Path to prosperity

The airline industry has been one of the most badly hit by the Covid-19 pandemic as international air travel ground to a halt. Even as there are green shoots of recovery in the economy and green lanes are opening up, air travel is still >90% down from pre-Covid levels. In light of this, investors have been reconsidering their stakes in the industry. I recently read an article about the recovery in the airline industry being unequal and would like to give my take on the points mentioned. Generally, it argued that the characteristics of low-cost carriers ('LCCs') would allow it to recover faster than full-service carriers. 

1. LCCs serve point-to-point destinations

Passengers at Changi Airport ready with PPE

3. LCCs serve leisure travellers

As the world experiences an uneven recovery from the Covid-19 virus, investors continued to pile into markets driving the S&P and NASDAQ indices to all-time highs. The divergence between reality and stock markets have been explained by some as the lack of any viable alternatives for return as interest rates have plummeted. 

On the S-REITs front, industrial REITs have continued their outperformance while hospitality and retail continue to lag. In this article, I will explore some general concerns investors have regarding REITs in order to provide readers with more tools to evaluate REITs. 

1. Have equity valuations fully accounted for real estate valuations?

2. Could leverage limits be breached?

3. When will things go back to normal?

Conclusion

PropNex released its 1H20 financial results and reported a 151% surge in net profit after tax to $16.0m. According to PropNex the key driver of earnings growth was the project marketing services segment, which had revenue growth of $75.1m vs total revenue growth of $75.2m. As this is a higher margin segment relative to the resale market, there was an increase in gross profit margin to 11.4% in 1H20 vs 9.8% in 1H19. 

PropNex 1H20 Results (Source: PropNex)

In previous quarters, PropNex mentioned that transactions usually would have a 1-2 quarter delay from the time the agreements are signed until the time PropNex is actually able to recognize revenue. Hence, we can deduce that the strong showing in 1H20 can be attributed to the stronger 2H19 in property sales. 

Due to Covid-19 and the ensuing Circuit Breaker in Singapore, 2Q20 sales volume was strongly affected as there was a 37.6% qoq decline in private residential properties sold from 4,269 to 2,664. I believe that this would negatively impact 3Q and 4Q results and do not rule out a >20% decline in net profit in the coming quarters. 

Outlook

Takeaways

Ascendas REIT announced their results about 2 weeks ago and reported a 3.7% growth in distributable income but a 10.8% yoy decline in 1H20 DPU. Broadly speaking results were seen as positive despite the Covid-19 pandemic raging on in other sectors. Positive rental reversions, especially in business parks, were encouraging and gearing of 36.1% continues to provide AREIT with a healthy debt headroom for acquisitions. In this article, I would like to focus on key points brought up during the analyst briefing that investors may have missed if they merely looked at the announcements on SGX.

AREIT 1H20 results highlights (Source: AREIT)

1. Positive reversions in the face of weakening outlook not weird at all

At first glance, it seems weird that AREIT could report +4.0% positive rental reversions in Singapore and +4.3% for the total portfolio despite the weakening outlook. However, management has revealed that a number of these discussions had already started taking place before Covid-19 hit and that properties were also under-rented relative to market. The positive reversions represent a mark-to-market of expiring rents rather than an actual growth in market rents. 

In particular, the management highlighted business parks as a bright spot with multiple instances of 20%+ reversions. The specific example given was that of an international bank renewing its lease at Changi Business Park for >20% reversion on a new 3-year lease for the same space (no reduction or expansion in space). CEO also highlighted that this was a positive read-through for the business park segment. 

For the rest of FY20, the management has guided for mildly positive rental reversions but cautioned that this was not indicative of the direction that the market was moving in. A better gauge could be looking at occupancies instead. 

AREIT rental reversions (Source: AREIT)

2. Logistics demand more transient in nature

Much has been said of the new-found stability and strength of logistics tenants that support e-commerce and Covid-19 related stockpiling. However, during the analyst briefing, AREIT did not believe that those 2 would drive the logistics sector much higher. 

Firstly, Covid-19 related stockpiling appears to be done on leases <1 year. Therefore, should the pandemic subside, landlords could see a decline in demand for such spaces. In the short term, we can probably see an improvement in rents from such short leases as they tend to be higher than leases with longer commitments. Such short leases also did not really have an impact on rental reversions as reversions only account for renewal leases >12 months. 

Next, while e-commerce has been doing well, it does not make up the bulk of leasing demand for logistics spaces. Instead, AREIT CEO mentioned multiple times that logistics demand in Singapore is driven by contract manufacturing and ~80% of it serves international markets. Therefore, the key catalyst for logistics would be whether Singapore can continue to attract contract manufacturers here and if product demand remains at current levels. 

Generally, excluding the transient demand from Covid stockpiling, the management said that the new take up is weaker and occupancy could trend down in the near future. 

3. Acquisitions and AEIs, while delayed, continue to be on the cards

It should come as no surprise that AREIT is reporting delays in the estimated completion dates for its AEIs and redevelopments due to the outbreak at the foreign worker dormitories. Nonetheless, asset enhancement plans continue to be on track and AREIT also announced 3 new AEIs (2 in Australia 1 in Singapore). 

There were also questions on potential acquisitions from the sponsor in Singapore and also overseas. Due to the sensitive nature of such transactions, management could only give very broad motherhood statements; they continue to be interested and have conversations with the sponsor and are doing what they can to unlock opportunities. Deals are coming back and it seems like we may see an overseas one before anything local; anyway, AREIT already did 25% of Galaxis earlier this year.

In terms of strategy, AREIT maintains that it would focus on sectors that drive economic growth like tech and bio-med. In the UK they continue to like logistics and business parks. They also continue to monitor opportunities in data centres. AREIT has a sizeable exposure to data centres from an absolute GFA perspective, however it does not pop out as much due to AREIT's size. Singtel (one of their top 10 tenants) leases data centre space from AREIT. From a pricing standpoint, the management highlighted that lower interest costs also improved the holding power of sellers and hence AREIT is not really seeing any 'Covid-pricing' yet. 

AREIT AEIs in progress (Source: AREIT)

4. DPU decline despite no retention and outlook

One analyst asked about a decline in DPU to around 3.6cts per qtr vs 4.0cts per quarter in 2019. This appeared odd given that AREIT did not retain any income and that the US acquisition in 2019 was supposed to be DPU accretive (+0.7%). To this question, the management highlighted that there were certain one-off distributions in 2019 like the rollover adjustment that contributed to about 0.25cts of distribution. 2020 results also had to account for rental reliefs given to tenants due to Covid-19 and also declines in occupancies leading to lower operational results. 

Looking ahead, one area that AREIT is poised to reap some savings is on interest cost. AREIT has some perps coming up on their reset date and whichever option it chooses to take (reset, refinance, issue bonds), AREIT is confident that there will be interest cost savings. Apart from this, most of the outlook really depends on how the Covid-19 virus progresses. 

In comparison to its Capitaland peers, AREIT has outperformed and even hit above $3.50 last week. Due to this, and the fall-off of CMT, AREIT remains the largest and most liquid REIT in Singapore. Trading at ~1.6x P/B and 4.3% FY20F yield, AREIT is in a good position to continue its growth via acquisition strategy. On the flip side, its size also means that acquisitions won't really move the needle much and AREIT does have to make portfolio-size acquisitions to continue its growth trajectory. 

Frasers Centrepoint Trust (‘FCT’) is a REIT that owns and operates 7 suburban malls in Singapore. FCT generates rental income from its malls that have a total of 1.4m sqft of net lettable area. The REIT is sponsored by Frasers Property Limited, which develops and manages a wide range of properties globally. While its share price has somewhat recovered, I think there is room for more premium than what the market currently accords to it. FCT continues to offer investors good value due to:

1. Visible pipeline for acquisition growth

FCT currently holds a 25% stake in PGIM ARF fund, which has 5 suburban malls with a total of ~1.0m sqft of retail space under the AsiaMalls brand. Its parent, Frasers Property (‘FPL’), holds 65% while the remainder is held by third parties. As part of a possible capital recycling strategy by FPL, the 65% stake could be divested to FCT given that the characteristics (type of malls and tenant mix) of the PGIM ARF assets are very similar to the type of malls FCT currently holds.

 Apart from acquisitions of stakes in the PGIM ARF fund, there is also the potential for FCT to increase its stake in Waterway Point, in which it currently holds 40%. The stake in Waterway Point was acquired in 2019 and this could go up once the mall stabilizes; Waterway Point is currently still within its first 2-3 renewal cycles which tend to be periods of stabilization in terms of tenant mix and footfall. Similarly, FCT could also acquire Northpoint City South Wing; FCT currently owns Northpoint City North Wing. Northpoint was reopened in 2017 after extensive asset enhancement works and is also yet to fully stabilize according to FCT. 

2. Dominant malls in regions with low floorspace per capita in Singapore

FCT’s 2 biggest revenue contributors, Causeway Point and Northpoint City North Wing, have dominant positions in the Northern part of Singapore. The Northern part of Singapore is also the region which has the lowest shopping mall floor space per capita according to a Cistri report in Aug 2019. This implies that both malls have an excellent catchment of residents and have less competition compared to other regions.

Floor space per capita (Source: Cistri)

3. Suburban retail to remain resilient amidst Covid

Suburban retail malls differ from their prime district counterparts in terms of tenant mix, with a higher proportion of tenants being in essential goods and services (ie. Supermarkets and F&B outlets). In the latest retail sales figures released by Singstat, Supermarkets and Convenience Stores were the only 2 categories that registered yoy and mom growth.

FCT is well-exposed to these sectors as shown in its portfolio trade mix where about 50% of its gross rental income is derived from F&B, Household and Supermarket tenants. The coming Covid-19 induced recession also plays to the value proposition of suburban malls, which is to have products that have accessible pricing relative to prime district malls. With consumers tightening their purse-strings, the search for value items could divert spending towards suburban malls.

FCT portfolio trade mix (Source: FCT)

Key risks 

1)     Business impact from Covid-19. An extended virus scare could negatively impact FCT’s tenants and could potentially lead to negative rental reversions and lower occupancy going forward. This could also negatively impact property valuations and cause P/B to rise in subsequent years. 

2)     Concentration risk. FCT’s top 2 malls, Causeway Point and Northpoint, contribute 75% of its Net Property Income. Any decline in population in the Northern part of Singapore or new malls built in the area could negatively impact footfall in the 2 malls.

3)     Large tenant non-renewals. About 14% of FCT’s total gross rental income is up for renewal in FY20 and non-renewals, especially for anchor tenants, could imply a period of reduced rent even if a replacement tenant is found due to the time required for fitout works.