CapitaLand Limited & REITs - DBS Research 2017-08-16: Ready For The Next Leap

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CAPITALAND LIMITED C31.SI CAPITALAND COMMERCIAL TRUST C61U.SI CAPITALAND MALL TRUST C38U.SI CAPITALAND RETAIL CHINA TRUST AU8U.SI ASCOTT RESIDENCE TRUST A68U.SI

CapitaLand Limited & REITs - Ready For The Next Leap

• Robust reception at CapitaLand and REITs day held in Bangkok.
• Consistent execution of asset reconstitution strategy to drive efficiency and returns.
• Recapitalised balance sheets for its REITs enable inorganic growth.

Capitaland and REITs day in Bangkok. 

• We hosted a CapitaLand and REITs day in Bangkok where management met with a select group of investors. The meetings were well attended, robust and engaging. 
• Questions revolved around 2018 growth prospects and if the group and its REITs are pursuing any M&A activities to bulk up their portfolios.

CAPL on track for its 8.0% ROE target; war chest of capital for deployment. 

• CAPL and its REITs will generally see stronger operational prospects come 2018. 
• For CAPL, we remain confident on the group achieving its return of equity (ROE) target of 8.0% in 2017 on the back of strong pre-sales (China and Singapore) while its commercial portfolio (retail and office) continues to see higher valuations given robust transaction volumes in Singapore. 
• Looking ahead, CAPL continues to look for M&A opportunities to grow its land bank and might even look at opportunities in new markets.

Its managed REITs are well positioned to weather market uncertainties. 

• CAPL's managed REITs are industry bellwethers whose returns should remain stable despite operational challenges. 
• CCT and CRCT are infused with improved financial flexibility post sale of non-core assets at high prices. Proceeds when re-deployed will present as upside to earnings. 
• Post a recapitalised balance sheet, ART is set to deliver accelerating returns on the back of debt-funded planned acquisitions in 2H17 and potentially more in 2018. 
• Retail REITs (CMT and CMMT) will ride through challenges in the retail sector in Singapore and Malaysia as active management of their malls underpins their dominant positions in their submarkets.

Propelling returns through asset recycling. 

• Over time, the group has been consistently re-constituting its portfolio to drive higher value accretion for unitholders. 
• In 1H17, CAPL and its REITs announced close to S$2.4bn in divestments and deployed close to S$3.6bn in capital towards higher yielding opportunities that management believe offer higher total returns (yields and medium-term capital values) under active management.

CAPITALAND LIMITED (CAPL)

Significant player in China's retail sector. 

• With a significant c..45% of its asset base in China, its fortunes are closely tied to the operational outlook for the residential and retail markets there. 
• The group has RMB11.7bn of unrecognised pre-sales; of which 20% is expected to be recognised in 2H17 and the rest from 2018 onwards, underpinning a strong earnings trajectory going forward.
• In the retail space, efforts to combat the rising threat of ecommerce are making headway. Portfolio same-store sales in China are up 16% in 1H17, and we believe that CMA is taking steps in the right direction. 
• The group's overall aim is to continue to gain mindshare with consumers through active management of malls in the portfolio, and introducing new concepts in fashion and F&B to its malls, which seem to be gaining traction with consumers.

Asset recycling a key strategy to drive returns and ROEs. 

• While CAPL has ample cash resources that can be deployed opportunistically, asset re-cycling remains a key strategy to optimise portfolio returns. CAPL and its REITs have divested or are in the process of divesting close to S$2.4bn of assets and will be redeploying the proceeds into S$2.0bn worth of income-producing properties, and have committed another S$1.6bn to the redevelopment of Golden Shoe car park. 
• We believe that the group’s strategy of optimising portfolio returns through active management of its portfolio will help to boost ROE towards the management’s longer-term target of c.8% 

Any mergers & acquisitions (M&A) on the horizon? 

• Management played down suggestions of a consolidation between its REITs when asked if a consolidation of its retail REITs (CMT, CRCT and CMT) to form an “Asia-Pacific REIT” is possible. 
• While such a scenario is under consideration given the intention might be to build scale and growth, we understand that management prefer to have their REITs split into “developed market” and “emerging market” exposures given different market dynamics and risks.

ASCOTT RESIDENCE TRUST (ART) 

A global presence that is second to none. 

• ART is part of Ascott Limited, which is one of the largest owners, operators and managers of serviced residence globally. As a group, it has c.70,000 units over 502 properties in 31 countries (more than 120 cities). 
• The group’s extensive reach and growing global network, through acquisition of Quest Apartment Hotels in Australia and Synergy Global housing in the US, will further underpin the group’s position as a leading global operator.

Brighter operational environment. 

• While 2Q17 results were weak, the manager is seeing a general pick-up in demand in its major markets, which implies that we should see an acceleration of organic growth momentum going into 2H17. This is on top of contributions from newly acquired and planned acquisitions. 
• The REIT’s properties in Vietnam, Australia and China should see improving RevPARs on the back of stronger corporate demand. 
• Europe, a key market for the REIT, is also seeing increased demand from travellers. That said, its master leases expiring in Europe are expected to be renewed at higher rates.

Improved financial flexibility post balance sheet recapitalisation, investors to ride the debt-funded growth.

• With the balance sheet recapitalised, asset disposals and uplift in valuations, ART's gearing is at a low of 32.4%. 
• Despite the planned acquisitions of DoubleTree by Hilton New York, Times Square South and Ascott Orchard, Singapore, we expect gearing to stabilise around the 36-37% level. Even then, we estimate that ART will still have a further headroom of close to S$300m, up to 40% level.
• The manager is casting an eye in Europe, Australia and even the US for opportunities from both Sponsor and third parties, which when acquired, will drive DPUs higher in the medium term.

CAPITALAND COMMERCIAL TRUST (CCT) 

Bright prospects over next few years. 

• We believe that CCT is poised to benefit from an expected improvement in office sector prospects over 2018-2020 planned new office completions are expected to fall fairly significantly to c.0.6m sqft per annum, which is below the average demand of 0.7m sqft per annum (5-year average). This is expected to swing the negotiation and pricing power back to landlords as the new supply gets taken up.
• In fact, we are already seeing signs that office rents may have bottomed in 2Q17 with consultants indicating that rents have turned the corner. This is earlier than anticipated recovery from end-2017 onwards and could mean downside from negative rental reversions in 2017 (expiring rents were signed when market conditions were buoyant) might narrow, minimising downside to DPUs.

Asset reconstitution strategy at work. 

• The recent disposals of a 50% stake in One George Street and Wilkie Edge at 16.7% and 39.3% above their respective book values highlights the REIT’s conservative NAV. The sale prices implies an exit yield of c.3.2% which in our view can be redeployed to other value-accretive acquisitions, if any.
• At this point, the manager has earmarked a majority of the proceeds towards the redevelopment of Golden Shoe car park, repayment of debt and if required, to top up any weakness in DPU given the loss of income post sale.

Golden Shoe redevelopment to drive longer term values. 

• The redevelopment through a JV with sponsor, CapitaLand Limited (CAPL) and Mitsubishi Estate Co., into a new skyscraper will be completed in 2021 at a cost of S$1.82bn. Instead of taking the development project on its own, this gives CCT financial flexibility and minimizes its concentration risk. 
• With a target yield on cost of 5.0% and an option to acquire the property post completion, the property will provide a medium-term uplift to CCT’s earnings and CCT’s current NAV per unit (excluding distributions) of S$1.77.

CAPITALAND MALL TRUST (CMT)

Focus on yielding up its assets and focus on making them “dominant” in their respective locations. 

• While noting the high number of completing retail supply in the next few years, the manager believes that CMT’s portfolio will remain resilient in the face of increased competition. The manager believes that the REIT’s portfolio of retail malls located at MRT interchanges with strong recurring traffic flow and its positioning will mean that tenants' sales performance can continue to grow, if positioned well.
• A key strategy is to constantly renew the tenant mix at each property to keep its mall offering fresh with a focus on more experiential elements. This is to eventually hope that each mall will be a dominant player in its sub-market. 
• One of the strategies is to cluster retailers with complimentary offerings together in the aim to bring up sales efficiency. Rental reversions could remain under pressure in the near term.

Limited impact from Amazon for now. 

• While the fashion retail trade have felt the disruption most from e-commerce players, the launch of Amazon Prime recently in Singapore aimed at the grocery sector, taking on incumbents like NTUC online and Redmart is another challenge that brick-and-mortar stores face. 
• While the impact is likely to remain minimal in the near term given limited offering online, if Amazon continue to expand and widen their offering, it could potentially have a bigger impact on the grocery sector, which at this point have remained fairly unscathed against the online threat up till now.

Opportunistic approach towards acquisitions. 

• While acquisitions are generally opportunistic in nature, the manager remains on the lookout for potential assets that will be value accretive to the REIT. The Sponsor, CAPL have a number of assets on the balance sheet (part ownership of Westgate and Star Vista) and even Singpost Centre, when stabilised and when the vendor is ready to divest, could be of interest to the REIT in the medium term.
• When asked about the prospect of taking its maiden step overseas for acquisitions, the manager believes that such a move could introduce increased volatility to an otherwise stable cash flow from its Singapore portfolio. Such a scenario could also result in higher risk premium ascribed by investors on the company and thus approach such a strategy with caution.

CAPITALAND RETAIL CHINA TRUST (CRCT)

Portfolio operational outlook remains bright. 

• CRCT's portfolio of malls continue to see improving operational performance in 2Q17 (healthy rental reversions of 7.0%, tenant sales up 1.9% y-o-y on the back of a 7.3% on-year increase in traffic) and is expected to continue firming up going forward.
• CapitaMall Mingzhongleyuan will continue to see strong rebound in traffic and sales post a major repositioning exercise over the past few years. Across its portfolio, the manager is looking at revamping its mall offering through active tenant remixing with new retailer concepts across its malls.
• The manager will be revamping CapitaMall Wangjing by taking back space from anchor BHG department store and converting them to specialty retail space. We expect a significant uplift in rents there. BHG is also expected to undergo a repositioning exercise. The completion of this AEI will drive organic growth higher.

Reinvestment of Anzhen sale proceeds. 

• The sale of CapitaMall Anzhen Mall at 13% higher than book value underpins our belief that CRCT’s portfolio remains undervalued when compared to transaction values. 
• We remain positive and believe the divestment offers the REIT an opportunity to more efficiently deploy its capital as the upside from CapitaLand Anzhen will be limited due to the long master lease expiring only in 2025 and low annual step-up rent of 1.0%.

Ample gearing to acquire. 

• The management has expressed interest to acquire assets with growth potential in tier-1/2 cities such as Guangzhou and Chengdu, and possibly gear up to 40%. In the unlikely scenario where the proceeds are used to repay debt, aggregate leverage will be decreased to c.31% from the current level of 35.3%.

Derek TAN DBS Vickers | Mervin SONG CFA DBS Vickers | Rachel TAN DBS Vickers | http://www.dbsvickers.com/ 2017-08-16

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