Parkway Reit cautious despite good results

It has also secured a $50m Islamic revolving credit financing facility

PRUDENCE is the call at Parkway Life Reit, even as the healthcare trust reported an improved set of second-quarter results yesterday. The trust has secured a $50 million Islamic revolving credit financing facility by The Islamic Bank of Asia, even though it already has ample funding facilities to support potential acquisitions.

‘This $50 million is both a defensive and competitive strategy,’ said Yong Yean Chau, CEO of Parkway Trust Management, which manages the trust. ‘Defensive in a sense that the market has rallied, no doubt, but we’re not very sure whether the recovery is sustainable or it may break somewhere.

‘It could, well, pardon me, crash and go back down to the bottom. With this facility, because we’ve got a $34 million loan that is due next year July, if market crashes, the capital market can close easily and we don’t want to be stuck without financing.’

However, the maturity of its existing $34 million debt can be extended to 2012. In the event that the Islamic financing facility is not used, then it will serve to beef up its war chest for opportunistic acquisitions.

Parkway Life Reit has previously set up a $500 million multi-currency term note programme that has yet to be tapped. It also has access to credit facilities of $160 million, of which $34 million has been drawn. Other long-term borrowing include a term loan facility and several revolving credit facilities amounting to 13.66 billion yen (S$207.9 million), due in late 2011. This was used in 2008 to finance the acquisition of Japan properties.

The trust has a debt headroom of $308.3 million before reaching 40 per cent gearing ratio. Its gearing ratio stood at 22.7 per cent, but it does not intend to gear up above 35 per cent.

Parkway Life owns the Mount Elizabeth, Gleneagles, and East Shore hospitals in Singapore, and 10 assets located in Japan, including nursing homes and a pharmaceutical product distributing and manufacturing facility.

For the three months ended June, the Reit posted a 13.7 per cent increase in income available for distribution to $11.4 million. This brings distribution per unit (DPU) to 1.89 cents, higher than the 1.66 cents in Q2 last year.

Gross revenue for the quarter rose 28.9 per cent to $16.1 million, primarily due to higher revenue contribution from its Japan properties. This was further driven by the higher rent from the group’s Singapore hospital properties, which is pegged to a CPI + 1 per cent (ie 6.25 per cent) formula.

Property expenses went up 43.6 per cent to $1.1 million, resulting in net property income of $15 million, a jump of 27.9 per cent over last year.

For the half year, income available for distribution went up 15.1 per cent to $22.8 million. DPU rose to 3.78 cents, from 3.29 cents.

Despite the downturn, there has been little change in the valuations of healthcare and healthcare-related properties, according to Mr Yong. However, the lacklustre economic climate has presented more opportunities for investment as more healthcare players and owners explore an asset-light strategy. ‘And these are very good names, both in Singapore and overseas,’ he said.

Shares of Parkway Life Reit closed 3 cents higher at $1.08 yesterday, before its results were released.

Asset enhancements and CPI to boost DPU

• In line. 2Q09 distribution of S$11.4m (+14% yoy) and DPU of 1.89 cts (+14% yoy) were in line with Street and our expectations. YTD DPU of 3.77cts forms 50% of our full-year forecast. Net property income of S$15.0m (+28% yoy) was driven by full contributions from Japanese assets as well as higher rent from Singapore hospitals due to a high CPI + 1% (i.e. 6.25%).

• Singapore Hospitals’ minimum guaranteed rent to grow by 4.36%. Management announced that CPI for the next minimum guaranteed rent period (23 Aug 09-22 Aug 10) has been determined at 3.36%. This implies that under its unique lease structure, the minimum guaranteed rent from PLife’s Singapore hospitals is set to grow by 4.36%, based on its CPI + 1% lease structure.

• First asset-enhancement initiative; no borrowings required. The manager announced the completion of its maiden asset-enhancement work on its Japanese property, PLife Matsudo, at end-Jul 09. A total of S$2.56m had been spent to convert a utility room to a production area. The work was funded by cash on hand, with no impact on asset leverage. The enhancement should be highly accretive with a 17.4% return on investment. However, the incremental impact on DPU is not material at less than 1%. Nonetheless, this is a positive move to enhance the contribution of assets. We understand that this is the start of more enhancement work, which could include Singapore assets that contribute the lion’s share of revenue at 80%.

• Maintain Outperform; FY10-11 forecasts and target price raised. We raise our earnings estimates based on the announced CPI numbers, and include the accretion from asset enhancement. Separately, we increase our trust expense assumptions. Our DPU estimates rise by 2% for FY10-11. Our DDM-based target price rises correspondingly to S$1.31 from S$1.29 (discount rate 7.2%). We like PLife REIT for its visible earnings from its CPI + 1% formula and possibly upside from further asset-enhancement work. The acquisition of assets also looks probable in the near future with its low asset leverage of 23% and the availability of funding at undemanding costs. PLife offers an attractive and sustainable yield of 7% at 0.8x P/BV. Maintain Outperform.

Steady performer

• Maintain Outperform. PLife’s exposure to the resilient healthcare sector, long lease structures of up to 15 years and built-in rent increases pegged to the CPI give greater clarity to its income streams than the other REITs under our coverage. Downside risks to the topline are almost zero for its Singapore portfolio which contributes 80% to PLife’s revenue. With low asset leverage of 23% and the absence of debt maturity till 2H10, PLife is positioned for stable growth even in a difficult financial climate.

• Acquisition rationale and strategies. While short-term acquisitions are likely to remain opportunistic, medium-term targets will likely come from low-risk countries with quality healthcare assets and transparency in government regulations. Management will also attempt to keep similar leasing arrangements for future acquisitions so as not to erode the defensiveness of the REIT. In the longer term, management intends to cut down concentration risks from its major tenant and sponsor Parkway Holdings to 60%. As offers from cash-strapped healthcare operators continue to grow and capital markets seem to be opening up again, we expect acquisitions to be a kicker for PLife.

• DDM-derived target price raised to S$1.24 from S$1.20. This is based on a lower discount rate of 7.9% from 8.1% earlier due to a lower risk-free rate of 4.8% applied across our REIT universe.

Inflation linked revenue model provides resiliency. Over 80% of revenue is derived from hospitals in Singapore while the rest are from nursing homes and healthcare facilities in Japan. Plife REIT collects rental from its tenants based on an inflation linked formula. In August 2008, rental for the Singapore hospital was revised up 6.25% (average CPI over the 12 preceding months plus 1%). Although we have seen CPI reading sliding off from 6.7% in Sep 08 to register a negative reading of – 0.3% in May 09, unless CPI continuously register a monthly reading of –9.5% for the next four months to offset the positive readings in the prior nine months, the CPI +1% formula ensures that rental revenue grows at the minimal rate of 1%. In our forecast, we have assumed a 2% growth and maintain our projections at the moment, though we think surprise may be on the upside.

Credit rating downgrade a non-issue. Fitch Ratings downgraded Plife REIT longterm issuer default rating from BBB+ to BBB with a stable outlook. We view the rating cut as a non-issue as fundamentals remain sound. Gearing is currently 23% and Plife REIT has total debt of $247.5 million with interest cover of 6.7. $34 million of loan is due in the 2nd half of 2010 while the rest are due in 2011.

We maintained our forecast numbers and reassert our optimism in Plife REIT. Plife REIT is not subjected to the cyclicity of the economic cycle unlike other REITs. We raised our fair value estimate to $1.18 due to lower risk premium input in our DCF model.

Risk factors. Risk includes a prolong deflation scenario, which will cause our revenue estimates to be excessive. However the variance is not significant as changes to our forecasted DPU is less than 1%. We think the main risk would be a further credit downgrade as the maturity of the loans draw near and Plife REIT has not announced its refinancing plans.

Nagging Concern, But . . . . .