Path to prosperity

Lendlease REIT reported year-on-year increases in financial metrics like Revenue, NPI and Distributable Income however I think these are quite difficult to analyze as the 1HFY20 figure was annualized and pro-rated since LREIT only listed halfway through that half. Focusing on operational performance would be more valuable. About 60% of its NPI for the half-year was from 313 Somerset and this is its only asset in Singapore. The other asset is an office property in Milan that is master leased so there would not be much variations to explain. 

Occupancy remained high at 98.7% at 313 despite the Covid-19 pandemic. With the phase 3 reopening, 313 reported a 19.5% qoq improvement in tenant sales and a 12.4% improvement in footfall. This represents 75/60% of pre-Covid levels respectively. This trend was similar across other REITs where tenant sales have improved more than footfall. I think this could be due to deliveries for sub-urban malls and also larger ticket sizes from Singaporeans as borders remain closed. 

LREIT highlighted that it is focused on maintaining occupancy levels and help tenants stay viable; my read through for this is that there could be rental abatements or reliefs given and reversions could be less positive than before. Nonetheless, some (albeit lower) income is better than no income. 

A key catalyst for LREIT is definitely more acquisitions; currently, it only has 2 fully-owned properties and a small stake in ARIF3 (which owns JEM). The Sponsor has cleverly structured the REIT to be global and commercial such that the range of potential acquisitions is quite wide. In the near-term I expect there to be acquisitions from the sponsor overseas and a gradual increase in the stake in ARIF3 and perhaps even new stakes in PPP (Parkway Parade) and PLQ. 

SPHREIT was the first to report its results in mid-Jan and is largely underpinned by Paragon (74% of revenue). Paragon suffered a 12.9% decline in revenue while Clementi Mall declined less at 6.6%. This is understandable as prime retail malls (especially luxury ones like Paragon) would suffer more from the dearth of tourists. Clementi Mall, as a suburban mall beside Clementi MRT, would have been less impacted as office workers work from home and patronize their nearby mall. 

Looking at the graphic from SPHREIT's presentation, tenant sales held up very well at Clementi Mall while Paragon still remained resilient. Footfall for Paragon actually held up more than Clementi Mall. A few possible reasons for this. 

i) Clementi Mall was affected by capacity restrictions. For those who have been to Clementi Mall pre-Covid, you would remember how packed the place used to be. There was barely enough space to walk more than 5 steps in a straight line. Safe distancing measures could have limited the number of people allowed inside the various shops. 

ii) The affluent are less impacted by Covid-19. Those buying luxury goods at Paragon's high-end shops like Balenciaga and Prada would probably continue buying during the pandemic due to their high level of financial resources. Luxury items also hold their value well. 

In terms of catalysts, investors can look out for:

a) recovery from Covid-19 and opening of borders 

b) acquisition of assets from the sponsor, in particular Seletar Mall, which has been talked about for the longest time

SGREIT continued to retain income as it only distributed 0.14 Scts out of the 0.35 Scts it retained. This could be an indication of where it sees the recovery of retail. I think the REIT could be worried about its exposure in Malaysia (13.4% of NPI) as the country remains in lockdown and also the lack of tourists in Singapore for its prime retail malls (Ngee Ann City and Wisma Atria). Of note would be the Re-Align Framework where qualifying tenants can renegotiate or terminate their leases without penalties. 

In terms of capital management, apart from issuing $100m of perpetuals at 3.85%, SGREIT managed to refinance $500m of debts and also had a DRP programme in place. This means investors should take their 35.8% gearing with a pinch of salt since it does not include perpetuals and also investors need to account for the small dilution from DRP in future quarters. 

An upcoming acquisition to look out for is the acquisition of Isetan's stake of Wisma Atria. This could have been the reason why SGREIT raised perps. However we understand that the yields for retail malls are still low (4-5%) and hence it may be challenging for SGREIT to acquire the property accretively. Furthermore, the remaining lease on Wisma is only 40yrs. 

The Covid-19 outbreak has thrown businesses and investors into a frenzy thinking about the long term viability of their business models. Inherent in all the crystal-ball-ing that everyone is trying to do is to address the question of what life post-Covid will be like. Without knowing that answer, businesses have to make reasonable guesses and try to balance the interests of multiple stakeholders. 

As the 1Q20 earnings season in Singapore comes to a close, I noticed that most analysts have identified the duration and severity of the Covid-19 virus as a key catalyst for share prices. While I believe that this is true, I think it is also important to focus on how managements are balancing various priorities and how this sets them up to take advantage of the catalyst aforementioned. My article will attempt to identify some of these balancing acts that companies have to do and give examples of companies that have gone both ways. 

Covid19 has caused the closure of borders and the disruption of supply chains globally. Where goods used to freely move across borders, we are now seeing countries restricting outflow of goods for their own national stockpile. Similarly, companies face supply disruptions. 

Taking the example of a supermarket chain, when there was panic buying they were faced with a short supply of goods to sell to consumers. Typically, supermarkets would have estimated consumer demand and kept a small amount of stock in warehouses; this was to reduce the cost of storage and ensure that consumers always receive the freshest goods. However, due to the demand spike, supermarkets have had to grapple with the following decision

1. Built-in redundancies

2. Diversity of supplies

3. Localization/control of supplies

1. Built-in redundancies

By keeping additional stock in the warehouse, supermarkets would have the spare capacity to meet demand spikes. While it is possible to let this 'demand' go unsatisfied, it could be detrimental in the long run if consumers decide to go to a competitor and stick with that competitor. Psychologically, there could be the thought that the competitor is better as he was able to meet the consumer's needs during times of crisis and hence invoke a greater sense of customer loyalty. 

On the flip side, having additional stock or some built-in redundancies like extra manpower to stock goods or be cashiers can lead to additional costs that businesses have to bear. For a supermarket that also sells perishables, the freshness of produce is an important factor. The larger amount of stock that supermarkets hold may also be at risk of expiry/spoilage if demand tapers off more than expected. As of 1Q20, Sheng Siong Group reported a quarterly net profit margin of 8.8%. Increases in warehousing and logistics costs as a result of the redundancies would eat into already-thin margins. 

2. Diversity of supplies

During multiple interviews/briefings, Singapore's Minister for Trade and Industry highlighted that Singapore has a diversified set of food suppliers and that would help reduce the risk of shelves going empty. Similarly, supermarkets would do well to ensure they have goods sourced from multiple suppliers instead of just one for risk management purposes. In the event there is a disruption from one supplier, at least the other supplier can pick up some slack. There is also the added benefit of having a greater selection of goods for consumers. 

However, businesses have to balance how diversified they want their suppliers to be as this can often drive up costs and take up a significant amount of manpower to manage multiple relationships. Supermarkets may find that ordering 100% of their apples from 1 supplier may allow them to achieve a lower cost price due to bulk discounts. 

3. Localization or control of supplies

Another point that is frequently highlighted is the need for localization of supplies. In Singapore, >90% of our food supplies are foreign-sourced, making us more vulnerable to trade shutdowns. Therefore the Singapore Food Agency has come up with a goal to have 30% of our food produced locally by 2030. Similarly for supermarkets, they may wish to have greater control over the value chain by diversifying upwards into having more house brands or their own supply chains. 

Apart from cost considerations, the shift into another business model (albeit complementary) may dilute the management time and focus on its core business. 

Due to the uncertain nature of the Covid-19 virus and varying nature of different business models, companies have to weigh the cost and benefits of tilting the balance for their operations. Importantly, company managements need to have a thorough understanding of their own strengths and weakness as well as the opportunities and threats of their industry.