CCT – DMG
Unencumbered Assets, But Economy Encumbers
FY08 performance met expectations. CapitaCommercial Trust (CCT) notched a 16.3% YoY jump (-12.5% QoQ) in 4Q08 DPU to 2.71¢, which was within expectations. For FY08, DPU came in at 11.00¢, matching the Street’s (11.10¢) and exceeding DMG’s (10.38¢) estimates. Underpinned by the introduction of 1 George Street and higher contribution from other properties, CCT’s 4Q08 revenue and NPI expanded to S$83.8m (+50.3% YoY, +5.1% QoQ) and S$65.6m (+47.8% YoY, -1.7% QoQ) respectively. However, 4Q08 EBIT was down 15.6% QoQ to S$51.3m due to higher trust expenses from the nonrecurring consultancy fees and expenses incurred for the aborted MSCP redevelopment. Most properties delivered improved or flat operating performances, aside from Capital Tower (higher property taxes) and MSCP
(redevelopment).
Birth of devaluations. CCT’s portfolio of assets devalued by 3.0% HoH to S$6.7b, attributable to valuers’ usage of higher cap rates (4.5 to 4.75%), premised on a weakened macroeconomic outlook, lower rents and occupancies. As such, NAV dipped 5.7% QoQ to S$2.97 per share. While gearing remain at a decent 37.6%, we believe this is prone to further upside pressures upon CCT’s subsequent semi-annual revaluation exercises this year and 2010. Given banks’ current comfortable LTV ratios of 30 to 40%, fresh refinancing concerns could surface when CCT’s S$850m worth of loans expire in 2010, from our view. From current levels, we estimate that CCT’s assets would need to drop by 7.0% (- S$467m) and 38.8% (-S$2.6b) to hit gearing of 40% and 60% respectively.
Remain NEUTRAL at lower S$1.00. Earnings visibility for this year should be rather stable for CCT, having locked in 79% of FY09 gross rental income, helped by full year contribution from 1 George Street and Wilkie Studio. While financial institutions’ confidence in CCT’s quality of assets has been affirmed with the respectable terms pertaining to its recent S$580m loan (a single securitized asset and spread of ~ 250bps), we believe the counter, similar to other landlords, would continue to be in the eye of the office re-rating storm, which should continue to stretch into 1H11. In light of the above, coupled with a continued deteriorating economic environment, we are lowering our occupancy levels and average rentals for CCT for FY10 and FY11 (portfolio occupancy: 85 – 90%, prime Grade A rentals: S$8 – 10 psf per mth, down from S$10 – 12, Rest of Central Area: S$6 – 8 psf per mth, down from S$8 – 10), but keeping our assumptions for FY09 intact as majority of the leases have been locked in. As such, FY09 DPU remains at 10.86¢ and FY10 DPU falls by 8.3% to 10.16¢. Maintain NEUTRAL at lower fair value of S$1.00.
FSL – OCBC
Honey, I shrunk the DPU
Lowers payout policy. First Ship Lease Trust (FSLT) recorded a 70% YoY and 8% QoQ increase in 4Q revenue to US$25.7m. The trust will pay out 3.08 US cents per unit as dividend for 4Q08, up 27% YoY and 0.9% QoQ. Significantly, FSLT’s board has decided to reduce the payout ratio to “increase financial flexibility going forward”. The trust is now guiding for a 1Q09 DPU of 2.45 US cents, or a 20% QoQ decline. This represents the payout of about 75-80%, a stark contrast from the trust’s 100% payout track record. The retained cash will be used to reduce gearing and potentially to fund new acquisitions. The trust will now provide DPU guidance on a quarterly basis “until longer term visibility returns”. We expect that the payout ratio may be further reduced after the subordination period expires on 30th June.
Right move… S-REITs and shipping trusts managers will have to realign their business model and debt tolerance with the market’s tolerance – and especially with their lenders’ tolerance. This is particularly true when the lender has the upper hand – such as with an upcoming refinancing or a loan-to-market value (LTV) covenant. As of mid-October 2008, FSLT satisfied its LTV covenants. But asset values in the shipping space are declining rapidly and lenders (on an industry-wide basis) are getting jittery. Shipping trusts do have a long-term secure income profile – but that cash is useless if it is just paid out as distributions to unitholders. We view this decision as a gesture of good faith to lenders.
…but not enough. We have commented on FSLT’s aggressive payout and debt financing strategy ad nauseum. Our valuation approach on the shipping trusts rewards (puts a premium on) sustainability. In that sense, we definitely support this decision. But we think this is a first step, at best. If the 1Q09 DPU is maintained for the full year, FSLT can pay down US$14m of debt in 2009 – a mere 2.8% of its total outstanding loans. This will not make a significant impact on its 1.35x debt-to-equity ratio. If FSLT is serious about adapting its business model to the current environment, it needs to do more. The payout ratio should (in our opinion) be even lower: Pacific Shipping Trust only pays out about 50% of cash income, for instance. An explicit debt repayment plan would also demonstrate the trust’s commitment to sustainability, in our view. Maintain HOLD with S$0.46 fair value.
PST – OCBC
4Q results par for the course
Acquisitions buoy revenue. Pacific Shipping Trust (PST) posted US$14.5m in 4Q08 revenue, up 67% YoY and 30% QoQ. For the full year, it recorded a 29% increase in revenue to US$44.6m. The strong gains were due to contributions from the four vessel acquisitions made over the course of 2008. The trust recorded a net profit of US$6.3m for the quarter. Because of a change in the accounting treatment, PST will no longer reflect fair value gains and losses on its interest rate swaps on its P&L statements. Stripping out the same from 4Q07 accounts, the trust saw roughly a 53% YoY gain in net profit. The results met our expectations.
DPU is lower. PST will pay unitholders 0.93 US cent per unit in distributions for the quarter, which translates to a 25% annualized trailing yield. Despite gains in cash income, this DPU figure is about 15% lower on a YoY and QoQ basis because of: 1) the lower payout policy adopted in 2008; 2) an enlarged shareholder base after the 3Q08 preferential offering; and 3) a partial revenue contribution from the CSAV Lauca, the fourth acquisition completed only in mid-November. We estimate a slight increase in 1Q09 DPU, which marks the first full contribution from CSAV Lauca. At the same time, PST’s interest expenses will decrease in sync with the trust’s debt repayment schedule. This should also boost DPU on a more gradual basis.
Stronger balance sheet. PST is in a comfortable position since the completion of its 3Q08 preferential offering, which raised about US$92.3m. The proceeds were used to partially fund the 2008 vessel acquisitions. PST is currently geared at about 1x debt-to-equity. We expect this to fall to about 0.94x by the end of this year as the trust pays down debt. PST can also sit tight as it has no refinancing needs in the near to medium term. PST also stands out because it is the only Singapore-listed shipping trust without loan-to-market value covenants on its books.
HOLD recommendation. Our key concern for PST is counterparty risk arising from the trust’s two customers, Pacific Intl Lines (PIL) and CSAV. Both charterers are among the world’s top 20 container operators1 . PIL, which accounts for about 70% of PST’s annual revenue, is the trust’s sponsor and 59.2% stakeholder. Tactically, we think it is too early in the cycle to become buyers of shipping trusts. There are still too many unknowns. We rate PST as a HOLD with US$0.16 fair value.
REITs – BT
Reits seek cut in payout to as low as 50%
They are also calling for a tax holiday for distributable income that is not paid out
Some real estate investment trust (Reit) managers have urged the government to reduce the minimum payout ratio to Reit unitholders to as low as 50 per cent, from 90 per cent now, while still allowing the trusts to enjoy tax concessions.
And they have even proposed a tax holiday on distributable income that they do not pay out.
The suggestions are aimed at helping Reits conserve cash to get them through today’s tight credit market conditions, BT understands.
Reits have to pay out at least 90 per cent of their distributable income to unitholders to enjoy tax transparency on the amount that they pay out. For example, if a Reit makes $100 million of distributable income in a year and pays out $90 million to unitholders, it does not pay corporate tax of 18 per cent at the Reit/vehicle level on the $90 million.
However, it has to pay tax on the $10 million that it withholds. If a Reit distributes all $100 million, then it does not pay any tax on its income for the year.
Instead, Reit unitholders are liable to be taxed on the distributions that they receive, depending on their profile. This ranges from zero tax for individual investors regardless of nationality, to 10 per cent for foreign corporate/institutional investors and 18 per cent for local corporate investors.
Reit managers have been giving a variety of feedback to the Monetary Authority of Singapore. One request is to reduce the minimum payout ratio from 90 per cent of distributable income to anything from 50 to 75 per cent, BT believes.
The Reits also want MAS to continue according them tax transparency, that is, to keep exempting them from paying corporate tax on the portion of income that they pay unitholders, even at a lower payout ratio. Some are even urging MAS to go a step further and grant Reits a tax holiday on the income that they withhold from distribution.
Market watchers say that this would lead to a substantial loss of tax revenue. To address this concern, some Reit managers have suggested that the tax holiday on income that is not distributed could be limited to, say, two years to help Reits ride out the current tough environment. Agreeing, an analyst suggested that Reits could be required to pay back taxes after the two-year period expires. By then, hopefully, things will be better.
MAS is understood to have sought the views of a gamut of parties – including Reit managers, bankers, lawyers and even unitholders – on the topic.
Among the issues is fairness in tax treatment in relation to other listed and non-listed entities. ‘Why should Reits continue to enjoy exemption of corporate tax at the vehicle level if their distribution payout ratios fall, when many other listed companies also distribute a chunk of their profits to shareholders but still have to pay corporate taxes?’ asked an industry observer.
Some Reit unitholders may not be happy with a lower distribution payout ratio, as it will create more uncertainty about returns. This could be a bugbear, especially for corporate investors such as funds and insurance companies that have obligations to achieve target returns for their own investors and policy holders.
The counter-argument is that, in times like these, the survival of Reits must be paramount. As OCBC Investment Research said this week: ‘While this may create income uncertainty for investors, we think the first priority is to ensure Reit survival and dividend sustainability. We note that a minimal cut from 90 per cent to say, a 75 per cent payout ratio requirement, is not a silver bullet for Singapore Reits with significant liquidity issues. But Reit managers may like to have as much flexibility and (cash) ammunition as they can get in the current environment.’