Perennial jumps 7.1% after investments

SHARES of Perennial China Retail Trust shot up yesterday following substantial investments from the co-founders of Wilmar International.

Perennial's mainboard-listed stock closed at 53 cents yesterday, up by 7.1 per cent or 3.5 cents.

"I think the market is hungry for any kind of good news," one trader said.

The Singapore-headquartered business trust with a focus on retail real estate in China announced late on Wednesday that Wilmar chairman and chief executive Kuok Khoon Hong bought about $60 million worth of shares in an off-market transaction to raise his deemed stake in Perennial to 16.94 per cent from 5.02 per cent. The shares were bought at about 44.625 cents apiece on average.

Wilmar chief operating officer Martua Sitorus also raised his deemed stake to 5.66 per cent from 3.17 per cent previously.

Mr Kuok bought his shares from China businessman Tong Jinquan, whose wholly owned Shanghai Summit (Group) Co is a strategic partner of Perennial. Mr Tong, who previously held a 14.9 per cent stake, no longer owns Perennial shares.

But Mr Tong will continue to be a key business partner in China, Perennial Real Estate Pte Ltd executive chairman Pua Seck Guan said. Mr Tong's Shanghai Summit has also agreed to an additional "earn-out" amount of 342 million yuan (S$67.9 million) from July 2013 to end-2014. That money can be drawn down to ensure that Perennial can pay a minimum dividend of 19.4 yuan cents per unit during the relevant period.

"This new agreement could lift 'guaranteed' dividend yields to 8-8.5 per cent till FY14," CIMB analysts Donald Chua and Lee Syn Yi wrote in a note. "While management has not indicated any target distributions for FY13 and FY14, this ample buffer provides greater certainty of [dividend per unit] growth over the next three years and potentially more than 8 per cent dividend yields till 2014."

Mr Pua also entered into a deal with Mr Kuok and Mr Sitorus to establish Perennial Real Estate Holdings Pte Ltd, an investment vehicle with a target capital size of $500 million. The vehicle will eventually hold 49 per cent of Perennial Real Estate Pte Ltd, which controls 78 per cent of the trustee-manager of the listed entity.

Mr Pua told BT that Mr Tong's sale was a solution to onerous and hampering interested-party transaction rules that resulted from Mr Tong's role as a business partner in China.

Mr Tong's ability to act as a major sponsor, like in a rights issue, was also limited because of China's capital controls.

"He can't subscribe! And then people will think something is wrong," Mr Pua said.

Mr Kuok was a valuable shareholder with the depth of his pockets and his experience in China, Mr Pua added.

"He said, 'Seck Guan, you remind me of what I was 20 years ago trying to build my business'," Mr Pua recalled. "If we combine our strengths we could actually capitalise on a lot of opportunities in the marketplace today."

Change in major shareholder

Change of shareholding saw PCRT’s local partner offloading his stake in PCRT. Mr Kuok now holds a 17% stake. New additional earn-out amount negotiated with Summit Group buffers this negative news.We take comfort in greatercertainty of higherdividend yields till 2014.

Without further guidance on target distributions for FY13/14, we leave our estimates unchanged. No change to RNAV or target price (35% discount to RNAV)either.Maintain Outperformon cheap valuations, attractive dividend yields and strong NAV growth.

WhatHappened

Mr Tong Jinquan has pared down his 15% stake in PCRT. Mr Kuok Khoon Hong replaces him as major shareholder with 17% ownership. An additional earn-out agreement has also been negotiated with local partner Shanghai Summit, wholly-owned by Mr Tong, for an amount up to Rmb342m for the period beginning1 July 2013 to 31 December 2014.

What We Think

The local partner’s sale of a 15% stake does not inspire confidence.However, additional earn-outbuffers the negative news. As this is likely to be used to support distributions, we take comfort in the added certainty of higherdividend yields. We estimate that the negotiated amount is sufficient to guarantee 8-8.5% dividend yieldsfor the next two to three years. We previously expected a dip in dividend yield in 2014. A quick chat with management confirms that there have been no changes to existing arrangements as laid out during the IPO. Mr Tong still retains a 50% stake in Longemont assets –interests are still aligned for these projects. The operations on the ground and PCRT’s relationship with Mr Tong remains unaffected.Transfer of shares to Mr Kuok (off-market transactions) was by way of mutual agreement, for Mr Kuok to gain more exposure to PCRT’s assets and PCRT’s for business dealings with Mr Tong to cease classification as “interested-party” transactions.

What You Should Do

Trust PCRT.As construction and acquisition forits portfolio of assets continue as planned, double-digit NAV growth is still expected.Trading at 0.7x P/BV and a 50% discount to our RNAV, valuations are undemanding (CRCT:0.9x P/BV, 7.7% 1Q12 annualised dividend yield).

Proxy for China’s retail spend

Pure-play China retail development business trust. Listed in June last year, Perennial China Retail Trust (PCRT) is Singapore’s first pureplay China retail development business trust. This means that there is no restriction on the number of development assets PCRT can hold, unlike a REIT. Gearing also is not capped, although management has a self-imposed limit of 60%.

Well-located properties. PCRT’s portfolio includes three properties in Shenyang and two suburban malls in Foshan and Chengdu that are still under construction. In addition, the business trust has the options and right of first refusal to prime commercial development sites directly connected to the high-speed rail (HSR) stations in Chengdu, Xi’an and Changsha. It recently obtained unitholders’ approval to acquire a 50% stake in Chengdu Longemont Mall, which will have a GFA of 455,260 sqm, to be built beside Chengdu’s HSR station.

Initial portfolio to be fully operational by 2014. PCRT’s initial portfolio comprises its 50% stakes in Shenyang Red Star Macalline Furniture Mall, Shenyang Longemont Shopping Mall, Shenyang Longemont Offices, Foshan Yicui Shijia Shopping Mall and Chengdu Qingyang Guanghua Shopping Mall. Currently, only the first two properties are in operation, but PCRT expects all the properties to be completed and income-producing by 2Q14. Even Chengdu Longemont Mall is expected to be completed by 3Q14.

Proven management record. PCRT’s sponsor is Perennial Real Estate Pte Ltd, helmed by Mr Pua Seck Guan. With over 20 years of real estate experience, Mr Pua was instrumental in Singapore’s first REIT listing of CapitaMall Trust and was CEO of CapitaLand Retail Limited (which later became CapitaMalls Asia). During his time at CapitaLand, Mr Pua was involved in the acquisition, development and management of 70 malls across China.

Ride the upside. PCRT unitholders can look forward to NAV growth as its properties get completed and stabilised, given the attractive acquisition costs which are on a completed basis. When China’s capital markets mature, there may be avenues to realise the enhanced value. In the meantime, unitholders are likely to be rewarded with a DPU of 3.86 cents for FY12F, translating to an attractive yield of 7.4%.

Catching the wave of China’s consumer demand

Through PCRT’s well-located malls in Tier-2 cities, we see potential for strong NAV growth, backed by an experienced management. China’s 2012 focus on expanding consumer demand could not be better timed. CMA’s strong YTD performance(+36%) leaves room for catch-up.

We initiate coverage with an Outperform and target price based on a 35% discount to RNAV (wider than CMA’s 25% discount). Higher-than-expected rents and asset revaluations through physical completions are potential catalysts.

Growth, costs, yields

We see strong rental-growth potential for PCRT’s sites, located at transportation nodes (e.g. high-speed rails, local metros, bus terminals) and likely to benefit from higher shopper traffic. Acquired at low costs through local partnerships, PCRT should be able to achieve optimal yields. Once its malls stabilise, positive rental reversions should be backed by yoy retail sales growth of 15-20% (for 2011). We expect 2015 to be an inflexion point once its malls are completed. Dividend yields of 7% are guaranteed for 2012, after which stabilised recurring income should support 4-5% yields on a 50% payout.

Experienced management

We are confident of management’s ability to manage malls and deliver NAV growth. Real-estate veteran Mr Pua Seck Guan’s (ex-CEO of CMA/CMT) experience is invaluable. Thus far, management has delivered on projected distributions and acquisitions, namely the Chengdu Longemont development. Newly operational assets in Shenyang also achieved decent initial occupancy rates of 70-90%. Factoring in a longer 3-year gestation (vs. management’s target of one year), a portfolio yield-on-cost of 7% in 2015 should be within reach.

NAV growth milestones

On top of 4-5% dividend yields, we estimate that NAV can grow by up to 16% CAGR till 2015. Clear milestones are established with at least one asset to be completed a year till 2014, and two more in the pipeline. At a 45% discount to our RNAV, its share price has yet to reflect its growth potential, we believe. With CMA’s strong performance YTD (+36%) compared with PCRT (+15%), we see room for PCRT to catch up.

Deepens exposure into Chengdu

• Seeks approval to buy 50% stake in Chengdu Longemont Mall

• Attractive pricing, financing flexibility minimises risk, strong total return potential

• Maintain Buy and S$0.83 TP

Acquiring Chengdu Longemont Mall at RMB10,000psm. In its latest circular issued to unitholders, PCRT is seeking unitholders’ approval for the acquisition of a 50% stake in Chengdu Longemont Mall (CLM) for RMB2.28bn. At the same time, it is also seeking approval for two other resolutions related to management fees and acquisition fees. To recap, in Nov 11, PCRT announced plans to buy a 50% share in CLM from the Summit Group for RMB2.28bn or a RMB10,000psm on a completed basis. In the latest circular, PCRT has also outlined the flexibility to upsize its stake in the mall to up to 80%, if transactional GFA falls 95% of the 455,260sm. In addition, the group has another option to buy a 50% share in another 544,740sm GFA in the Chengdu Longemont mixed-use project.

Attractive pricing with additional ‘Earn Out Support’ for better visibility on dividends. The deal will not only enable PCRT to expand its asset base at an attractive price but will also strengthen its retail presence and tenant network in Chengdu. Post acquisition, Chengdu will account for about 36% of its attributable GFA. It will be earnings and NAV accretive. We expect this transaction to generate a yield on cost of 8.4-10% when completed and fully occupied, an attractive level when compared to the market net cap rates of 6.5-7%. In addition, the flexible financing terms and fixed psm cost would enable the group to minimize risk of cost overruns during the construction period. Moreover, with an additional RMB226.5m from the new Earn Out Deed negotiated by the Trustee-Manager, this will boost Earn Out support to c90% of the anticipated distribution of the trust from FY11-1HFY13, thus providing unitholders with more stability and visibility on dividends. When

completed, we estimate CLM could add 10cts to RNAV to $0.93.

Strong total returns when malls become operational. PCRT offers investors a strong total return derived from NAV growth as well as yield when its malls are gradually developed and ramped up. The portfolio is currently 41% operational by GFA, rising to 54% and 63% by end FY12-FY13 and fully ramped up by end FY14. We have tweaked our distribution income to account for some changes in asset completion dates. At the current share price, the market is valuing PCRT’s existing portfolio at below replacement cost, at cRMB6,320psm. Maintain Buy with S$0.83 TP, based on a net present value of the existing portfolio value, assuming fully operational by FY14.