retail Trust reported first quarter profit attributable to units of the trust of S$5.0 million, mainly due to the drawdown under the RMB226.5 million earn-out deed (“New Earn-out Deed”) for distribution to Unitholders.
  
• The available distribution per unit (DPU) for 1Q13 amounts to 0.95 cents, translating to an annualized dividend yield of 6.1%.
  
• Within its operational assets in Shenyang, the trust secured Guangcai Group, an antique wholesale, as a master-lease tenant in Shenyang Red Star Furniture Mall which would increase the mall’s occupancy to 93%. But the Shenyang Longemont Offices’ leasing commitments only stand at 32.0%.
  
• Perennial Jihua Mall is on track to open in 3Q 2013, whilst Perennial Qingyang Mall is on target to open in either 4Q 2013 or 1Q 2014.
  
• Looking ahead, the key catalyst for the stock would be how well the trust could execute its ramp-up strategy.

Continues to execute

• Results lifted by earn out deed support
  
• Operations ramping up, new development assets to extend earnings and RNAV growth visibility
  
• Maintain BUY, TP $0.84
  

Highlights

Results in line. PCRT reported 2H12 DPU of 1.96Scts. Together with the 1.90Scts recorded in 1H12, the group posted FY12 DPU of 3.86Scts, in line with expectations. Underpinning the results was also the inclusion of S$10.7m of earn out deed support (S$21.5m for FY12). At the same time, the group booked in a net portfolio revaluation gain of S$91.2m (Rmb2.9bn) despite taking a 10% writedown for Shenyang Red Star Macalline Furniture Mall (RSMFM), lifting its book NAV to S$0.70.

Slight improvement in operations. Operations-wise, the RSMFM saw higher commitment in occupancy to 71.7% as the master lease for Red Star kicks in while the take up at Shenyang Longemont Shopping Mall (SLSM) remained at 70%. Meanwhile, the committed leases at Perennial Jihua Foshan climbed up to 60% while the Perennial Qingyang Chengdu has 33% of its space taken up in advance. The former is expected to commence operations in 2Q13 while the Chengdu property is expected to open ahead of schedule, in 4Q13 or 1Q14.

Our View

Execution is key. Looking ahead, with 90% of the initial portfolio now completed, the group can focus on ramping up occupation of its properties. It is currently evaluating leases from wholesale tenants for the West Wing of the RSMFM. If successful, this will fully fill the RSMFM. Meanwhile at the SLSM, the group is targeting to lift occupancies, currently at 70%, as well as shopper foot traffic of 40-50k/day. Rental rates have been maintained at Rmb3.72psm/day. At the Shenyang Office component, about 16% of the space has been taken up or committed, at Rmb90+psm/mth. The group would continue to look to boost take up at this property in coming months.

New developments to boost RNAV in the medium term. In addition, the group recently added the Beijing Tongzhou development (10% stake) as well as a ROFR for the retail portion of the Tongzhou project to its development portfolio. This is in addition to the option for the Xian HSR project. This will continue to extend the visibility of earnings and RNAV growth into the medium term. Gearing remains healthy at 19.9%.

Recommendation

Maintain BUY. We continue to like PCRT for its attractive valuations, at 6% yield and 0.9xP/bk NAV. Earnings visibility has improved as the development assets are completed and generating cashflow. Maintain Buy with TP of $0.84.

Looking towards monetisation

Traditionally a weaker quarter,4Q12 was saddled by pre-operatingcosts for Foshan and Chengdu malls too. Management expect leasing improvements. Of greater interest is a clear direction towards asset trading and strata titling to boost near-to mid-term returns.

4Q/FY12 was in line with consensus and our expectations at 25%/100% of full-year estimates, supported by earn-out structures. Our target price rises as we cut our RNAV discount from 30% to 20% as >90% of the IPO portfolio is now completed. We raise FY13 DPU by 4% and lower FY14 by 6% for balance earn-out structures. Maintain Outperform, with accretive divestments as the catalyst.

Expect weak earnings

Underlying core earnings from JVs were up a marginal 1.5% qoq in 4Q12, bringing FY12 to S$5.4m, below our expectations. Core net profit was also hit by higher-than-expected pre-operating costs for Foshan and Chengdu Qingyang malls. We expect the weak earnings to persist but project the trust to turn profitable in FY13, boosted by revenues from Foshan mall (to commence with target 90% occupancy) and Shenyang office. On the leasing front, pre-commitments stand at 16% for Shenyang office, 60% for Foshan mall and 33% for Chengdu Qingyang mall, with more progress to come in the next few months.

Strategy articulated

Management has reiterated its confidence in the long-term value of its properties but articulated the need for short-term gains to grow the business, through monetising completed assets (recycling capital) and strata sale of non-block retail and office components. FY12 valuations, at 6.5% cap rates (unchanged from FY11), are up to 58% above the purchase price of assets – divestment gains could be substantial.

6.3% yield for FY13-14

Based on management’s target Rmb227m distribution for FY13 and balance earn-out for FY14, we estimate 6.3% yield for the next two years in addition to 10-15% NAV/share growth from FY12’s S$0.70. Valuations are still attractive at 25% discount to RNAV and 0.9x P/BV. Maintain Outperform.

Gaining a little more traction

• Results in line, lifted by Earn Out Support
  
• Leasing activities gaining a firmer foothold
  
• Maintain Buy, TP unchanged at $0.84
  

Highlights

Results in line, supported by Earn Out. PCRT reported 3Q12 results that were in line with projections. Operating income at associate and JCE level was S$1.5m, up 5.5% q-o-q. This was achieved on the back of improved occupancy of 72% at Red Star Macalline Furniture Mall (vs 50.6% in 2Q) while occupancy and average rents at the Shenyang Longemont Shopping Mall held steady at 70%, with rents averaging Rmb3.72psm/day. There was also a top up of S$12.2m of earn out deed support during the period. This was partly offset by higher interest expense of S$1.5m for the recent MTN raised.

Gaining a little traction at Shenyang. PCRT had converted Red Star Macalline’s (RSM) lease at the furniture mall to a master lease from Sep 12. The lease is for more than 10 years at a slightly lower average rent of Rmb1.35psm/day but offers security of long term tenure. Effectively, RSM takes c.60% of the furniture mall’s total GFA. Occupancy of the Shenyang Longemont Mall (SLM) remained relatively flat at 70% with rents unchanged at Rmb3.72psm/day despite tenant mix shifting towards a little more cosmetics and fashion related. The Shenyang office space has seen slightly higher interest for about 10% of space (vs 1% previously) and these are currently under negotiation and review.

Our View

Taking time to ramp up. Looking ahead, we believe 4Q would remain relatively flat q-o-q as PCRT will continue to ramp up take up rates at the Shenyang Longemont shopping mall with more entertainment and education related tenants expected to commence from 1Q13. Meanwhile leasing activities at the office component, scheduled to commence in 4Q12, is expected to accelerate during its Earn Out period. With the conversion of RSM into master lease, the group would focus on leasing out the remaining space and is expected to target wholesale tenants. Perennial Jihua Foshan, currently 50% pre-leased at Rmb4plus psm/day, is expected to open at end 1Q13. This will improve the trust’s operating cashflow position. This should be complemented by the Perennial Qingyang Mall in Chengdu in 2Q14.

Gearing at 30.1%. With the latest $130m MTN note issue, PCRT’s gearing had risen to 30.1%. The proceeds will be deployed to paying for the 1st 15% installment of the Dongzhan Mall as well as investment in the Tongzhou project.

Recommendation

Retain Buy. We maintain our Buy call on PCRT with a RNAVbacked TP of S$0.84. The stock is trading at 0.73x P/Bk NAV. With a remaining Rmb342m of Earn Out Support, distribution visibility to unitholders is certain during the period of operational ramp up. As its projects start to generate income, we expect the gap between RNAV and share price to narrow.

Leasing progress

Further strengthening of operational malls in 3Q12 and leasing progress at upcoming malls ahead of commencement augur well for 2013.While interest costs inched up, loan facilities provided sufficient financing to meet future cash commitments.

3Q DPU accounted for 25% of our full-year estimate while 9M12 DPU made up 74%, in line with our and consensus expectations. We roll over estimates to FY13, reducing the target price to S$0.59, now based on a 30% discount to RNAV (previously 35%) as more assets are operational. We maintain Outperform, with stronger leasing and retail sales as catalysts.

Operational improvements

Underlying operational performance saw a second quarter of pick-up with profits from operational malls growing 6% qoq. While 4Q12 could be slower due to leasing difficulties in winter, we should see further strength in 1Q13. 60% of NLA at Shenyang furniture mall has been converted to a master lease for income stability while further leasing progress has been made at the upcoming Shenyang office, Foshan Jihua mall and Chengdu Qingyang mall.

Balance sheet strength

Interest cost is our main concern following issuance of S$130m of 6.375% 3-year notes in Sep, bringing 3Q’s weighted average financing cost to 4.74% (2Q12: 2.96%). 9M12 interest expense was above at 80% of the FY12 estimate. We expect potential partial onshore funding of Chengdu Longemont to raise financing cost further but loan facilities should be sufficient to meet cash commitments. Factoring in future progress payments, we estimate c.40% gearing in 2013 and 2014, within management’s internal limit of 50% (3Q12: 30%). Monetisation of assets in 2014-16 could fund further acquisitions. Management estimates 25-40% IRR if assets are monetised in 3-4 years after commencement.

Dividend buffer

Earn-out structures alone guarantee 8-9% dividend yield. We see potential for stronger yields in FY13-14 on improved operations.