Staying the course

Event

• PREIT announced a DPU of 2.09 cents (+10.6% YoY) for 2Q10, factoring in the revenue contribution from its acquisitions in Japan. The number is in line with our expectations. The group is targeting other high‐growth healthcare markets, such as Malaysia, for more acquisitions. Maintain BUY with target price raised to $1.64.

Our View

• At half‐year, PREIT recorded $25.1m in distributable income, which accounted for 50% of our full‐year forecast. We expect earnings to be stronger in 2H, as the minimum guaranteed rent for its Singapore hospitals is set to increase by 2% and its two Japanese acquisitions in June and July will begin to contribute to revenue.

• PREIT’s enlarged portfolio of 32 properties has a committed occupancy rate of 100% and a weighted average lease term to expiry of 13.6 years. These serve to underpin the defensive nature of its income.

• Gearing has risen to 34.4% after its July acquisitions. PREIT has debt headroom for only $121.5m before reaching 40% gearing. Hence, any major acquisition henceforth would be funded by debt and equity.

Action & Recommendation

Potential acquisitions, which have yet to be factored in, are catalysts for a re‐rating. With the uncertainty over the ownership of its sponsor Parkway Holdings being resolved, the acquisition of its Malaysian Pantai group of hospitals now looks probable, in our view. We have raised our target price to $1.64 on lower cost of equity assumption. Maintain BUY.

Parkway Life Reit on the prowl

HOT on the heels of two recent acquisitions, Parkway Life Reit has indicated it could take a more aggressive growth stance as the recovering property sector in the Asia-Pacific presents more acquisition opportunities.

‘The global economic recovery has driven improvements in the regional real estate and Reit markets, bringing about further growth opportunities for Parkway Life Reit,’ said Yong Yean Chau, CEO of the trust’s manager Parkway Trust Management. ‘With the improving economy, healthcare operators are looking to expand by going asset-light, thereby enlarging the pool of healthcare assets available in the market and availing of more options for Parkway Life Reit in our selection of good-quality acquisition targets.’

Without revealing where the targets are, Mr Yong said the Reit has ‘a strong acquisition pipeline’. He added his company had been approached by more healthcare asset owners looking to sell their properties. However, the trust will continue to target developed and mature markets that share similar legal frameworks and risk profiles as Singapore, such as Malaysia and Australia.

As for Japan – where the trust recently acquired six nursing care facilities in June and another five nursing homes in July – it will be looking to consolidate and derive greater synergy across its properties.

Meanwhile, its portfolio of properties in Japan already accounted for 28 per cent of its Q2 net property income of $17.3 million, according to financial results announced yesterday. The Reit posted a 10.9 per cent increase in Q2 income distributable to unitholders to $12.6 million.

For the three months ended June, gross revenue went up 16.4 per cent to $18.7 million, boosted by contributions from the Japan acquisitions and higher rent from existing properties in Singapore. Q2 distribution per unit (DPU) works out to 2.09 cents, up from 1.89 cents a year back.

Including DPU of 2.07 cents in Q1, DPU for the first half came to 4.16 cents. On an annualised basis, this is a yield of 6.11 per cent, based on the closing share price of $1.36 at end-June.

Property expenses in Q2 went up 27.2 per cent to $1.4 million, while non-property expenses rose 27.6 per cent to $4.7 million. The Reit is due to refinance its Japanese yen loan facilities, amounting to about $207 million, in H2 next year. But it plans to do so by the current quarter. As at June 30, its debt-to-asset ratio was 32.6 per cent.

Other than its 29 properties in Japan, Parkway Life Reit’s assets include the Mt Elizabeth, Gleneagles and Parkway East hospitals in Singapore. Its total asset value is about $1.3 billion.

Humming Along Nicely

• Distributable income rose 1% sequentially (and 11% y-o-y reflecting contributions from the nursing homes in Japan acquired since 2008) to $12.62 mln or 2.09 cents per unit. (PLife now owns 24 nursing

homes and other healthcare-related assets in Japan, representing 37% of total revenue.)

• On an annualized basis, that translates to 5.8% yield. Price / NAV is 1.04x. Gearing is a comfortable 32.6%.

COMMENTS

1. We maintain BUY even though the healthcare reit is at a record high. (It hit $1.50 on Aug 2.)

2. PLife has become even more “transparent” with more disclosures.

3. It is comforting to know that despite several acquisitions in Japan, 88.1% of PLife’s revenue has “downside protection”, ie not just the 3 Singapore hospitals, where minimum revenue is set to grow by 1.73% from Aug 23rd ’10 – Aug 22nd 2011 under the arrangement with Parkway Holdings: annual rental to grow by at least 1% + CPI.

4. PLife expects to complete in the current quarter the refinancing of 46.1% of its total existing loans (or S$207 mln), likely at even lower interest rates, given the anemic economic growth in Japan.

5. We also believe PLife offers an attractive alternative to Parkway, which Khazanah may well end up taking full control of, given the “rich” valuation that its $3.95 a share offer represents. Expectation is for Khazanah to then raise hospital charges here, which can only be good for PLife. (Parkway owns 35.77% of PLife.)

6. This could also result in more acquisition opportunities for PLife, for which PLife has ample “debt headroom”: $122 mln and $835 mln before gearing hits 40% / 60% respectively.

Stable as it is

At a Glance

• 2Q10 DPU of 2.09 Scents (+10.9%) within our expectations; NPI growth driven by 8 nursing homes acquired in Nov’09

• Potential for interest savings (current : 2.6%) as it explores refinancing for JPY facility of S$207m (due in 2H11) in 3Q10

• Buy, TP: S$1.59, for its 6% yield, stable, defensive structure with 88% rental downside protection

Comment on Results

2Q10 DPU 2.09Scts, within expectations. 2Q10 DPU of 2.09 Scts (+10.9% yoy; 1% qoq) was within our expectations. Gross revenue grew to S$18.7m (+16.4% yoy), driven largely by additional contribution (S$1.8m) from the 8 nursing homes in Japan acquired in Nov’09, higher rental from existing properties, and partial contribution from 6 nursing homes acquired in Jun’10. NPI margin fell marginally to 92.4% arising from expenses related to the 8 new nursing homes. As a result, NPI grew by 15.6% to S$17.3m.

Minimum rent for Singapore Hospital to grow by 1.73%. Rental for its Singapore hospital is set to grow by at least 1.73% in its 4th year of lease (Aug’10 – Aug’11) over the actual rental in the 3rd year of lease, based on (CPI+1%) formula.

All-in effective borrowing costs at 2.6%, with a weighted average term to maturity of 2.87 years. PREIT is exploring and targeting to complete the refinancing of a JPY facility of c.S$207m (due in 2H11) in 3Q10, to further lengthen debt weighted average term to maturity. With the tightening of credit spreads, this could present potential interest savings.

Recommendation

Resolution of tussle at Parkway offers Life a clearer path. With the emergence of a clear “winner” for majority control for Parkway, we believe this bodes well for PREIT. Having Khazanah as the major shareholder also provides for the possible injection of Pantai hospitals in Malaysia, in our view, though this could take place over the medium term.

A defensive play, with opportunistic growth. We like PREIT for its stable, defensive portfolio with 88% of portfolio revenue with downside rental protection and 98.4% with rent review provision. Gearing stands at 34%; PREIT has an additional debt headroom of c.S$121.5m before reaching 40% for acquisitions, though we believe there could be some form of equity raising should there be a potentially larger deal, given our view that management will likely not overstretch its balance sheet. Maintain Buy, TP S$1.59 based on DCF (WACC 6.6%, t=2%)

Adds another five Japanese nursing homes

Further enhances presence in Japan. PREIT bought another five nursing home properties in Japan, for a total of JPY3.1b (~S$46.8m). These properties come with an expected net property yield of 8.35%. We estimate that this acquisition (expected to be completed by 23 Jul 10), would boost our FY10 DPU to 9.3 S¢, from 9.1 S¢. With this acquisition, PREIT’s Japanese assets will have a value of S$408m, which is what management has been building towards. With the additional contribution from the new assets, based on our DDM valuation we derive a TP of S$1.66 (from S$1.62), which would translate into 5.6% FY10 yield. PREIT currently trades at 6.8% FY10 yield. Maintain BUY.

Achieves minimum asset size of S$400m. PREIT has been building up towards a minimum asset size of S$400m for its Japan portfolio, which is one of the requirements to allow it to switch tax structure. Its Japan assets are acquired under the “Tokumei Kumiai” (TK) structure. Switching to the “Tokutei Mokuteki Kaisha” (TMK) structure could allow PREIT to lower its withholding tax from 20% to 5%. The TMK structure issues bonds (TMK bonds) or preferred shares to its investors. Hence, the other requirement to consider, for a successful switch to the TMK structure, is the Japanese bond market’s reception to the bond issue. Hence, even though PREIT has achieved the minimum asset size needed, it does not need to immediately switch structure.

Gearing still below 40%. The acquisition of these five nursing homes will be funded entirely by debt. PREIT’s gearing would rise to 34% at end FY10. This leaves it with debt headroom of ~S$140m before crossing 40% gearing.