PCRT: Full divestment.

In a recent blog post, I compared Croesus Retail Trust and Perennial China Retail Trust, explaining why although both are business trusts, the former is a better investment for income.

I avoided Perennial China Retail Trust at its IPO in 2011 believing that the distribution yield did not compensate investors sufficiently for the level of risk which they were being asked to take on. I only initiated a long position at a much lower price of 47.5c a unit much later in the middle of 2012.





I did that because I believed that the level of risk had reduced significantly and that the distribution yield of more than 8% or so was sufficient compensation while I waited for the Trust to deliver better results.

About a year ago, I mentioned that the earn out deeds which the Trust was distributing income from will be exhausted by end of the year 2014 and that the management must work harder to ensure its portfolio of assets pick up the slack. When I blogged about the Trust again in November last year, some encouraging progress was made.

In the latest announcements by the Trust, although I am pleased to see that progress continues to be made, I am very concerned that, by the management's own admission, the situation in Shenyang is still challenging. I recently shared this concern with some friends over a lunch gathering too. Shenyang Longemont offices, completed in 2012, is still less than half occupied by the end of December 2013.





So, where is the Trust's income coming from? Its 50% share of the properties in Shenyang contributed $2.25 million in Q4. Perennial Jihua Mall in Foshan contributed $1.28 million in Q4. Assuming that the Trust makes no progress and keeps the status quo, these properties should generate a gross revenue of some $21.56 million this year.

The 5th and last property in the Trust's IPO portfolio is Perennial Qingyang Mall in Chengdu. This is to begin operations in April 2014. This is a bigger mall than the one in Foshan and has secured 85% leasing commitment thus far. If we were to assume a similar level of revenue as what has been achieved by Perennial Jihua Mall in Foshan, this mall could contribute $5.12 million in yearly revenue or more.

So, realistically, the Trust's IPO portfolio of properties should be able to generate some $26.68 million in gross revenue on a full year basis. This is a conservative estimate, all else remaining equal. Not too shabby especially if we consider the fact that there is still quite a bit of vacant office and retail space to be filled.

However, there are costs to take into consideration. In the department of costs, there are recurring costs and one off costs. I will take in just the recurring costs in this analysis because they will impact results on a more enduring basis.





Trustee-Manager's fees, I estimate these at $6.8 million a year once Perennial Qingyang Mall in Chengdu is completed. Finance costs, I estimate these at $10.28 million a year. Assuming that there are no one-off costs in the full year which, of course, is most unlikely, these two major recurring costs would already amount to $17.08 million a year.

Remember that, in earlier blog posts, I mentioned that Perennial China Retail Trust could half income distributions to unit holders once the earned out deeds are exhausted by end of 2014? Now, using the numbers I just presented above, that statement could have been too optimistic.





In an unrealistically optimistic scenario, the Trust could be distributing $16.4 million of income to unit holders a year. Of course, this does not take into consideration possible further improvement in occupancy. However, it also does not consider costs apart from the Trustee-Manager's fees and finance costs. In such an instance, hypothetically, how much income is that going to translate to on a per unit basis?

Right now, the Trust has a DPU of about 3.8c a year. This translates to about $44 million a year for the Trust. So, proportionally, we could see DPU fall to 1.41c a year in 2015.

Now, when we are reminded of the fact that Perennial China Retail Trust said at its IPO that they would distribute at least 50% of distributable income to unit holders, DPU could then be as little as 0.71c in 2015.

Bear in mind that the Trust has two other malls under development, Perennial Dongzhan Shopping Mall in Chengdu (80% share) and an integrated development in Tongzhou (10% share). The former is to be completed in another year or so while the latter in another 2 or 3 years.

Progressive payments must be made and the Trust could either resort to more debt or tap the cashflow generated by its portfolio of completed assets. Which option would the Trust adopt? I don't know but I do know that DPU will take a big hit in 2015 no matter which option is adopted.

Now, what?





My assumption made last year that DPU, in the worst case scenario, will drop by half in 2015 and thereby delivering at least a 4% yield on my purchase price of 47.5c per unit has been very much undermined.

I do not know if the Trust will do better in the next couple of years but for me to stay invested would require a lot more than just faith in the management that they will deliver in future. I need to be adequately paid while I wait.

Last year, I partially divested my investment in the Trust at 61.5c a unit. Today, at XD, I divested my remaining investment at 50c a unit, booking a very small gain of 5.26% but I will receive the 1.9c per unit of income distribution as well.





This is probably a good time to remind myself of something Warren Buffett once said:

"Have the purchase price be so attractive that even a mediocre sale gives good results."

For anyone still vested in PCRT, I hope the Trust does deliver eventually and that its operating assets will do well enough to generate enough income for distributable income to be maintained. Otherwise, a big reduction in distributable income could also possibly lead to a big decline in stock price.

So, what do I think is a fair value for PCRT? I won't give a number but the day PCRT is able to offer me a reasonably attractive distribution yield using only 50% of its distributable income and at the same time maintain a relatively strong balance sheet, I could be interested again.

See: 4Q Financial Statements.
See: Presentation Slides.
See: Appendices.







After writing this blog post, I found that the latest issue of The EDGE has an article on Perennial China Retail Trust in which Pua Seck Guan revealed that he is looking into the possibility of liquidating some of the Trust's assets in order to continue funding payouts to investors to avoid disappointing them in 2015 and beyond. With this strategy, he hopes to continue giving a DPU of 3.86 cents per annum.

Although it is reassuring to a certain extent that there is a plan to maintain DPU, we have to remember that a plan like this, even if executed successfully, is essentially a return of capital. It seems to me like a desperate measure amidst very challenging conditions.

If we wish to invest in income generating properties and get a meaningful yield on our investment, I believe that there are better options available, options which would not have to resort to asset sale in order to fund future payouts.

Related posts:
1. Perennial China Retail Trust: 1H 2013 DPU 1.9c.
2. Perennial China Retail Trust: Progress in Q3.
3. Croesus Retail Trust and Perennial China Retail Trust.

Tea with Solace: Frasers Centrepoint Limited (FCL)

A Peek into Frasers Centrepoint Limited (FCL)

Frasers Cpt (FCL) has been spun off by F&N, the real estate division carved off from its operation business. It was listed on the SGX Mainboard on 9 Jan 14. The stock opened at $1.61, reaching a high of about $1.70 a couple of days later before retreating to the current price of $1.41 to $1.42.

FCL operates as an international real estate company. It owns many properties that we are very familiar with. It has major stakes in two REITs – FCT and FCOT.

Souce: FCL 1Q14 Results Presentation. Click to enlarge.

Financial Highlights

Revenue increased by about 87% and PBIT increased by about 63% Year on Year. The strong set of 1Q14 results showed year on year gains in all segments. Strong overseas development sales were the key driver.

Development PBIT rose by about 121% year on year. It was led by Australia with the completion of One Central Park (CP) and Park Lane Block 5A in Sydney. As for China, around 750 units were sold in 1Q14, but the overall residential market remains cautious in China. In Singapore, Overall prices declined 0.9% q-o-q in 4Q13. Around 15,000 new homes were sold in 2013, 32% lower compared than 2012

Given the increasingly cautious sentiment in the local property market which has been affected by cooling measures, Frasers Centrepoint’s strategy of venturing overseas can put it in a good position for further growth,

There was also an increase in commercial rents and room rates with higher contribution from One@Changi City . Construction of Waterway Point is progressing well, slated to be completed in 2015.

Currently the Net Asset Value per share is $2.15. At current price of about $1.41, it is about 35% discount to its NAV. I am vested at this price

I resisted entering when it was trading at $1.50 or $1.60. Recently, I make a comparison of similar real estate companies listed in Singapore. On average, they are trading at about 0.75x book value. At current price of $1.41, with about 35% discount to NAV, I feel comfortable vested in FCL properties. Valuation is attractive in my opinion.

FCL has a net debt to equity of about 50%, which I am uncomfortable with. Recent media reports suggest that FCL will launch a hospitality trust, which could raise S$600m. Once they spin out the hospitality REIT, they should be able to move some debt off their books. This asset recycling move is beneficial to FCL similar to what OUE and SPH have done in recent times.

This move can fund new acquisitions and allow them to be asset light. This strategy also allows them to earn more REIT management fees and improve its commercial portfolio.

Potential Risks

FCL has a small free float of only about 12%. This does not sit well with large investors. Hopefully, this will change over time. Increasing FCL free float will improve investor participation and narrow the valuation discount. This remains a uncertainty and likely to depend on market forces.

Another potential risks lies in the majority shareholder. In this case, it is Thai boss, Chaoren, holding a direct stake at 76%. It is of utmost important that the Thai towkay's interests are aligned with minority shareholders.

What are the things the management can do to the detriment of minority shareholders? They can set unreasonably high directors remunerations or, worse still, IPT (Interested Person Transaction) which will solely benefit the majority shareholder instead of all shareholders. I believe IPT risk possibility is low but still it is a risk.

As Warren Buffett said, integrity of management is very important. This is an area which I have to pay attention to.

Conclusion

I believe at current valuation, FCL is attractive, trading at about 35% discount to its book value of $2.15. The portfolio is spread across residential, commercial and hospitality properties in markets such as Singapore, China and Australia which reduces the risk of downturn in any particular country dragging down the whole company. It has a good history of increasing its profits and assets. FCL also has a potential catalyst in the form of REIT listings in the near future,

Key risks like free float and management integrity still remains. The financials of FCL look extremely attractive and there is huge potential upside to go but it also holds hidden risk that goes beyond financial statements.

While many people are proclaiming doom for the real estate, my strategy is to invest at attractive valuation and sit tight to wait for events to unfold. I like to stay invested in good counters for longer period of time. All counters are good investments at the correct valuation.

I came across a recent quote from the papers which best explains my strategy in holding this stock.

"We believe that if you don’t believe in holding a share for 10 years, then don’t even think about holding it for three days… Speculators can still get their thrills through other means. But let’s not make the mistake of confusing investing with gambling"

- Mr David Kuo, Chief executive of Motley Fool Singapore.

Some other guest blogs by Solace in ASSI:
1. King Wan Corp. Ltd.
2. Common Sense Investing.
3. Getting ready for investment.