Croesus Retail Trust - Phillip Securities 2015-09-14: Steady Japanese Consumption.


Steady Japanese Consumption. 

  • We initiated on Croesus Retail Trust (CRT) in April 2014. Since then, CRT has returned 7.7% vs STI’s -4.6% (inclusive of dividends), an outperformance of 12.3%. 
  • Following the recent price correction, we reiterate our BUY call on CRT, notwithstanding a lowered target price from S$1.08 to $0.96 following a change in covering analyst. 
  • Here, we provide some updates on CRT, DPU growth drivers going forward and the Japanese economy and retail scene. 

Company background and latest updates 

  • Croesus Retail Trust (CRT) is the only business trust in Singapore which gives investors exposure to the retail scene in Japan. 
  • Investors optimistic on Abenomics reviving the Japanese economy and kick-starting consumption spending could invest in CRT as a proxy. CRT owns a portfolio of 7 predominantly suburban malls. Portfolio WALE (weighted average lease expiry) stands at 8.6 years, with ~72% of leases expiring beyond 2019. 
  • Coupled with the fact that fixed rents constitute ~88% of total gross rental income, CRT offers an investment proposition that has extremely stable rental incomes in local currency terms. We will discuss foreign currency exchange issues, which could be one of the main concerns of investors, in a later part of this report. 
  • Tenant sales are largely driven by domestic consumption of the locals in each mall’s catchment area. Additionally, ~66% CRT’s malls are structured as Fixed term leases (vs Standard Leases). 
  • In Japan, standard leases provide perpetual renewal rights to tenants and thus restricts the flexibility of landlords to adjust rental reversions or tenant mix. In contrast, fixed term leases provide greater flexibility in adjusting rental income and tenant composition upon lease expiry. 
  • Among the 7 properties, 4 of them, Croesus Shinsaibasi, Luz Omori, Mallage Shobu and One’s Mall have variable rent components in their leases, allowing investors to participate in any upside in tenant sales. 
  • Rental reversions from Mallage Shobu and new acquisition to drive DPU growth For FY16, rental reversions at Mallage Shobu, which were mostly completed in FY15, are expected to drive DPU growth. 
  • Lease renewals were done for 155 tenants (out of 242) throughout FY15. With most renovations completed and tenants settled in, the full impact of these renewals will be felt in the coming FY16. One’s Mall, which was acquired in October 2014, would start to have a full year contribution impact starting from FY16. 
  • Our last site visit report in April this year, which describes our visit to these malls, has more in-depth details. The crowd and buzz we experienced at these malls reinforced our optimism about the prospects of CRT. 

Recap of Key Investment Thesis 

Stabilization of Shopping Mall Supply 

  • The revisions to the Three City Planning Law in Japan in 2006 implemented tightened conditions for large scale retail development exceeding 10,000 sq m in suburban areas. Developers rushed to submit development permit applications prior to the implementation of the new law. This resulted in an oversupply of new shopping malls in the following years 2007 and 2008, which unfortunately coincided with the Global Financial Crisis. 
  • Consequently, after a prolonged period of economic recovery post GFC, and the gradual absorption of excess supply in 2007-2008, retail real estate capital values showed signs of stabilisation from 2010 to 2012. 
  • In December 2012 newly elected Prime Minister Shinzo Abe launched his “Three Arrows” stimulus program, now widely known as Abenomics. Since end 2012 and the launch of Abenomics, we have seen a gradual compression in cap rates for prime and suburban retail malls. 

Consumption expenditure to be supported by falling unemployment and rising real wages 

  • Since the launch of Abenomics in end 2012, Japan has seen signs of improvement especially on the jobs and wages front. Basic wage growth is understandably one of Abenomics’ key focus, with Japan being a country that derives ~60% of its GDP via household consumption expenditure. 
  • Wages are showing signs of improvement and in April this year, real wage growth turned positive for the first time in 2 years as the impact of April 2014’s sales tax hike subsided. Basic pay in Japan for January was reported to have grown at its fastest pace in 15 years. Unemployment rate also fell to 3.3% in July 2015, hitting one of the lowest rates in 18 years. 
  • As recently as May this year, BOJ revised up their assessment of the Japanese economy on signs of pickup in private consumption. Expectations are for more fiscal spending to kick-start further consumption. 
  • In August, Etsuro Honda, economic adviser to Japanese Prime Minister Shinzo Abe called for an extra spending package of JPY3t to help lift the economy. Last week, Japan’s economy minister also called for the consideration of fresh fiscal stimulus to the tune of JPY2tn. 
  • We think PM Abe’s push to increase real wages and Japan’s falling unemployment would provide a support for retail sales in Japan. 

Shift in shopper preference towards shopping malls 

  • An independent Japan Retail Sector market review by CBRE in 2013 listed several shifts in social trends in Japan in recent years. One key observation was the shift in shopping habits from daily shopping in nearby supermarkets to weekly family outings in large shopping malls which offer entertainment and leisure facilities for families. A similar Japan Consumer Survey Report 2014 by CBRE also found that 73% of respondents preferred to shop at department stores and shopping centres rather than high street shops. 

Occupancy Rates at low end of sustainable range 

  • From our chats with management, we estimate the occupancy costs of CRT’s Japanese malls to be in the 8-9% range. The average suburban occupancy cost in Japan ranges from 12-15%. A CBRE Japan Retail Sector market review (2013) conducted an analysis on gross margins of major retailers. It was concluded that across most tenant categories, the sustainable rent ratio ranges from high single digits to mid-teens. This suggests that tenants in CRT’s portfolio are likely able to tolerate upsides in rental reversions when leases expire. 
  • Our optimism is also helped by the fact that Japan retail sales are showing signs of stabilisation post GFC. 

Health Mall Occupancy rates and Good Management Track Record 

  • CRT’s malls enjoy near full occupancy since IPO in 2013. The long portfolio WALE of 8.6 years also provide for stability of income, with fixed rents constituting ~88% of gross rental income. 
  • While CRT does not have a long track record to boot since IPO was a short 2 years ago, we think management has displayed keen acumen with their property purchases so far. 
  • Upsides in valuations from purchase price range from +3.4% to +10.8% as of latest valuation date in June this year. We do however note that CRT’s trustee-manager fees are slightly higher than typical retail S-Reits, and will continue to monitor going forward, if these higher fees are justified. 

Investment Outlook 

  • With the change in analyst, we adjusted certain valuation model parameters and re-iterate our BUY call on CRT, though with a reduced target price of S$0.96 using the DDM valuation method. 
  • We assume a new total equity risk premium of 7% and Bloomberg-derived beta of 0.78. Risk free rate remains at 3.1%. Currency and interest rate risks Currency exchange risks should be one of the top concerns of investors as CRT collects income in JPY and distributes in SGD. CRT adopts a sound capital management strategy, with close to 100% of distributions hedged up to December 2016 (1y forward). Interest rates are also fixed for 100% of its debts, with the nearest maturity in 2017. 
  • Since IPO on 10 May 2013, the JPY has depreciated from SGDJPY 82.03 to around SGDJPY 85.2, a ~4% depreciation. We have factored in a gradual depreciation of the SGDJPY rate to 90 (2017), 92 (2018) and 96 (2019) in our valuation models, in line or more conservative than Bloomberg Composite estimates. 

Dehong Tan | Phillip Capital 2015-09-14
BUY Maintain BUY 0.96 Down 1.08