Treasury China allays fears over supply glut

Trust upbeat on office, retail rentals, citing strong demand in China

TREASURY China Trust (TCT) expects further upside in office and retail rental rates on the back of strong demand in China and dismisses concerns over a potential office supply glut in Shanghai raised by a brokerage report.

TCT chief executive Richard David said the group is looking at 10-12 per cent rental price growth this year, similar to the growth pace in the past three years.

A 21 per cent rise in Shanghai’s Grade A office rents projected by Jones Lang LaSalle in a report late last year also looks achievable.

‘Based on transactions that we have done in the first half of this year, we don’t think this is an unrealistic number,’ Mr David told BT.

‘What we are seeing over the last 12 months in our portfolio is stronger rental growth, so as we are headed for the next 12-24 months, there are leases up for renewal and I think we are in a very good position.’

A recent report by Phillip Securities cited office supply glut in Shanghai as the main threat to TCT, given that one million square metres of new office supply is expected to come onstream this year – about three times the average historical annual supply.

Apart from concentration risk in Shanghai, Phillip Securities also cited higher borrowing costs amid an interest rate hike and credit tightening in China as factors weighing on TCT.

‘These are legitimate questions to answer,’ Mr David said. Fund managers and investors have sought updates from the group since. But there are several mitigating factors, he said.

TCT’s properties are located in the less cluttered district of Puxi, where only 21 per cent of the new office supply are located, he added.

High capital costs and disruptions to business also hold companies back from relocating to new office space.

The bigger risk to TCT, Mr David reckoned, is any major loss of staff to deal with rental renewals effectively.

‘That’s probably more of an issue for me than to worry about the guy who is building 50,000 sq m down the road because he should be worried about us. I’m not worried about him, because I know we have a very compact business structure.’

Mr David also explained that TCT’s borrowing costs is cushioned from the impact of rising interest rates in China, as only 15 per cent of its debt are in yuan and 85 per cent of its debt are US dollar loans.

TCT’s current portfolio comprises Central Plaza, City Center, and Treasury Building in Shanghai Puxi and the 74,000-square-metre development space in Beijing International Logistics Park.

With its Shanghai properties enjoying over 90 per cent office occupancy, the business trust is seeking expansion space for its tenants.

It has also set aside one billion yuan (S$190 million) for acquisitions of retail assets it has identified in Shanghai and Xi’an.

The recent acquisitions of a 55 per cent interest in Central Avenue Mall in Qingdao and a 100 per cent interest in Huai Hai Mall in Shanghai are expected to boost the group’s gross revenue by 15 per cent, Mr David said.

TCT had, in the first quarter ended March 31, achieved gross revenue of $19.45 million, 1.9 per cent above forecast, and a net property income of $12.45 million, exceeding its forecast by 8.6 per cent.

Proactive asset management

•We visited commercial properties of TCT recently in Shanghai and Qingdao

•High quality of assets demonstrate capability of team in managing property

•Strong refurbishment and development pipeline, imply rental upside in future

•We have no rating on TCT

Background

Treasury China Trust (TCT) is a property owner, developer and manager with exposure purely in China commercial real estate market. Listed on SGX in June 2010, the trust is positioned as a ‘total return vehicle’ aims to increase shareholder value via both capital appreciation and income growth. These can be achieved by holding both income producing commercial real estate as well as development properties. Listed as a business trust also allows TCT to undertake higher component of development, up to 30% of total assets, compared to REIT. Currently the trust holds commercial property portfolio worth over RMB11.5bil (circa S$2.18bil).

Key takeaways

• Central Plaza is a showcase of TCT’s ability to carry out asset enhancement initiative to increase the assets rental and capital value. Current rental yield on cost improved from 5.5% to 6.7%.

• A sizable extension is being built to enlarge City Centre by ~50%. Higher rental reversion is expected when the current anchor tenant, Parkson, vacates the mall in 2012 as the existing rent is well below market rate. TCT has secured Marks & Spencer to be the next anchor.

• TCT is in the process of acquiring Huai Hai Mall, located in one of the high-end shopping precinct in Shanghai. Thorough refurbishment work is planned to reposition the status of the mall. We see great potential on this acquisition due to its prime locality.

• Out of Shanghai, TCT acquired Central Avenue Mall in Qingdao earlier this year with an attractive gross yield of 10% on the current operating mall, in addition to 3 adjoining land parcels to be developed into retail malls by 2015. The sites are situated in the centre of activities in the Laoshan District.

Investment merits

• Rental income upsides substantiate by the strong pipeline activities.

• Potential divestment of majority stake in Central Plaza allows redeployment of cash to other high-yielding investment opportunities.

• Expansion in Tier 2 and 3 cities, with the fast growing Xi’an is next in the line.

• Professional management team.

Key risks

• Interest rate hike and credit tightening are concerns to TCT as the Chinese government continues to curb runaway property price and inflation.

• Concentration risk is high with main exposure in Shanghai commercial market, and rental income is 70% derived from City Centre.

• Supply glut in Shanghai office sector may pose pressure on rental yield going forward.

Total Return Strategy

TCT’s total return strategy is to acquire, own, develop and manage commercial properties in China and thus diversify risks and income sources across the real estate spectrum.

Flexible investment vehicle

TCT is listed as a business trust featuring a more flexible capital and operating structure. Compared to conventional REIT, business trust has higher development cap of 30% of total asset value compared to 10% for REIT, and a self-imposed debt covenant of 45% gearing limit compared to 35% for REIT. The Manager has the discretion to make distribution from net distributable income as well as from realised and unrealised gains from asset enhancement of its properties. That aside, TCT is committed to distribute 80% of net rental income for the first 3 years compared to 90% compulsory distribution in REIT, which allows more funding capacity for future growth.

TCT’s unit buyback boosts liquidity, valuation

Unit price rises 12% in first month of implementation

TREASURY China Trust (TCT), the first business trust to initiate a unit buyback programme, said this exercise has bolstered its liquidity and valuation.

Over the first month of its implementation to June 3, third-party trading activity accounted for 40 per cent of total trading turnover.

The period also saw its unit price rise by 12 per cent, narrowing the discount between the unit price and net asset value to 43 per cent from 49 per cent over the one-month period.

TCT said this unit buyback programme is part of its strategy to ‘proactively manage its capital structure, provide a strong platform for stable growth and ultimately increase unitholders’ value’.

This programme will continue until June 24, when TCT will enter a ‘close period’ for the release of its mid-year valuation updates and half-yearly trading results during which it is not allowed to deal with the units.

TCT chief executive Richard David said he was pleased that the programme has met its objectives in just the first month in providing liquidity, a consistent trading pattern and closing the valuation gap.

He also assured shareholders that the unit buyback scheme ‘has been implemented under a regime that values integrity above all else’.

The Business Trust Act does not provide for the specific mechanics of a buyback programme.

Under listing rules, TCT has to promptly inform the market of any acquisitions made under the unit buyback programme and units can be purchased at a price no greater than a 5 per cent premium to the average closing price of five prior trading days.

TCT is also limited to buying back no more than 10 per cent of its total issued units over a 12-month period. All units acquired under this programme are cancelled.

Listed since June last year, TCT owns commercial real estate in China comprising completed assets in Shanghai, Beijing, and Qingdao and a development pipeline. Its 800,000 sq m portfolio is valued at more than 12 billion yuan ($2.3 billion).

It reported last month a net property income of $12.45 million for the first quarter ended March 31, exceeding its forecast by 8.6 per cent and marking a 3.5 per cent improvement over the fourth quarter of 2010.

Diversification into China’s tier-2 cities

Betting on China. We recently visited TCT’s commercial assets in Shanghai and Qingdao, including the newly acquired Central Avenue Mall and pending Huai Hai Mall (midst of acquisition with settlement no later than 30 Jun). We observe that TCT has over time evolved its strategy in China, which used to focus on commercial assets and development projects in tier-1 cities such as Beijing and Shanghai . Recently, it has concentrated on regional expansion into tier-2 cities, including developing a large-scale retail property at the Laoshan district of Qingdao with the Trio group. TCT is also actively looking at deals in Xi’an in Shangxi province, forming a strategic partnership with the Ginwa Group to tap the emerging retail market in central and west China.

Three key advantages. We observed that TCT has three key advantages in China. First, TCT is listed as a business trust instead of a REIT, with the more flexible structure of 30% development cap and 45% gearing limit, as stipulated in its trust deed. The development component sets TCT apart from REITs which have little development exposure (10% deposited property max). TCT is thus better positioned to achieve accretive-yields due to cost savings from vertical integration. It is also not bounded by investment constraints, such as at least 75% of assets must be invested in income-producing properties. Secondly, TCT is upscaling its tenant mix from mostly low-mid tier to mid-high end retailers, which provide income uplift. Presently, some of its existing leases are well below prevailing market rates. For example, the anchor tenant Parkson, at City Centre, is paying only RMB1.73 psqm/day (average rate is RMB6 psqm/day). With the completion of the City Centre extension, Parkson will be vacating the property in 2012, while Marks and Spencer was roped in as the replacing tenant on a 10+5 years lease. On TCT’s debt portfolio, 85% is USD-denominated but 100% of its revenue is in RMB. TCT thus enjoys low borrowing costs, while the likely RMB appreciation in the mid to long term provides further forex upside.

Supply overhang remains. According to DTZ, there is an anticipated supply of new office space in Shanghai, amounting to about 100% of existing stock in 2011-2014. Likewise, highend retail space is expected to increase by another 50% from 2011 to 2013. The large new supply is expected to drag down overall occupancy rates and intensify the “winners/losers” divide among the Shanghai properties. Oversupply and inflation risks (dampening demand) remain our top concerns for the trust and we expect management to consciously address these as the trust grows in asset size. We do NOT have a rating for TCT presently.

Treasury China beats Q1 forecast

Net property income of $12.45m also 3.5% better than that for Q4, 2010

TREASURY China Trust (TCT) said that it achieved a net property income of $12.45 million for the first quarter ended March 31, exceeding its forecast by 8.6 per cent.

This is a 3.5 per cent improvement over the fourth quarter of 2010. But earnings per share came to 2.7 cents, compared with 8.7 cents for the fourth quarter of last year.

First-quarter gross revenue for the business trust hit $19.45 million, 1.9 per cent above forecast but 4.9 per cent below the fourth-quarter mark.

TCT yesterday reaffirmed its earlier intention to declare a distribution per unit of 10 cents for 2011 with a payment of five cents per unit each to be made on June 30 and on Dec 31.

There are no comparative figures from a year ago as TCT was listed only last June by way of introduction, after taking over China Real Estate Opportunities that was formerly listed on London’s Alternative Investment Market.

TCT said that its portfolio committed occupancy came to 93.3 per cent at the end of the first quarter, outperforming the target of 87.9 per cent for 2011, and beating the 2010 year-end occupancy level of 90.9 per cent.

It has also entered into formal negotiations to dispose of a majority stake in its Central Plaza asset and is in separate discussions to acquire a Shanghai-based retail asset.

TCT’s current portfolio comprises Central Plaza, City Center and Treasury Building in Shanghai and 74,000-square-metre development space in Beijing International Logistics Park.

It just completed an acquisition that provided a 55 per cent interest in Central Avenue Mall in Qingdao. TCT has also obtained regulatory approval to acquire 100 per cent of Shanghai Huai Hai Mall and a US$50 million loan from Citic International Bank to assist with the acquisition.

Richard Barrett, chairman of TCT, said that he expects the completion of the Central Avenue Mall purchase in Qingdao to provide a strong revenue stream from the second quarter onwards.

The group noted that leasing activities in the Shanghai office market remained active in the first quarter, with strong demand from multinational corporations, while demand for retail space is mainly driven by mid-market fast fashion retailers.

Some 33 leases were negotiated in the first quarter ended March 31, comprising new lettings and renewals. They produce an aggregate per square metre rental representing a 12.8 per cent increase over the expiring leases.

Among the new leases were a three-year lease to Eastern Life Insurance in Treasury Building and a 10-year lease pre-commitment from Marks & Spencer at TCT’s City Center Extension development.

TCT said that it is confident that ‘the retail and office sector will continue to perform well for the remainder of 2011’.

TCT units closed trading 1.6 per cent lower at $1.87 yesterday.