Mall REITs - CapitaRetail China, Fortune, and Frasers Centrepoint

Introduction

This research note is on three of the pure-retail commercial REITs listed on the SGX, Frasers Centrepoint Trust, Fortune REIT and CapitaRetail China Trust. They are all in the business of acquiring and managing retail properties within their respective geographical mandates and paying out 90% or more of their distributable income, as per standard REIT rules. This note will be the first of a series analysing the commercial REITs in Singapore

The charts below give us an idea of how the respective REITs have performed in the stock market.

Competitive Comparison

These three trusts operate in different geographical jurisdictions and do not compete directly against each other. They compete with other trusts and retail malls within their respective geographical areas. Because the market for retail space is relatively fragmented on the supply side, lease and occupancy rates depend on the macroeconomic performance of the region.

CapitaRChina – The majority of CapitaRetail China’s retail properties, Wangjing, Jiulong and Anzhen mall, are in Beijing. Together, they account for 77% of CapitaR’s net property income for 2Q 2007. The performance of the REIT will therefore depend largely on the Beijing commercial property market. A recent research piece on the Greater China property market by Jones Lang Lasalle has a positive outlook on Beijing:

“Some pessimists may point to the fact that Beijing’s double-digit vacancy rate of 15.5% in 2Q07 is already a clear indication of an over-supply condition. We hold a different opinion, viewing this as a structural problem, due to the existence of a pool of stock that cannot meet the requirement of tenants, and as such contributing to the high tenancy levels. … The implication from this is that new quality buildings with the right specifications should not have a problem finding tenants to fill the space.” – Lee Wee Liat of Jones Lang Lasalle

Fortune REIT – A recent report by Colliers on Hong Kong’s property market gives the following commentary. The general economic sentiment in Hong Kong, as in Greater China, is positive, and this has had the effect of causing rents to rise:

“Essentially, asking rentals were raised by vendors in view of the positive market sentiment attributed to the record-breaking stock market prices and the positive consumption sentiment. Meanwhile, retailers were impressed by the stronger-than-expected business volume registered in late 2006, thus becoming even more aggressive in securing their outlets. Individual retailers were found to raise their rental offer for a shopping unit in the prime districts by as much as 40% in an attempt to outbid rivals during 1Q 2007.”

Frasers CT – 3 main retail malls in Singapore all connected through MRT and bus routes and in populated housing areas. A recent Colliers’ report on the real estate market in Singapore indicates that the retail rates as a whole grew slightly due to growth in the tourism market and the expansion of the presence of retailers in Singapore. However, Frasers’ retail properties are mainly in residential areas and not in the prime shopping districts so the impact of the expansion of the upscale retail industry and tourism industry is likely to have a muted impact on Frasers’ performance. Nevertheless the general economic condition in Singapore remains positive and Frasers is expected to experience the benefits of the economic expansion as announced by PM Lee Hsien Loong in his latest NDP Rally Speech.

Quality of Accounting

CapitaRetail China – The first thing confronting the analyst is the page long note explaining the lack of historical comparative statements for various reasons such as “ownership period is too short,” “period of operations is too short,” and “relevant information to prepare the historical pro forma financial information is unavailable to the manager.” While these are valid reasons to exclude comparative preceding year statements, the lack of comparatives makes it slightly difficult to gauge the performance of CapitaR relative to its peers.

Another thing to note is that in the cashflow statement CapitaR starts the calculation of CFO using net income after tax, instead of using net income before tax as is usually the case for the other REITs. CapitaR also does not exclude the asset revaluation figure from its starting net income after tax, making it harder for the analyst to make comparisons while excluding non-recurring items. The Fraser CT financial statement is much more investor-friendly in this respect.

The quality of disclosure of CapitaR is quite high, although not as detailed as Frasers CT, which is considered below.

Fortune REIT - Shortest report of the 3, by far. While length of disclosure is not necessarily indicative of quality of disclosure, this is still a point of notice. However, compared to the CapitaR financial statements, the footnotes are more detailed than CapitaR.

Frasers CT – Of all the 3 financial statements, I found Frasers’ to be the most comfortable to navigate. It is the longest of the three, and there are very detailed footnotes to every financial statement.

A couple of things to note regarding Frasers CT is that it has a relatively high proportion of gross revenues coming from “other revenues.” This will be dealt with below in the financial & profitability analysis. Another thing to note is that is has recorded a significant surplus on revaluation of properties of $44.5m. This is not a problem because the surplus is appropriately recorded below the investment income as a non-recurring item and is not included above the bottom line unlike HMI.

Financial & Profitability Analysis

The table above shows key comparative ratios between the three REITs.

Operating Efficiency – Fortune REIT appears to have the greatest operating efficiency amonst the three REITs by a substantial margin, while CapitaR has the lowest operating margin. However, due to taxation, Fortune REIT yields a lower net margin compared to FrasersCT, with CapitaR having the worst performance.

Cash Flow Quality – The numbers show that CapitaR has the worst cash flow quality of the three REITs, by a substantial margin. There has been a marked increase in accounts receivable and this has had the effect of lowering operating cash flows. The CFO numbers for the other REITs are quite normal, with FrasersCT having the best cash flow quality.

Leverage – In terms of leverage, CapitaR has the greatest amount of debt, at 37% of assets. Fortune at 27% has the greatest capacity to take on debt in order to make yield-accretive acquisitions. Frasers is somewhere between the two.

Relative Valuation

The numbers clearly show that CapitaR is the worst performer, from a financial analysis standpoint. It has the highest leverage, the lowest margins, and the poorest cash flow quality. Yet the bizarre thing is that it has the highest valuation, by a mile. The projected payout ratio based on latest share prices is a mere 2.52%. Yet it has the highest leverage. Furthermore, it has a P/B of 2.48. This looks like an insane valuation.

Fortune REIT appears to be the most reasonably priced of the three. With a yield of 6.16% and a P/B of 0.67, it looks like a relative bargain. Furthermore, its balance sheet has much greater room to take on debt for accretive acquisitions

FrasersCT is somewhere in the middle, and looks fairly priced on a comparative basis. It’s yield of 4.18% is somewhat below what you would expect from a REIT, but is not too low as compared to CapitaR

What is keeping CapitaR up high in the sky? Is it the expectation that the REIT will find an opportunity to unload assets at a significant gain? Or is it because rentals are expected to soar overnight? I really don’t understand.

As far as I’m concerned, I’m staying away from CapitaR for the time being, and I’ll keep Fortune on my watchlist.