Parkway Life REIT - CIMB Research 2016-09-25: Still revving its engines

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PARKWAYLIFE REIT C2PU.SI

Parkway Life REIT - Still revving its engines

• Potential value uplift from Japan’s strong real estate market.
• Opportunity to deliver asset monetisation and capital recycling strategy to create value for unitholders.
• Resilient Singapore earnings, with possible medium-term upside from growth-biased revenue formula.
• Upgrade to Add with DDM-based TP of S$2.78.

Still revving its engines 

• We spoke with PREIT recently on latest developments as well as its strategy going forward. 
• Management’s ongoing plans for portfolio positioning, particularly for its Japan assets, and to seek inorganic growth via asset acquisitions are very much intact and visible. 
• In addition, with Singapore healthcare operations growth outpacing the current anemic inflation outlook in the country, we think there could likely be potential for upward revision in Singapore contributions over the next 3-5 years, should the group’s revenue formula revert back to a growth-biased structure.

Japan portfolio rejuvenation remains intact 

Active Japan investment market, cap rates compressing 

• According to CBRE, the Japanese real estate market remained fairly active in 1H16. Although lower on a yoy basis, there were an estimated ¥1,535bn (US$15.2bn) worth of deals done, largely coming from J-REITs. 
• While there appears to be more investors who view the current market as a selling opportunity, there is no change in sellers’ bullish stance due to the still buoyant rental market.

Potential for surplus asset value realisation 

• We think this is positive for PREIT. Its Japan portfolio is valued at S$604.7m and generates an average NPI yield of 6.5%, based on annualised 2QFY16 numbers. The latest valuation (Dec 15) cap rate range was between mid-5% to 7.4% for this portfolio. The compressed market yields would enable the group to 
  1. benefit from a potential upward revaluation of its existing portfolio (and narrow its equity premium over book value) and 
  2. allow it to unlock value from the existing portfolio and recycle capital into new and better quality assets. 
• We have not factored in any potential value accretion into our current estimates.
• Our sensitivity analysis below shows the potential impact of various levels of compression in Japan asset cap rates on PREIT’s book value. For every 10bp decline in NPI yields, book value per unit would increase by 1.6-2.3 Scts. A 20- 30bp reduction in NPI yields would bring PREIT’s P/BV closer to its +1s.d. valuation.

Capital recycling is key 

• We think what would be of more interest to investors is PREIT’s ability to monetise its assets and reward unitholders in the form of capital gains distributions as well as reinvesting into yield-accretive acquisitions.
• As a matter of track record, the group had sold a portfolio of eight properties in Dec 14 to Fortress Japan Investment Holdings for S$88.3m or at a 16% premium to book value and 8% above independent valuation. In cap rate terms, the properties were transacted at an average 5.9% vs. 6.2% carrying yield.
• Divestment gains of S$12.3m were paid back to unitholders in 2015. PREIT had subsequently purchased S$126.1m worth of properties at a higher 6.4% yield.
• PREIT remains focused on growing its portfolio in Asia, particularly in Japan, given the more favourable outlook for nursing homes, as well as Malaysia, Australia and China.
• With a strong balance sheet and gearing of 37.8%, PREIT would have additional debt headroom of c.S$230m, assuming a gearing ceiling of 45%.
• The group has also termed out all its FY17 loans as well as 27% of loans due in FY18 via a 5-year committed loan facility. Overall cost of debt remains low at 1.4% and 98% of its interest rate exposure is hedged.

More than just deflation protection 

Potential for medium-term revenue upside from growth biased structure 

• Focusing on Singapore, we note that while PREIT’s revenue is very resilient via a deflation protected structure, we believe there could be upside risk in the next few years even if inflation outlook remains anemic. This could happen as the gap between its current inflation-pegged vs. base-plus-percentage-of-hospital revenue growth structure narrows as Singapore hospital operations continue to grow at a faster clip, outpacing modest inflation expectations over the next few years.
• In the section below, we assess the possibility and timing of PREIT’s topline reverting back to a more growth biased revenue structure compared to the inflation pegged formula used currently.
• To recap, PREIT’s Singapore operation derives its revenue from master leases from Mount Elizabeth, Gleneagles and Parkway East hospitals. This is calculated based on the higher of: 
  1. preceding year’s rent plus (CPI+1%, subject to a minimum of 1% if inflation is less than 0%), or 
  2. S$30m base rent plus 3.8% of adjusted hospital revenue. Adjusted hospital revenue includes inpatient and outpatient revenue, rental and other income fee from healthcare operations such as laboratory and radiology services, carpark, retail pharmacy and F&B contributions from the staff cafeteria and doctors’ lounge at these three hospitals.
• PREIT’s Singapore topline growth from FY09-15 was pegged to the inflation rate, ranging between 0.05% and 5.3%, which outpaced its share of adjusted hospital revenue. For the period of 23 Aug 2016 to 22 Aug 2017, we expect Singapore revenue to grow at a minimum of 1% based on the CPI+1% formula given the deflationary outlook in Singapore.
• We think the gap between inflation pegged vs. adjusted revenue based topline will narrow over the next few years due to the expected stronger Singapore hospital operations growth, and we believe that the REIT’s topline growth could have some upside risk bias in the medium term. Our healthcare analyst projects the hospital and healthcare revenue from these three hospitals to grow by 7-12% annually (6.1-7% in S$ terms) over FY16-18F and assumes modest 5% growth p.a. thereafter. This compares to a consensus inflation outlook of - 0.5% in 2016 and 1% in 2017.

Valuation and recommendation 

Upgrade to Add 

• We have raised our FY16-18F DPU estimates by 0.1-1.5% as we fine-tune our estimates to factor in potential for stronger longer-term growth from robust hospital operations. Hence, our DDM-based valuation is raised to S$2.78. As such, we upgrade our call to Add with potential total returns of 14-15%.
• In addition, we think there could be further upside should PREIT successfully execute its strategy of further asset divestments, particularly in Japan, and recycle capital into higher-yielding properties. This has not been factored into our present estimates.
• In terms of valuation, while PREIT is currently trading at 1.55x P/BV, higher than its peers FIRT and RHT’s multiples of 1.2-1.3x, we think PREIT is strongest in terms of earnings stability through its long average lease expiry profile of 8.9 years (12.92 years for Japan), resilient rent structure and downside protection for 93% of its gross revenue. It also has a solid track record in asset and capital management.

LOCK Mun Yee CIMB Research | YEO Zhi Bin CIMB Research | http://research.itradecimb.com/ 2016-09-25

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