Mapletree Greater China Commercial Trust - DBS Research 2017-04-28: The Penny To Finally Drop

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MAPLETREE GREATER CHINACOMM TR RW0U.SI

Mapletree Greater China Commercial Trust - The Penny To Finally Drop

• 4Q17 and FY17 DPU up 2% and 1% y-o-y - above expectations.
• Successful negotiation of lower VAT in Beijing.
• Guidance for high single/low double digit positive rental reversions at Festival Walk.

WHAT’S NEW

Impressive negotiation skills 

Successful tax negotiations led to FY17 DPU rising by 1% y-o-y versus market expectations of a decline 

• 4Q17 came in at 1.959 Scts (+1.9% y-o-y), taking FY17 DPU to 7.31 Scts. The 1% y-o-y increase in FY17 DPU was contrary to our and market expectations of a fall in DPU (DBS: -1% and market -0.4% y-o-y).
• The better than expected 4Q17 results was mainly due MAGIC’s successful negotiations with the Beijing authorities, which resulted in the reversal of Value Added Tax (VAT) payable previously at Gateway Plaza.
• MAGIC, taking a conservative stance, had accrued for this VAT at 11% of top line from May 2016. Before May 2016, VAT was not payable as Gateway Plaza was held by an offshore structure.
• Following clarification obtained from the local tax authorities and the implementation process, the new VAT applied is based on 5% of gross revenues. After adding back an estimated S$2-2.5m in tax payable from prior quarters, 4Q17 net property income (NPI) from Gateway Plaza jumped 10% y-o-y to S$20m or 15% y-o-y increase in RMB terms.
• The current VAT regulations are in place for the next three years and are subject to change by the local authorities. However, we understand the VAT is expected to be made into law, rather than a regulation, which reduces the risk of future sudden changes in the VAT tax rate.

Festival Walk and Sandhill continue to perform 

• Meanwhile, Festival Walk continued its healthy performance, with 4Q17 NPI up 4% to S$51.5m (up 3% y-o-y in HKD terms). Sandhill Plaza also had a strong quarter, with 4Q17 NPI up 16% y-o-y to S$5.9m (up 21% y-o-y in RMB terms) as it benefited from the robust rental reversions in the prior quarters.
• Occupancy on an asset and overall basis remains stable. Festival Walk and Sandhill Plaza are fully occupied with Gateway Plaza at 96.9%. Overall portfolio occupancy stood at 98.6%.

Moderating rental reversions as expected 

• As expected, rental reversions across MAGIC’s portfolio moderated. 
  • At Festival Walk, MAGIC achieved 12% uplift in rents for FY17 versus 14% for 9M17, 37% in FY16 and 22% in FY15. We understand the lower level of rental reversions especially in 4Q17, was due to a change in trade mix (e.g. switch from fashion trade to lower paying F&B tenants), rather than any significant reduction in demand for space at Festival Walk. Passing rents at Festival Walk now stand at HKS$143.50 per sqft per month as at end 4Q16.
  • Gateway Plaza recorded 10% positive rental reversions for FY17 versus 10% for 9M17 and 25% for FY16. Passing rents for the property were reported to be at RMB333.50 per sqm per month.
  • Meanwhile, Sandhill Plaza delivered a healthy 16% increase, lower than 28% in 1Q17, 23% in 1H17 and 16% in 9M17. Passing rents for Sandhill Plaza ended the year at RMB5.18 per sqm per day.
• In terms of lease expiry, 38% of leases are up for renewal. However, to date 14% of leases have already been renewed or re-let.
• Over 4Q17, while MAGIC reported a 4.7% y-o-y decline in tenant sales, the drop has started to moderate as expected. This is down from the declines of 16% and 9.4% in 4Q16 and 3Q17 respectively. In addition, foot traffic has recovered, up 11% y-o-y in 4Q17, up from 2.7% in 3Q16 and -14.2% in 4Q16.

Optimised capital structure and uplift in property values.

• MAGIC’s gearing remains stable at 39.2%, close to the 40-41% optimal level that MAGIC has targeted.
• The effective cost of debt increased to 2.72% from 2.43% at end 4Q16. While MAGIC now faces slightly higher borrowing costs, this is balanced against having a longer debt maturity which now stands at 3.73 years up from 3.01 years at end 4Q17.
• The proportion of fixed rate debt also remains steady at 71%. Furthermore, MAGIC has hedged 65% of expected distributable income for 1H18.
• For FY17, MAGIC reported a 5.1% y-o-y increase in property values. Out of the S$304m in revaluation gains was S$219m increase in property values on the back of higher income at its properties and S$78m in net translation gains arising from a strong HKD versus SGD partially offset by a weaker RMB versus SGD. Cap rates were stable at 4.5%, 6.5% and 5.75% for Festival Walk, Gateway Plaza and Sandhill Plaza respectively.
• As a consequence of higher property values, NAV per unit now stands at S$1.301 up from S$1.239 at the end of 31 March 2017.

Some near term vacancy risks at Gateway Plaza 

• MAGIC guided that there is some potential volatility in the occupancy at Gateway Plaza as a tenant which occupies around three floors is vacating the building (equivalent to around 6% of Gateway Plaza NLA). We understand that this tenant is moving out mainly due to its desire to consolidate some of its operations in a single location.
• However, we understand MAGIC is already in discussions with a potential tenant to take up half or all of the vacated space.

High single digit or low double digit rental reversions at Festival Walk 

• Despite headwinds from the soft HK retail market, MAGIC remains positive on the outlook for Festival Walk. Its occupancy costs of c.20% is no barrier to raising rents given the ratio remains between the 16- 22% range for other comparable malls.
• Thus, MAGIC guided that it will still be able to achieve high single digit or even low double digit rental reversions, which is within our expectations.

Raise FY18-19F DPU by 1-2% 

• To better reflect the likelihood that MAGIC had locked in favourable hedges as the HKD was strong versus the SGD between November 2016 and February 2017, we lowered our SGDHKD FX assumption from 5.65 to 5.60. In addition, we raised our margins assumptions at Gateway Plaza, given slightly better than expected performance.
• As a result, we raised our FY18F and FY19F DPU by 1- 2%. 

Time for the market to recognise MAGIC’s quality portfolio and strong track record – TP raised to S$1.25 from S$1.11 

• The market has historically placed MAGIC at a large discount to book given the lack of familiarity of Singapore investors with the HK and China commercial markets and FX risks.
• However, we believe MAGIC’s strong four year track record since its listing in March 2013 warrants this discount to close. Evidence of this strong performance includes: 
  1. 17% increase in DPU from 6.265 Scsts in FY14 (which beat IPO forecast by 13%) to 7.32 Scts in FY17 
  2. Total cumulative shareholder returns in excess of 40% (assuming reinvestment of dividends) since listing, making it the fifth best performing REIT over the same period 
  3. Impressive delivery of a 1% y-o-y growth in FY17F DPU despite the significant impact from higher property taxes in Beijing and headwinds from a weak RMB. 
• Moreover, given MAGIC’s sponsor is the Mapletree Group, which has an enviable track record of delivering value to the SREITs it manages, as seen by the strong returns from sister REITs such as Mapletree Commercial Trust (MCT) and Mapletree Industrial Trust (MINT), we believe some of the Mapletree Group premium should also be accorded to MAGIC.
• Thus, to better reflect investors realisation that Mapletree’s quality portfolio of Grade A retail malls and offices which are located in irreplaceable locations should trade at tighter yield, closer to that of its HK listed peers with comparable asset exposure, we lowered our WACC from 6.75% to 6.5%. Our WACC was previously based on a weighted average of HK’s and China’s cost of capital. Given MAGIC has now been listed in Singapore for more than four years, our cost of equity and WACC is now pegged to the Singapore market. In our WACC estimate, we have assumed a market return of 9.4% (consistent with our other SREITs), beta of 0.86 and 3% risk free rate.
• This results in our DCF based TP being lifted to S$1.25 from S$1.11 previously.
• At our TP of S$1.25, the implied yield stands at 6% slightly above comparable HK REITs such as Fortune REIT which currently trades at forward yield of 5.9%.

Valuation:

• After lowering our WACC assumptions, we raised our DCF- based TP to S$1.25 from S$1.11. 
• With 16% upside to our TP and 7.1% yield, we maintain our BUY call. 

Where we differ 

Market forecast of flat DPU too conservative.

• Consensus is forecasting DPU of 7.2 Scts over the next couple of years given doubts over the ability of Festival Walk to deliver higher rents. We believe this view is incorrect, given occupancy cost for the mall remains in the middle of the 16-22% range for other malls in HK, there remains a queue of potential tenants wanting to enter the mall, and its focus on local residents rather than Chinese tourists. 
• These factors should result in Festival Walk delivering positive rental reversions in the high single to low double digit range, translating to DPU growth for MAGIC.

Continued boost from Sandhill Plaza. 

• Since its acquisition in June 2015, Sandhill Plaza in Shanghai has boosted MAGIC’s earnings. However, we believe the benefits from this acquisition have not been fully realised as passing rents at the property remain below market.

Key Risks to Our View

• The key risk to our view is a significant downturn in the HK and Chinese economies, causing a decline in rents at Festival Walk, Gateway Plaza and Sandhill Plaza.

Mervin Song CFA DBS Vickers | Derek Tan DBS Vickers | http://www.dbsvickers.com/ 2017-04-28

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.25 Up 1.110