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LMIR: Gearing ratio and margin of safety.

Monday, February 17, 2014

A reader asked me why did LMIR's gearing ratio go up so much. It was 34.3% in the last quarter ending 31 Dec 2013 while it was only 28.2% in the quarter ending 30 Sep 2013. That is a 21.63% increase!

There is a simple explanation.

LMIR issued new debt in October 2013 and this was reflected in last quarter's report. The money raised was used to retire a loan facility in January 2014 which was, of course, not reflected in last quarter's report. This was why the gearing ratio jumped.

You might remember that I said that a good thing happened:

"When I blogged about LMIR in August last year, I said that the REIT's term loan maturing this year in June worried me but this concern was addressed when they used the proceeds from the issuance of a 3 year bond to repay the term loan a few months early. This also lowered the REIT's average cost of debt from 6% to 5.3%. A big improvement."

So, we should see gearing ratio come down again the next time LMIR announces results, everything else remaining equal. 

However, if the Rupiah were to continue weakening, gearing ratio will continue to increase. The REIT's assets are denominated in Rupiah but their debt is denominated in S$.

To illustrate this point, look at the presentation slides for 3Q 2013.

Debt at the end of 31 December 2012 and 30 September 2013 was the same at S$472.5 million. However, the gearing ratio went up from 24.5% to 28.2%. This was because property values fell in S$ terms.

Comparing 3Q and 4Q 2013 presentations, we see that property values in S$ terms fell again by 6.4%. 

So, with this in mind, it should not surprise us if the gearing ratio stays above 30% in the next results presentation even after taking into consideration the retired loan facility mentioned earlier.

Although I have said that the Rupiah will recover and that it always does, it is anyone's guess as to when it would recover. 

Whether LMIR will continue to be a good investment will depend on its future performance which is very much dependent on the Rupiah's future performance too.

Having said this, even if the Rupiah stays at the current level, we are likely to see DPU in S$ terms recovering in the next quarter as financial expenses normalise and I have estimated that a DPU of 0.66c is realistic. Is this attractive enough though?

Well, if we were attracted to LMIR because of the estimated 8.6% distribution yield in the recent past, then, we would probably want the same 8.6% yield to be attracted now. 

With a prospective DPU of 0.66c a quarter, to get a yield of 8.6%, unit price has to fall to 30.5c a unit. That is quite a bit to fall from the current 40.5c.

If we were to include the 10% savings from a reduction in the average cost of debt, we could see a DPU of 0.7c in the next quarter. To get a yield of 8.6%, unit price has to be about 32.5c.

So, as anyone can see, unless we are expecting a dramatic decline in unit price, I think an 8.6% distribution yield from an investment in LMIR is probably wishful thinking now, no matter how we slice it. This is the new reality.

If an investor says that he is quite happy with a 7% yield, then, he could get it by investing in LMIR at 40c a unit. 

However, if a 7% yield is all he wants, he could get it from some other S-REITs in Singapore without having to worry about foreign exchange issues. 

If he were to invest in LMIR, he would do well to demand a bigger margin of safety.

For anyone interested in investing in LMIR now, I would say that there really isn't enough margin of safety (i.e. need much higher distribution yield) although for anyone who has been vested for a long time at prices much lower than now, there is probably lesser harm in holding on since he would have benefited from many rounds of income distributions and would also be sitting on some paper gains.

Related post:
1. LMIR: 4Q and FY2013 results.
2. LMIR: There and back again.


Gary said...

Good article and analysis. I too sometimes miss out finer details in the financial results. Thanks for sharing! =)

AK71 said...

Hi Gary,

I am thankful that I am not an accountant or auditor as lazy me truly dislike having to go over pages of numbers.

Well, you know what they say about a job worth doing. I have to do it when my money is at stake. -.-"

Anonymous said...

Hi AK,

The IR did reply, as below:
I send an email to IR and this below is our correspondence:

I refer to your Q4 results.
The gross revenue in IDR has fallen from 326,105 million in Q3 to 315, 065 in Q4 million when your occupancy rate is steady at 95% with positive rental revision for the past few quarters, can you explained why?
Thank you for your kind attention
The reply:
Thank you for your email. To answer your query, there are at least several reasons:
1. Generally speaking, Q3 revenue is higher than 4Q due to Indonesian Lebaran Festivals (a nationwide festival throughout the whole month of Aug) which stimulates spending nationwide.
2. The MNK operating agreement, whereby we outsource mall’s operation to third party MNK and only collect 77% of the net operating income. As operating expenses were finalized in 4Q, the net operating income was seasonably lower than first three quarters.
3. Positive rental reversion is good indicator but it only applies to the renewal leases, so that it cannot represent the overall income level.
Further questions:
1. Generally speaking, Q3 revenue is higher than 4Q due to Indonesian Lebaran Festivals (a nationwide festival throughout the whole month of Aug) which stimulates spending nationwide.
Isn’t rental income, or rent collected from tenants fixed? Do you mean you have a clause that allow rental increase or decrease due to the sales of tenants?
IR reply:
There are certain proportion of GTO tenants in every shopping centre whereby GTO rent is linked with tenants’ sales volume. And this is only one of the reasons that can explain the drop in our revenue when you compare QoQ.
Hope the above clarify your query.


My thoughts:

The reasons offered seem reasonable, and I accept them. But its does mean revenue is going to be a bit volatile, depending on how well the malls are doing. A longer tracking of their IDR revenue is needed to see if competitiveness is lost.

AK71 said...

Hi Mike,

Thanks for sharing this. Much appreciated, I am sure. :D

So, it was a mistake to annualise Q3 DPU in guiding my decision to add to my long position last week. The expectation of an 8.6% distribution yield was just wishful thinking! A good lesson for me. -.-"

Well, it seems like LMIR's unit price would have to decline significantly or its earnings in S$ terms must recover significantly before I would add to my investment in the REIT.

Capricon said...

Hi Mike, AK,
Wondering how the national festival has an positive impact to the income since rental is fixed at a monthly rate. Or there is a component of the rental that ties to the sales of each tenant ? I guess it is latter as I vaguely remembers that is what I was told by a salon business owner.

I felt that malls REITS are driving our cost of living and inflation. :(


AK71 said...

Hi Capricon,

Your guess is correct. A portion of monthly rent is variable and it is based on the stores' monthly gross turnover. Well, it can be a good thing because it incentivises the REIT manager to do a better job of managing the malls to attract more shoppers. :)

Xquisite Coloraturas said...

Hi AK,

Is it ok if you re analyse LMIR at this juncture again?


AK71 said...

Hi Xquisite,

I decided that LMIR is going to face some headwind with the Indonesian Rupiah weaker and the probability of greater weakness in the Rupiah is high. This is not an operational issue. It is structural. It is the way LMIR funds its business in Singapore Dollars and how its properties are valued and how income is collected in the Rupiah.

Given such a scenario, I reduced my exposure to LMIR some time ago at above 40c a unit, retaining a much smaller long position.

LMIR could one day be a great investment again for income. I try to remind myself that all investments are good at the right price. :)

Xquisite Coloraturas said...

Hi Ak,

Thank you very much.

So at this juncture with the price around S$0.365, is it a good time to take up a long position?

Will the it drop further?

Many thanks for your help.

Greatly appreciated.

AK71 said...

Hi Xquisite,

Given the headwinds, I would feel more comfortable if I have a bigger margin of safety and since we are investing in REITs mainly for income, I would like to see at least a 10% distribution yield before I add to my long position.

As for whether the unit price will drop further or not, I have no way of predicting Mr. Market's behaviour accurately. :(

Xquisite Coloraturas said...

Hi AK,

Thanks again.

Lastly, in your opinion is the operation and management of LMIR up to your standard. I have read your this post in February on LMIR and it seems that there are problems as pointed out by you.

Will these problems have huge impact on price and the business going forward? Is it too risky minus the consideration of structural problems.

Thank you very much once again for your kindest assistance.

Thank you.

AK71 said...

Hi Xquisite,

Well, I don't think we can minus the structural issues. They are the reasons why I am not too keen on adding to my long position.

The Indonesian domestic consumption story is intact. That domestic consumption is growing and will stay important to the country's GDP is well documented.

However, we are buying into a REIT that is riding on this story. We are not buying into the story per se. How well the REIT is able to translate the benefits in the story to us as investors is what we should be concerned about.

I have never been really impressed by the REIT's management and I have made this quite clear several times over the years. I was quite impressed with the new CEO although there is little he could do given the structural issues in the REIT he took over.

You asked about price again. I don't know how the price is going to move but I know that I need a bigger margin of safety and I might see that at a much lower price.

Xquisite Coloraturas said...

Hi AK,

Thanks much!:)

AK71 said...

LMIRT Management Ltd., in its capacity as manager of LMIR Trust (the “Manager”), is proposing to carry out a placement of 117,647,000 New Units to institutional and other investors at an issue price of S$0.34 per New Unit (the “Issue Price”) to raise gross proceeds of approximately S$40.0 million (the “Placement”).

As part of its consistent growth strategy, LMIR Trust has recently secured approval from Unitholders for the acquisition of Lippo Mall Kemang at a purchase consideration of S$385.7 million, which is expected to increase the size of LMIR Trust’s portfolio by approximately 27% to S$1.8 billion. It is the policy of the Manager to utilize a prudent mix of equity, debt, existing cash and consideration Units to fund LMIR Trust’s acquisitions.

After a recent review of LMIR Trust’s capital structure, the Manager has decided to only raise approximately S$40.0 million under the Placement instead of S$110.0 million which was initially envisaged. The difference in the amount will be covered by additional debt and internal sources of funds.

LMIR Trust’s Aggregate Leverage is expected to remain below 35.0%. With the revised capital structure, the resultant accretion arising from the acquisition is expected to be more favourable.


AK71 said...

Morning AK, know you hold Lippo Mall reit from your blog. Recently all reit move up, while Lippo Mall reit move side way. I look at the numbers:
Occupation rate keep stable around 95% in last 4 years.
Pay 0.03 dividend
Yield 9+% in last two years
Gearing from 44% to 40.3% in last 4 years
Interest coverage ratio various from 2.98 - 4.32 in last 4 years, now at 4.07
PB is 0.95
Is there any particular reason cause its price moving up?
Do you think it's in fair price now? Thanks

You might want to read this blog.
Price? Your guess is as good as mine. ;)

AK71 said...

Reminded by your blog, check IDR/SGD, weaken from 2013 to 2015, strong in 2016, and no much change in 2017. Weak Rupiah, lower property value, cause gearing increase, so higher gearing is still concern, right? So 8.7% is a safe margin?

See the gearing then and the gearing now. Safe margin or not? You decide.

AK71 said...

No point leaving money uninvested as bank interests are low. Do you have any worries about lippo malls?

Lippo Malls? Read this.

Kevin said...

Hi AK and Reader,

Do take note that most of their acquired assets come with income support from sponsor . ;)

AK71 said...

Hi Kevin,

Financial Engineering 101. ;)

AK71 said...

Jacintha Poh, Moody's vice-president and senior analyst, said: "We expect that LMIRT's financial metrics will weaken, on the back of aggressive acquisitions, such that the trust will prove more vulnerable to foreign exchange rate fluctuations and asset devaluations."

"The trust also faces high refinancing risk with around 30 per cent of its total debt coming due in 2018."

LMIRT's leverage will also increase following the proposed debt-funded acquisitions of two retail malls, Lippo Plaza Jogja and Kediri Town Square, S$98.1 million, which are scheduled to complete by the end of 2017.

Financial metrics

Specifically, the trust's pro-forma adjusted debt to total deposited assets will increase to 39 per cent from 36 per cent at Sept 30, 2017, and its adjusted net debt to normalised Ebitda (earnings before interest, taxes, depreciation and amortization) will weaken to 4.1 times from 3.7 times over the same period.

LMIRT also faces a refinancing wall in 2018, with S$100 million in medium term notes due in November and S$90 million of secured loans will come due in December.


AK71 said...

To inspire confidence in investors, the Trust's debt to total assets should be very much below 40 per cent to buffer against foreign exchange rate fluctuations and asset devaluations.

AK71 said...

The Indonesian government has passed new amendments regarding taxes on income received from real estate, and the change will affect REITs that are significantly exposed to the country.

One REIT that has warned that it may see material impact due to this change is Lippo Malls Indonesia Retail Trust, which has a portfolio of 30 properties across the archipelago.

The REIT’s properties, which are located mostly across Java and Sumatra with over 900,000 square metres of net lettable area, serve over 150 million shoppers annually.


Betta man said...

Hi AK,

Lippo mall has a slew of bad news recently:

Price has crashed from $0.40 to $0.325 at point of writing. I was lucky to sell off all my holdings in LMIR at $0.39 in Mar 18, making a profit in the process. I understand that all investments are good investments at a good price. As at 31 December 2017, LMIRT has reported having S$ 0.322 in net asset value. I am thinking of buying into LMIR again should the price hits $0.30.

Appreciate if you could talk to yourself on LMIR.

Betta man said...

Taking the above bad news into consideration, would you consider investing in LMIR should the price falls to $0.30 ?

AK71 said...

Hi betta man,

I think you might remember that I sold a big chunk of my investment in LMIR many years ago.

I have the impression that you have been following my blog for many years. :)

Since then, I have not added to my investment in LMIR even as its unit price declined.

I am OK with holding on to my remaining investment in LMIR as it is virtually free of cost but to add, given the mediocre management, it has to be at a lower price for yield to expand a lot more.

AK71 said...

Reader says...
Hi AK, may I know what are your thoughts on Lippo Malls Indonesia Retail Trust? I understand you had some exposure to it previously but can't seem to find much in your blog now.

AK says...
My views have not changed since this blog.

AK71 said...

AK said...
I sold a big chunk of my investment in LMIR many years ago at more than 50c a piece.
Since then, I have not added to my investment in LMIR even as its unit price declined.

Loke Oilin said...
More than 50cs a piece is in 2013.I remembered as I was hesitating and I sold at much lower prices a few yrs later.Big brother seem to have the ability to exit investments at a high price at the right time.Asia TV too

AK said...
Pure dumb luck, I am sure. ;)

Loke Oilin said...
U too humble.U did your analysis and I dumbly hold it till I offloaded them for my delisting bets.

AK said...
Alamak. If I am so smart, I would have sold everything and not just a big chunk. LOL :p

Loke Oilin said...
A big chunk is good enough liao as u made a sizable profits if u have brought them in GFC.They were trading at around 17-20cts in GFC.

AK said...
The number 18.5c stuck in my head. ;)

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