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Saizen REIT: Refinancing expenses reduced net income.

Friday, May 10, 2013

Saizen REIT reported a 70.5% decline in quarterly net income from operations. What investors in Saizen REIT should be concerned with is the permanence of the decline.

Saizen REIT saw a 2% increase in gross revenue, quarter on quarter, but a 15% increase in operating expenses and this led to NPI reducing 3.3%. If the higher operating expenses are the new norm, then, expecting a marginal decline in future DPU makes sense.

The biggest blow comes from "other operating expenses". This saw a 7.5x increase. This was what led to such a big decline in quarterly income from operations. However, remember that this is a one off event.

Basically, Saizen REIT terminated certain loans to refinance under better terms and to extend maturities. Although with the early terminations came hefty costs, bearing in mind that these are one time costs, the REIT has emerged stronger from the refinancing efforts. Why?

1. The cost of refinancing will be recovered in less than two years from interest savings achieved from new lower interest bearing loans.

2. The higher loan to value ratios of the new loans lead to more possibilities in debt funded acquisitions which will up income and, most probably, DPU too.

3. The earliest maturity date of Saizen REIT's loans is now in February 2018.

The pain that comes from such a large decline in quarterly net income from operations will pass because the costs that come from refinancing are a one off event. However, the benefits of the mentioned refinancing are longer lasting and will benefit anyone investing in Saizen REIT for income, all else remaining equal.

A pertinent question would be how the weaker Japanese Yen is going to impact valuation in S$ terms. NAV/unit of JPY18.69 means 22.86c in S$ terms today. So, the REIT is still undervalued, trading at under 20c per unit. However, this is less so than a year ago.

In the absence of yield accretive acquisitions and further improvement in occupancy which has improved to 92.2% on average, it is reasonable to expect DPU to be affected negatively. However, I sense more acquisitions in future and with higher average occupancy too.

Investing in Saizen REIT is buying into a conservatively leveraged play on Japanese residential real estate and a conviction that the Japanese economy will see better days ahead. With the JPY much weaker than the S$ these days, anyone investing for income should temper their expectations in terms of DPU in S$ terms.

See Saizen REIT's 3Q 2013 results: here.

Related post:
Saizen REIT: DPU 0.66c.


ryan said...

Hi AK,

Wow.. That was really fast! Was expecting the blog post this coming weekend tho! Thanks for the blog post. It further reinforce my conviction to stay vested and add more long position to this counter. I believe the forex risk for 2H 2013 DPU is already hedged, hence the impact is already mitigated. Moreover, 2 properties which were recently acquired in 3Q 2013 should also provide cushion to DPU. Therefore, there shouldn't be much impact to 2H 2013 DPU. However, the prospect for coming years will be more uncertain for Saizen with Abenomics and etc

AK71 said...

Hi Ryan,

I got too curious to wait and decided to use my lunch hour to do this. Hahaha... ;p

Overall, not too bad. Some short term pain, I guess, but nothing to damage the longer term fundamentals of the REIT. In fact, I feel more comfortable about the REIT now. :)

Steven said...

its quite wise of the managers to refinance now. its likely interest rates r going to go up this yr or early next. so they just got themselves a good bargain interest now^^

Steven said...

but, wonder y the price drops so much....

AK71 said...

Hi Steven,

I think Mr. Market does not like the idea that net income dropped 70%...

Steven said...

Hi AK,
yup... no1 likes net income drp lol...

AK71 said...

Hi Steven,

Of course, more discerning investors will look at the reason for the decline and if it is the result of worsening fundamentals. :)

AK71 said...

We project forward FY13‐14 yields at 5.9‐6.3%.

Saizen REIT’s FY13 yield is expected to take a slight dip due to its refinancing costs and acquisition‐related expenses as well as the impact of a weaker yen.

However, as the full revenue
contribution of recently‐acquired properties is being recognized in FY14 and with further acquisitional growth in the coming quarters, this will lift its yield to 6.4%, according to our projections.

Upgrade TP to S$0.220.

AM Fraser, 10 May 2013.

AK71 said...

No wonder that Argyle Street Management, the single largest shareholder of Saizen REIT (with 8.97%) has been a persistent seller of the stock in the past few weeks.

This was the opening paragraph in Lim & Tan's update on Saizen REIT. I had a good laugh. Yes, now we know why. Haha.. ;)

Garfield75 said...

Not scaring you but valuation in the real estate sector can be "managed" ...better to look into the capitalization rate used in the valuation relative to the current int. rate and how it will move up when int. rate increase. Rates movements are double whammy situation for REITs. It causes valuation to drop and financing costs to increase.

Unknown said...

Hi AK71,

Thanks for your blog analysis on Saizen Reit. Is Saizen Reit worth invested with the dip in price below 0.20? Can we expect good capital gain?

AK71 said...

Hi Garfield,

In a country where real estate valuations have been declining for 20 years almost consistently, more people are renting than buying their homes. This is despite the fact that BOJ has been keeping its interest rate close to zero.

So, the current valuations of Saizen REIT's properties are depressed. How can we tell? They are actually below replacement cost.

Even with an uptick in financing cost, I believe that Saizen REIT's properties will see revaluation upwards especially if inflation sets in and people see more sense in buying than renting.

In fact, more foreign investors are interested in investing in real estate in Japan in recent times. If I remember correctly, Saizen REIT divested a property with a 10+% premium to valuation not too long ago. :)

AK71 said...

Hi Dividend Chaser,

Well, at 20c a unit, it is almost 3c below NAV/unit (based on current exchange rate) and if we believe that real estate prices will start rising in Japan due to monetary easing and attendant inflationary pressure, then, Saizen REIT's units should trade higher.

However, depending on the direction of JPY/S$ exchange rate, this might or might not happen.

If you are looking for capital gains, Saizen REIT is a dicey proposition at the current price. If you are investing for income, it is pretty decent at under 20c as even the most pessimistic estimate of 1c DPU a year would mean a 5% distribution yield now.

Andy said...

I wonder why quite a few directors who are major shareholders are selling off their stake in saizen...

AK71 said...

Hi Andy,

Scroll up 5 comments before yours. ;p


Hi AK,

With the strengthening of Yen against the US$, my limited knowledge tells me that as such, DPU should in fact be affected positively?

I'm not too good with these foreign currency counters... learning as I go :)

Thanks in advance.

AK71 said...

Hi Solidcore,

Well, the JPY is rising from a much lower base.

The rate was S$15.5 to JPY1,000 in December last year. It is now S$12.5 to JPY1,000.

Even with the recent strength in the JPY, it is still some 20% lower than it was a few months ago.

Ernest said...

Hi AK,

A very inexplicable event happened. To me at least. There was a buy order for more than 4million shares and it went up to $0.195, a pop of 8.3% from opening price today.

Such events are really confusing for me as I cannot understand how it can a counter just pop like that?

Could you shed some light on events like this?

ryan said...

Hi AK,

Saizen REIT suddenly broke the resistance with high volume and it surged to 0.195 now, when all the SREITS are severely battered. Any idea what happened?

AK71 said...

Hi Ernest and Ryan,

I know that insiders have been buying as unit price softened.

This surge in unit price could be due to more insider buying or some institutional players liking the REIT.

Your guess is as good as mine. ;)

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