SREITS – OCBC
Surprise rule change on REIT M&A. In our 2007 strategy report dated 11 Dec 2006 “M&A theme a strong possibility in 2007/08”, we had articulated that M&A could be another avenue for growth. This scenario is now coming closer to reality with the Securities Industry Council’s (SIC) surprise announcement on Friday that it will extend the Singapore Code of Takeover & Mergers to REITs. This move is significant as it means that there is now clarity on M&A rules for S-REITs. Now anyone who acquires 30% or more of any REIT must make a general offer (GO) for the remaining units. Furthermore, anyone who owns 30%-50% of any REIT and acquires a further 1% of the units must also make a GO for the rest of the units.
Market getting more competitive. The key issue with the high-beta REITs such as CCT, MLT, CMT, ART, AREIT is the ability of the managers to meet market growth expectation. This is particularly so in a property up-cycle where fewer properties are available to be acquired. Some are venturing overseas, while others remain domestic focus (AREIT, Cambridge). Another avenue for asset size growth is via own development (AREIT, CMT), but this is a riskier strategy and is constrained by REIT guidelines. However with the SIC rule change on M&A, the REIT manager has another avenue to meet market’s growth expectations
A function of risk appetite. In our opinion, the market has segmented SREITs into two camps, i.e. REITs with high and low growth expectations. The key differentiating factor is the P/B ratio. We see potential for both camps, and the choice for investors for either is a function of their risk appetite. The high-beta REITs are those with high P/B ratio. As the market has already priced in growth, the risks are higher. On the other hand lowbeta REITs, we see minimal downside risks. In fact with them now being eyed as targets for acquisitions, we see a strong upside possibilities.
Potential winners in M&A. We see the likely winners in the new M&A rules to be those trading with higher yield and low price to book relative to their peers in the same sector. We see these REITs to be Allco, Cambridge, Macarthur, MM Prime and First REIT. (Winston Liew)
CCT – DBSVickers
Wisma Technip sale. CCT intends to sell Wisma Technip to Quill Capita Trust (“QCT”) for RM125m (S$56.1m) through asset securitisation vehicle Aragorn in which CCT owns 100% of the junior bonds. CCT would gain about S$2m from transaction, expected to complete by 4Q07, pending a funding raising exercise by QCT for the acquisition.
QCT as main channel of growth in Malaysia. While it’s the first asset sale by an S-REIT since its inception, it’s CCT’s strategy to focus on growth in the Malaysian office market through its 30% strategic stake in listed investment vehicle QCT. We believe this is a positive for QCT (Buy, TP RM2.37) which would benefit from growth through acquisitions as Capitaland’s main platform for opportunities in Malaysia and Capitaland’s 28%-owned incubator, Malaysia Commercial Development Fund (MCDF).
Minimal impact, TP S$2.97 unchanged. We like CCT’s platform of growth in Malaysia through QCT, but see a small, albeit positive impact on CCT in the near term. While CCT would primarily remain Singaporecentric, we continue to see organic growth through strong positive rental reversions for CCT’s portfolio. On the acquisitions front, 3rd party acquisitions continue to elude CCT at this point since the HSBC acquisition in 2005, apart from the injection of 60% stake in Raffles City from developer sponsor Capitaland in 2006. With the sale of Wisma Technip, this would reduce distribution income estimates in FY08 by 0.8% with DCF based target price of S$2.97 unchanged. Maintain Hold.
Office REITs – DBS
All-time high for office property. Office asset values continue to heat up, with transacted prices hitting new highs and now past the last peak, driven by property funds active in asset transactions. With the previous high for office assets set by the sale of 7 floors of Prudential Towers by Straits Steamship Land (Keppel Land), a record of S$2,200 psf set in 1996, office capital values have now hit an all-time high with latest sale of 1 Finlayson Green by Hong Leong to UK-based property fund Develica at unit price of S$2,650 psf (S$2,470 assuming full efficiency). This transaction is hot on the heels of the recent sale of Parakou Building at Robinson Road for S$2,013 psf.
Asset revaluation across office REITs set to continue. Along with the latest year-end revaluation, the Singapore office portfolio for S-REITs has been revalued upwards (CCT +10%, Suntec +30%, K-REIT +7.3%, Allco +7%). We expect asset reflation for office S-REITs to continue, with growth in average rents to boost office asset appraisals.
Boom and bane for office Reits. Office REITs are direct beneficiaries of asset reflation from potential upward revaluation based on market comparison of market transactions. However, with the current bullish outlook for Singapore office rentals, price expectations of asset owners have also escalated, compressing physical yields to lower levels (below 3% for the case of the Temasek Tower acquisition by MGPA). Yield accretiveness of acquisitions are reduced, and coupled with strong competition for assets from private property funds with more flexibility and less stringent regulations on investment and access to funds, S-REITs in our view are currently priced out of the market for commercial assets.
Overseas expansion would be a natural course to drive acquisition growth. K-REIT stands out in asset reflation scenario. While we prefer the DCF approach in valuing S-REITs because it takes into account the intrinsic cashflows generation ability of the underlying assets, RNAV approach could also possibly breach the gap, as it factors in asset pricing by market players acquiring assets at capital values pricing in future rental growth prospects. In an asset reflation scenario, K-REIT stands out with potential upside of 93% versus CCT (-2.7%), Suntec (+7.3%) and Allco (+48%). We have BUY recommendation for K-REIT with target price of S$3.70 per unit based on DCF estimates.
MI-REIT : BT (HSBC)
June 7 close: $1.35
HSBC GLOBAL RESEARCH, June 7
MACARTHURCOOK Industrial Reit is the smallest industrial S-Reit with 12 quality Singapore properties set for steady contractual rental growth. We expect a re-rating once the manager demonstrates its ability to execute on acquisitions, which should amplify distribution per unit (DPU) growth on a small asset base and low gearing.
We initiate coverage with an Overweight (V) rating and target price of $1.57, implying 30.7 per cent total return potential.
Expect amplified DPU growth via acquisitions on a small asset base and low gearing. With a visible pipeline of over $150 million, MI-Reit aims to grow its assets by up to $500 million per annum over the next three years, implying a CAGR (compounded annual growth rate) of 79 per cent to end-FY10. We believe this target is achievable, given the asset-light trend in a fragmented industrial real estate environment and the company’s ability to tap into the networks of its parent and strategic partner.
With an initial gearing of 8.7 per cent and the ability to gear up to 60 per cent of gross assets (on receiving a credit rating from Moody’s), we estimate MI-Reit could acquire some $400 million of assets purely by debt, which could add 46 per cent to its FY08f DPU.
The portfolio has a weighted lease term to expiry of 6.7 years and occupancy of 100 per cent as at April 2007, with built-in weighted average rental escalation of 3.4 per cent per annum for the first four years. We believe MI-Reit could benefit from potential industry consolidation, in the event that the S-Reit takeover code is formalised in the medium term.
Target price of $1.57 including acquisition premium: We see this as an undervalued S-Reit trading at a large discount to its peers. Our target price comprises a base case DDM value of $1.22 on its existing portfolio, on an 8.0 per cent cost of equity and an acquisition premium of $0.35 assuming $500 million of acquisitions over FY08-09 (March) at 7.0 per cent average yield.
With a total return potential of 30.7 per cent (including 5.9 per cent FY08f yield), we initiate coverage of MI-Reit stock with an Overweight (V) rating.
Risks: The manager’s inability to execute on growth strategies, default risks by tenants or subtenants, competition for assets and interest rate risks.
OVERWEIGHT
MI-REIT : BT
It has available debt capacity of about $193m to fund acquisitions
MACARTHURCOOK Industrial Reit (MI-Reit) yesterday got a first-time Baa3 investment grade rating from Moody’s, boosting its maximum gearing limit from 35 per cent to 60 per cent of gross assets, which translates to over $75 million of additional debt capacity.
The Reit, which has a portfolio of 12 industrial real estate assets in Singapore and was listed in April this year at an issue price of $1.20 and distribution yield of 6.2 per cent, traded up to a high of $1.35 at yesterday’s close.
‘With the credit rating, MI-Reit has increased gearing capacity, with available debt capacity of approximately $193 million to fund acquisitions,’ said chief executive Chris Calvert.
The trust said it intends to maintain a long-term target gearing of between 40 to 45 per cent, but might on occasion increase this to secure strategic industrial properties around Asia. Debt is an ‘efficient mechanism’ by which to achieve the target of growing the Reit’s assets by at least $500 million in new acquisitions per year, said Mr Calvert.
The trust’s portfolio had a combined value of about $316 million at listing date. It has not announced any acquisitions post-listing.
Analysts have received the stock warmly, with a present total of four ‘buy’ calls on MI-Reit, according to Bloomberg. These include two reports initiating coverage in the last two days – HSBC and UBS each issued calls on MI-Reit with target prices of $1.57 and $2.07 respectively, making much of its relatively low gearing and capacity for further purchases.
MI-Reit’s acquisition target ‘is achievable given the asset-light trend in a fragmented real estate environment’, HSBC said yesterday. ‘This represents more than doubling its asset size within the first year and a CAGR (compounded annual growth rate) of 79 per cent in portfolio size over the next three years to end FY10.’
Only 12 per cent of the 286 million square feet of Singapore’s private industrial space is owned by Reits, though yields have been driven down by stiff competition, it said.
The bank expects MI-Reit to benefit from JTC’s potential divestment of $3 billion worth of industrial assets, as well as from the networks of strategic partner United Engineers, which it said is expanding in the region.
MI-Reit should trade at a lower yield than peer Cambridge Industrial Trust, due to lower gearing and smaller asset base, which implies higher proportionate accretion from the same value of acquisitions, according to HSBC.
Meanwhile, UBS said industrial assets around Asia are ‘typically the highest-yielding of the main Reit asset classes, providing around a 250 basis point spread over cost of capital’. It believes MI-Reit has identified potential purchases valued at around $210 million in Singapore, to be injected over the next 18 months.
However, UBS noted that 10-year bond yields in Singapore – which have fallen to 2.9 per cent – could rise in the medium term to a forecast 3.2 per cent at the end of the year and put pressure on the Singapore Reit sector.
For its part, HSBC noted MI-Reit’s lack of a sponsor pipeline, but said third-party acquisitions are historically more prevalent for industrial Reits. The potential establishment of JTC Reit could also intensify competition, it noted.
MI-Reit said separately it has appointed Matthew Wrigley, currently head of legal and compliance at parent MacarthurCook in Australia, as chief operating officer of the Reit’s manager in Singapore.