Sasseur REIT - Maybank Kim Eng 2018-06-07: Premium BUY In China’s Discount Malls

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SASSEUR REIT SGX:CRPU

Sasseur REIT - Premium Buy In China’s Discount Malls

Initiate coverage with BUY

• Sasseur REIT (砂之船)’s portfolio of four outlet mall properties in China’s fast-growing Tier-2 cities of Chongqing, Hefei and Kunming arguably offers a unique and compelling investment proposition. It
  1. captures one of China’s most important consumer trends – ‘premiumisation’,
  2. is a front-runner in China’s fastest-growing retail format,
  3. has downside protection to its distributions with minimum rental guarantees till FY19 while the embedded 10-plus-10-year entrusted management agreements (EMAs) enjoy growth upside from sales-based leases, and
  4. has a visible sponsor-led acquisition growth pipeline.
• Initiate at BUY to our SGD0.90 DDM-based Target Price (WACC: 10.7%, LTG: 3.0%).

INVESTMENT THESIS

Initial portfolio strategically-placed, first-mover in China’s Tier-2 cities

• Sasseur REIT’s portfolio comprises four outlet mall properties in China with NLA totalling approximately 304,573 sqm. 
• The assets are strategically located in China’s fast-growing Tier-2 cities of Chongqing, Hefei and Kunming, with per capita expenditure expected to increase at an 8.2% 5- year CAGR to 2021. This would be ahead of the 6.7% and 6.8% CAGRs forecast for Tier-1 and Tier-3 & 4 cities respectively, driven by rising disposable incomes and penetration of outlet malls.

A play into China’s retail ‘premiumisation’ theme

• Outlet malls are capturing a larger wallet share of China’s brand-conscious, yet price-sensitive ‘aspirational consumers’. The combination of premium product offerings, discounted prices and malls that incorporate lifestyle elements is a potent draw for China’s burgeoning middle class. 
• The appeal to brand owners includes the opportunity to offload overstock, predominantly short-term and sales-based leases and reach out to new customers. China’s outlet mall industry is nascent, with growth projected to jump at 24.2% CAGR from 2016-2021E.

Protection from risk-absorbing EMAs

• Although leases are structured as a percentage of sales, FY18E and FY19E distributions should be stable as operational risks are transferred to its sponsor through embedded EMA structures. 
• EMAs provide for minimum fixed rents while integrating upside via a variable component linked to the sales performance of its retail tenants. Besides the EMAs, FY18E and FY19E distributions are safeguarded by minimum yield guarantees.

Clear acquisition growth pipeline

• Higher occupancy (currently 95.1% leased) and traffic from the relatively new Hefei and Kunming Outlets support near-term organic growth. Beyond that, we see acquisition growth outlook being supported by SGD700-850m debt headroom post-IPO, as two ROFR assets and three third-party pipeline properties potentially triple the total NLA of the REIT’s existing portfolio.

Valuation compelling on growth relative to peers

• We value Sasseur REIT on DDM, given stable distributions supported by income derived from minimum rent payments and growth from its well- structured EMAs. Our SGD0.90 fair value implies a distribution yield of 6.6% and 6.9% for FY18 and FY19 respectively. 
• We see valuation as undemanding relative to comparable peers’ yields of 6.6-8.6% for FY18E, and its stronger 4.1% FY19 DPU growth profile, versus 2.5% for peers.

Key risks

• Risks to our valuation are: competition from existing and new players which is increasing given favourable sector dynamics, tenancy risks, which should be limited by its shorter sales-driven leases, currency-exchange fluctuations due to a mismatch between its CNY-denominated revenue and SGD-denominated distributions, and asset-level risks.

CORPORATE INFORMATION

Four assets in key Tier-2 cities

• Sasseur REIT’s portfolio comprises four outlet mall properties in China with NLA totalling approximately 304,573 sqm. The assets are strategically located in China’s fast-growing Tier-2 cities of Chongqing, Hefei and Kunming, and boast a total appraised value of approximately CNYB7.34b (SGD1.48b).
• Founded by Chairman Mr Xu Rongcan in 1989, the sponsor of Sasseur REIT, Sasseur Cayman Holding Limited (Sasseur) has its roots in fashion, art, and retail distribution. These themes are incorporated into various lifestyle elements of the retail outlet malls to drive shopper traffic and sales growth. Each outlet mall embraces a different theme to reflect its own character but all are positioned as shopping and lifestyle destinations. ‘The Yard’ in Sasseur’s Chongqing Outlets for instance, depicts an agro-farming culture themed farmhouse, designed and constructed using old-style materials to showcase elements of Chongqing’s traditional farming houses.

Tenant relationships backed by sales-based leases

• Outlet malls depart from traditional malls as the bulk of revenue generated from these properties is predominantly sales-driven. Most of the tenants in Sasseur REIT’s properties enter into short-term sales-based leases, whereby rental income is determined almost solely by turnover instead of fixed rents. According to management, more than 90.0% of its rental income for FY16 was tied to tenants' sales. As such, active management of the outlet malls is critical and strong mutually beneficial relationships exist between Sasseur and its retail brand tenants.
• There are about 414 stores carrying 600 international and domestic brands at the Chongqing Outlets, which is the city’s first outlet mall and the first in China to house a cinema within its complex. Sasseur opened its second mall, the Bishan Outlets, in Oct 2014, which currently features 213 stores and carries about 350 brands. Sasseur opened the Hefei Outlets and Kunming Outlets in 2016, which feature 283 and 209 stores, and carry 450 and 350 brands respectively, as of end-Sep 2017.

Sponsor background and strategic shareholders

• We believe Sasseur is a reputable and established operator of retail outlet malls with strong experience in the retail outlet mall industry, and backed by strategic shareholders. Headquartered in Chongqing, Sasseur is ranked as one of China’s largest retail outlet mall operators, and boasts a 10-year track record in outlet mall management after the opening of its Chongqing Outlets. Sasseur currently manages and operates six retail outlet malls, accounting for a total NLA of approximately 408,544 sqm.
• Sasseur is expected to be the largest unitholder, with 58% interest in Sasseur REIT, and continues to align its interest with Sasseur REIT. We expect Sasseur REIT to receive strong endorsement and support from L Catterton Asia Advisers and Ping An Real Estate Company Ltd., Sasseur’s other strategic shareholders. We believe that Sasseur has already forged strategic partnerships through L Catterton Asia to expand its brand portfolios. At the same time, Sasseur is likely able to leverage Ping An Real Estate’s extensive real estate network to expand into new sites, thereby providing opportunities for potential third-party asset acquisitions.

Shareholding structure

• The following diagram illustrates the relationship between Sasseur REIT, its manager, trustee, and other holding entities.

• Notes (1) Chongqing PRC HoldCo holds 40% interest in Chongqing West Outlets Brand Discount Commercial Co., Ltd. and Shanghai Pacific Rehouse Service Chongqing Co., Ltd.. Remaining 60% interest is held by Shanghai Pacific Rehouse Service Co. Ltd., an independent third party unrelated to the Sponsor (Sasseur Cayman Holding Limited) or Sasseur REIT.

Entrusted Manager (EM) remuneration package

• The EM fees are tied to the performance of Sasseur REIT. This incentivises the EM and aligns its interest over the long term with the REIT. The EM collects a base fee of up to 30% of gross revenue and a performance fee of 60% of gross revenue net of its EMA resultant rent and base fee.

A Play Into China’s Retail ‘Premiumisation’ Theme

‘Aspirational consumption’ has led to ‘premiumisation’ in China’s retail sector

• Chinese consumers are brand-conscious, yet price-sensitive. They favour premium and/or foreign brands, and are prepared to trade up in a wide range of consumer discretionary products that are instrumental in defining their personal image or perceived social standing. Many Chinese judge themselves and others by what they buy, or the brands they are associated with. They are prepared to indulge in premium goods in high-visibility categories such as apparel, footwear, sportswear and smartphones. But for inconspicuous products, consumers are more likely to embrace cheaper merchandise. Thus, branded/premium products in high-visibility categories have gained market share at the expense of unbranded products or those perceived as lower-end products. 
• The phenomenon of ‘aspirational consumption’ has been captured by a large number of consumer studies, including those from Boston Consulting Group (see 21 Dec 2015 report ‘The New China Playbook – Young, Affluent, E-savvy Consumers will fuel growth’ published with AliResearch) and McKinsey (its 2016 China consumer report titled ‘The Modernisation of the Chinese Consumer’ was based on interviews with 10,000 Chinese consumers).
• ‘Aspirational consumption’ is also a theme in the Chinese sportswear sector. In an MKE report ‘China Sportswear – Loose Footing’ dated 5 Jun 2017, analyst Benjamin Ho argued that lower-end, unbranded products are losing market share as consumers’ preferences shift towards premium/foreign brands, thus motivating global brands such as Under Armour, Reebok and Skechers to step up efforts in their China expansion. This transition from lower-end products to better-known brands extends to a wide swathe of high-visibility consumer products.
• Chinese middle-class consumers, with their higher disposable income, are also becoming more sophisticated and discerning in terms of product branding, quality and value, as reflected in their increasing willingness to pay for better designed and well-crafted goods. This shift in China’s consumer pattern or ‘premiumisation’ is most visible in increased demand among the Chinese for luxury goods from domestic and international brands that appeal to the rising aspirations of the middle class.
• Indeed, China has quickly become one of the world’s major consumers of luxury goods. Luxury brands have likewise continued to invest heavily in China to cultivate brand awareness amongst Chinese consumers, and to deepen loyalty. We see a corresponding growth in demand for luxury goods in China, as the population’s preference for well-known luxury brands grows with increasing brand awareness.
• Many Chinese ‘aspirational consumers’ have, however, travelled abroad to satisfy their appetite for premium goods, given the substantial price difference between China and the international market. Hence, overseas luxury goods consumption by the Chinese grew 13.6% from 2012-2016, and is expected to outpace domestic demand from 2016-2021E.

Outlet malls target ‘aspirational consumers’ seeking value

• According to Euromonitor, mixed retailers in China grew sales revenue at a dismal 4.9% CAGR from 2010-2016 to CNY1.0b, with the main channel, department stores, contributing to the overall weakness in outlets and value sales. This contrasts with the performance of variety stores and warehouse clubs, which recorded sales revenue CAGRs of 50.7% and 18.2% respectively during the same period and are expected to deliver strong double-digit CAGRs from 2016-2021E.
• While Chinese consumers are still purchasing higher-priced premium goods in flagship stores and malls, they are relentless in seeking value. This has resulted in more diverse selling points, both online and offline, with the emergence of outlet stores often positioned further away from the city’s commercial core. They sell premium brands, as well as popular international and domestic brands, at lower price points, thus expanding the category’s reach to middle-income shoppers.
• This bodes well for the growth of China’s retail outlet mall industry, as it benefits from demand for such products amongst the Chinese, given their appetite for higher-quality, branded, or luxury goods, at discounted prices. Outlet malls which emerged as effective retail channels for surplus products now fill an important niche in targeting the ‘aspirational consumer’, as they retail items and at times exclusive lines for premium or luxury brands, directly to the customer at a discounted price.

Growing middle-class population = large potential customer base for outlet mall market

• We see strong structural growth drivers for the retail outlet mall industry in China on the back of its growing middle class and resultant increase in spending power. China’s per capita disposable income is expected to increase at a 7.8% CAGR from 2016 to reach CNY34.7k (USD5.0k) by 2021E. This is on the back of the growth of its middle-class population (defined as adults with net wealth of USD50k-500k), estimated at 109.0m in 2015 and accounting for 7.8% of its population. However, this could reach 216m or 15.0% of the Chinese population of about 1,437.3m by 2021, based on CIC’s projections. A large and growing middle class implies more consumers are ready to trade up, creating a larger pool of demand for aspirational products.
• We believe urbanisation will remain a key macro driver of consumption in China. Its urban population (people residing in cities and towns) increased from 714.5m in 2012 to 800.0m in 2016 at a 2.9% CAGR, during which the urbanisation rate rose from 51.9% to 56.8%. The government’s introduction of a National New Urbanisation Plan should accelerate the urbanisation process, with its goal to raise the urbanisation rate above 60.0% by 2021. As such, China’s urban population is expected to increase to 890.9m by 2021, with the urbanisation rate correspondingly rising to 62.0%. A progressively larger urban population, with disposable household incomes at three times that of rural households, should encourage the development of the retail industry, including the retail outlet mall industry.

Outlets are fastest-growing retail format

Outlets in a sweet spot

• The major retail platforms in China include department stores, shopping malls, outlet malls and online channels. Outlets are in a sweet spot. Consumers biased towards a brick-and-mortar shopping experience (being able to see, touch and feel the products and to gain a sense of instant gratification upon purchase) perceive the outlet malls’ shopping experience, higher end/premium product offerings and discounted prices as a captivating combination. Brand owners, on the other hand, are assured of their channels through outlet malls and are able to adopt a similar discount pricing strategy as their online platforms.
• While online retailing has seen rapid growth in recent years, the majority of purchases of consumer goods in China took place via traditional retail channels. According to CIC, less than 10% of luxury brands sell products through their official online channels. Online sales, which are expected to grow faster than traditional retail, may be irrelevant to outlet malls in the types of products purveyed, as consumers demand a higher level of assurance for premium products.
• We also see the outlet mall business model as more resilient than other traditional retail platforms, whereby retailers face the challenge of high fixed rentals, as these malls tend to be located in city centres.
• High rental costs against the recent weaker sales outlook also pose challenges to the development of large retail platforms in top-tier Asian cities. This is exacerbated by e-commerce disruptions to the traditional retail model. Retail landlords like CapitaLand (Rating: BUY; Target Price SGD4.10) have thus adopted a more conservative expansion strategy in China, having opened only seven new shopping malls between 2013 and 2016, compared to the same number in 2012 alone.
• The above reinforces our view that outlet malls could deliver stronger growth than other traditional retail platforms, which CIC estimates at a 24.2% CAGR from 2016 to 2021E to CNY144.9b (USD21.0b), against the 17.0% CAGR for the overall market in the same period. Outlet malls’ sales revenue is also expected to outpace that of online retail’s 19.8% CAGR, given strong underlying demand. China is the most penetrated in terms of online sales in the region.

The industry tends to exhibit counter-cyclical behaviour and resilience during economic recessions

• The outlet mall business has a history of counter-cyclical characteristics and resilience during economic recessions. Tanger (SKT US, USD22.14, Not- rated), for example, is a US outlet mall operator that achieved an 8.3% average revenue growth rate from 2008-2016. Such defensive qualities have also been observed in the Chinese outlet mall industry. For instance, Bailian Group’s (600827 CH, CNY12.09, Not-rated) traditional retail sales revenue shrank from 2012 to 2016, while its outlet sales improved from CNY3.1b to CNY9.4b over the same period.

Outlet malls are effective channels to clear inventory

• Additionally, we observe an increase in the number of days of inventory turnover for brand companies during the recent economic downturn. Selected major A-share listed companies in the apparel industry recorded a rise in the average number of days before inventory turnover from about 186 days in 2011 to 224 days in 2016. These large inventory stocks exert pressures on profitability and cashflows for the brand owners, but could benefit the outlets. We believe brand owners aim to avert frequent discounts at their full-priced retail stores, given the potentially dilutive influence on their brands’ values. Outlets are effective answers to alleviate the elevated inventory challenges brought on by slower sales growth during economic downturns. They are able to offer attractive mark-downs to cater to more budget-conscious consumers, and are therefore unaffected by discounting pressures.
• We thus see further collaboration between the brand owners and the outlet malls, with the latter serving as viable channels towards easing of inventory pressures. At the same time, overall profitability for the brand owners could be enhanced, as additional marketing costs associated with sales of their out-of-season inventories are not incurred.

Business model facilitates strong tenant relationships

• Sasseur’s ‘Super Outlet’ business model, based on its ‘1 + N’ business model, with ‘1’ representing the outlet mall business platform and ‘N’ reflecting the various lifestyle options that are offered in each of the outlet malls that it operates, is the key pillar of its growth strategy. These may include entertainment and cultural activities, food and beverages, sports and health, children care centres, sports halls, ecological activities (such as farms) and furniture stores. Its Bishan Outlets for instance, features a ‘Super Children’s Centre’, with retail stores offering a selection of infant and children’s clothing labels, an early education centre, an enrichment centre, a children’s playground, a children’s photography centre and a children’s theatre, and a ‘Super Sports Hall’ which houses outlet stores of sports brands such as Nike, Adidas and Le Coq Sportif, and a fitness centre. 
• There is strong emphasis on ‘1 + N’ in the design of all of Sasseur-operated malls, as it aims to transform the outlet malls from pure retail venues to shopping and lifestyle destinations. Hence, Sasseur’s outlet malls, with their wide offerings and activities conveniently available in a single location, are tailored for the entire family instead of individual shoppers. This results in stronger shopper traffic.

… with strong brand-management know-how

• Sasseur has employed a proficient brand management system to ensure that the product and tenant mix in its outlet malls continually appeals to its customers. Specifically, Sasseur has curated a 1,770-strong database of domestic and international retail brands, which it can approach to fill vacancies at its malls, as and when these arise. Sasseur has sorted this database into three key categories:
  1. brands currently offered in its outlet malls (numbering 670),
  2. brands considered as strategic partners (numbering 103), and can opt to take up new retail space at other Sasseur outlet malls, and
  3. new brands which have been shortlisted, and could be introduced into its outlet malls (numbering 997).
• Sasseur monitors and updates its database of brands semi-annually, as it aims to stay abreast of consumer preferences and retail trends.
• Sasseur has further differentiated itself in the proactive management of its tenant mix, with profit-sharing with its retail tenants through turnover rent, which is typical for outlet malls. Sasseur works closely with its tenants to generate sufficient sales revenue and as a result, may at times propose adjustments to its rental agreements to further promote and improve sales. Sasseur can also eventually opt to discontinue the leases of its weaker-performing brands, and replace these with new tenants from its database. We believe Sasseur’s tenancy management system enables optimisation of tenant mix in response to prevailing market trends.

… and firm alignment of landlord and tenant interests

• The majority of leases, and in particular those entered into with retail tenants, are sales-based leases whereby the tenants pay an agreed proportion of their sales revenue as turnover rent to Sasseur. These leases are typically 1-2 years for domestic Chinese brands and 3-5 years for international brands. 
• Sasseur has also entered into more conventional leases with a smaller fraction of tenants at its outlet malls. These tenants operate food outlets and restaurants, run cinemas or are lifestyle and entertainment providers. They pay a fixed rent or the higher of turnover rent and fixed rent, with the term of their leases typically ranging from 3- 15 years (for the cinema operators).
• The bulk of the rental revenue which Sasseur generates from its assets is predominantly sales-driven, which motivates stronger collaborative efforts on retail strategy and inventory management to drive tenants’ sales. As a result, Sasseur often engages in its own market research and consults its tenants on publicity and marketing, as well as suitable product lines to be promoted at its malls. Similarly, Sasseur supports promotional events to increase sales of slow-moving inventories. We believe these initiatives should continue to reinforce relationships between Sasseur and its tenants over the longer term. 
• Sasseur has also introduced a VIP membership programme with a CNY600 minimum spending requirement for enrolment. It counts more than 809k members across its portfolio. Sasseur estimates that 50-65% of sales at its outlet malls are driven by members of its VIP programme.

REIT gains from risk-absorbing EMA structures

EMA structure to iron out income volatility

• EMA (Entrusted Management Agreements) is a risk-absorption structure that Sasseur REIT has put in place with its sponsor to reduce the volatility of rental income accruing to the REIT due to a high proportion of sales-based leases and the relative immaturity of the Hefei and Kunming outlets as they were only operational in 2016. We estimate that the REIT should receive a fixed component amounting to SGD75-82m from FY17-20E. 
• The variable component would be about 30% of total revenue in FY17E, potentially increasing to SGD51.0m, or 38% of its total revenue in FY20E.

EMAs have fixed and variable components

• We believe Sasseur REIT's business model is distinct from other typical retail malls in that its leases are mostly short-term and sales-based, with about 90% of its income (in FY16) determined only by turnover and not fixed rents. Sasseur has installed a point-of-sale and cash-management system in each shop unit such that it first retains all revenue collected from the sales of each retail tenant, then deducts the monthly rental and returns the balance to its tenants.
• While sales-based leases arguably introduce volatility to rental income, such fluctuations are fully transferred to Sasseur by its well-structured EMAs. Under these agreements, Sasseur is obliged to pay Sasseur REIT a minimum rent based on the fixed and variable components.
• The fixed component also comes with a 3.0% annual escalation rate for each property, providing downside protection to Sasseur REIT. Meanwhile, the variable component, pegged to sales, gives Sasseur REIT a share in the growth upside driven by the sales of its tenants. This is tied to a proportion of tenants’ sales at:
  • 4.0% with respect to Chongqing Outlets
  • 4.5% with respect to Bishan Outlets
  • 5.5% with respect to Hefei Outlets and
  • 5.0% with respect to Kunming Outlets
• We estimate that in FY17E, the variable component would be about 30% of total rental income. This proportion is lower for the newer assets, but should increase at a faster rate as they mature.

…and a performance component

• Beyond the fixed and variable components described above, the EMAs are further enhanced by a performance-sharing bonus. This is a residual amount, based on a differential between Sasseur REIT’s gross revenue and the EM resultant rent after deducting management base fees, according to the following formula:

• 40% X ((gross revenue – EMA resultant rent) – EM base fee)

• Sasseur REIT will, however, not be entitled to any performance-sharing, if the EM base fee is less than 30% of gross revenue and/or where there is no positive performance-sharing.

Rental income assured at least till FY19E

• The structure of the EMAs thus allows the REIT to leverage Sasseur’s operational experience and capabilities, whilst transferring the full measure of sales-related risks and start-up risks for its three new properties to the REIT manager. These help to mitigate the impact of business and operational risks on Sasseur REIT’s rental income and ensure stable distributions from the properties. The minimum rent requirement will only fall away if its initial portfolio achieves the minimum rent for two consecutive years commencing 2018.

First mover in fast-growing Tier-2 cities

• We believe the properties in Sasseur REIT’s initial portfolio are strategically located in three fast-growing Tier-2 Chinese cities, being Chongqing, Kunming and Hefei. Sasseur had purposely selected Tier-2 Chinese cities for the development of its outlet malls, given their strong growth potential. It has thus gained from lower entry costs and early brand positioning. 
• Within the cities, Sasseur REIT’s properties are located in areas served by well-developed transportation networks and supported by large captive residential populations. Its Chongqing Outlets, for instance, is able to share parking space and customer footfall with IKEA, which is within a 2-minute walking distance. Sasseur has further leveraged its ‘Super Outlet’ business model to position its outlet malls for destination shopping, with stronger traffic growth.

One of China’s leading privately-owned outlet mall operators

• China’s outlet industry is concentrated, with the top five best-performing outlet malls comprising about 30.0% of its total outlet mall market in sales revenue, according to CIC.
• We believe Sasseur’s advantage lies in its consistent execution of the experiential shopping concept, which targets middle- and upper-income residents and families. For instance, a competing outlet to its Chongqing Outlets is the New Century Department Store Outlets. New Century commenced operations in 2016 in the Guanyinqiao retail hub. Initially planned as a large-format retail mall, it faced retail sales weakness and currently exists as an outlet mall for offloading excess inventories.
• We expect the addressable market of China’s outlet industry to expand further, especially in its Tier-2 cities, as per capita expenditure could increase at an 8.2% 5-year CAGR to 2021. This would be ahead of the 6.7% and 6.8% CAGRs forecast for Tier-1 and Tier-3 & 4 cities respectively, driven by rising disposable incomes and penetration of outlet malls.

China’s outlet mall industry is nascent, implying strong growth potential

• China’s first outlet mall opened in Beijing 15 years ago. The market has since grown rapidly, to USD7.1b in 2016, surpassing Japan's (USD5.7b) but still smaller than those in Europe (USD16.1b) and the US (USD47.4b).
• Spending per capita in China’s outlet malls is low at about USD5, in contrast with the US, where its residents spent on average more than USD140 per capita shopping at outlet malls in 2016. China also lags in the number and size of its outlet malls, with GFA per 100 residents at only 0.4 sqm, against 2.4, 1.0 and 0.5 sqm for the US, EU and Japan respectively. These factors suggest that the development of China's outlet mall market is still at an early stage and far from being saturated. Indeed, we see room for a greater number of larger-scale outlet malls to be developed in China, given that average spending per capita in its outlet malls is expected to increase substantially, on the back of a growing middle class and corresponding spending power.
• According to CIC, the addressable market of the outlet industry in Chongqing, Kunming, and Hefei could increase from CNY3.4b (USD0.5b), CNY1.5b (USD0.2b) and CNY1.4b (USD0.2b) in 2016 to CNY7.4b (USD1.1b), CNY3.6b (USD0.5b) and CNY3.5b (USD0.5b) by 2021, at CAGRs of 17%, 19%, and 20% respectively. These growth rates are expected to outpace those of Beijing and Shanghai. Figure 43 compares the addressable market size of Chongqing, Hefei, Kunming, Shanghai and Beijing and their supply gap.
• Sasseur has experienced strong growth rates at its Chongqing Outlets and Bishan Outlets, which were opened in 2008 and Oct 2014 respectively. Sasseur REIT is therefore expected to gain from strong organic growth given the positioning of its initial portfolio properties.

Acquisition growth outlook supported by two ROFR and three pipeline properties

• Sasseur REIT has been granted a right of first refusal (ROFR) to two properties owned by its sponsor - Sasseur (Xi’An) Outlets Plaza (Xi’An Outlets) and Sasseur (Guiyang) Outlets Plaza (Guiyang Outlets). Both properties are still undergoing construction, and expected to commence operations in 1H18.
• Sasseur also manages and operates three pipeline properties, which are owned by third parties. They are Sasseur (Hangzhou) Outlets Plaza (Hangzhou Outlets), Sasseur (Nanjing) Outlets Plaza (Nanjing Outlets), and Sasseur (Zhongdong Changchun) Outlets Plaza (Zhongdong Changchun Outlets). Sasseur has been granted ROFR from each of the owners to acquire their respective properties if they decide to divest their interests, and will offer these to the REIT under similar ROFR terms.
• We estimate that Sasseur REIT’s portfolio GFA could expand by about 335,000 sqm or 0.9x with the acquisition of the two ROFR properties and by 700,000 sqm with the acquisition of all five properties, including the three pipeline properties. This would triple the total NLA of its initial portfolio.
• Acquisitions could be funded by debt, given substantial headroom. We estimate headroom at about SGD700m on 40% aggregate leverage, or SGD850m on the 45% regulatory limit.
• We have not factored in any acquisitions in our forecasts for Sasseur REIT for FY17-20E, as we expect growth to be driven by its initial portfolio of four properties. Our key income assumptions are:
  • Sales growth from FY17-20E ranging from 3-40% based on each property’s maturity profile; hence, we expect stronger 30-40% growth for its Hefei and Kunming properties, as they opened in May 2016 and Dec 2016 respectively, compared to Chongqing, which opened in 2008.
  • Occupancy at the Chongqing Outlets to remain at 100%, and for those at the Bishan, Hefei and Kunming Outlets to ramp up from the current range of 77-84% in FY16 to 90-95% in FY20E.
  • Management fees paid 100% in cash, comprising a base fee at 10% per annum of distributable income, and 25% of the differential in DPU in the FY with DPU in the preceding FY.
  • Gearing of 31.2% at end-2017 with all-in borrowing costs to factor in 50bp increases in FY18E and FY19E.
  • 100.0% of Sasseur REIT’s available income for distribution is distributed for FY17E, FY18E and FY19E on a semi-annual basis, with the first pro-rated and expected to be paid in Aug 2018, following the announcement of its Jun 2018 results. Distributions are to be at least 90.0% over the longer term, from FY20 onwards.

VALUATION

Valuation methodologies

• We view Sasseur REIT as one with stable distributions supported by income derived from minimum rent payments and growth from its well-structured EMAs. We believe investors should focus primarily on a dividend discount model (DDM), and then relative valuations via dividend yields. 
• We believe Sasseur REIT’s closest comparables include other China-focused REITs / business trusts. We see DDM-based fair value at SGD0.90 which including the 7.8% promised dividend yield, implies 24% total return upside.

DDM valuation of SGD0.90 implies 24% total return

• We believe that DDM-based valuation should be utilised for REITs given their reliance on underlying asset cashflows as a significant return component. We base our methodology using our cashflow and distribution forecasts to 2028 to arrive at a DDM-based valuation of SGD0.90.
• The key assumptions in our valuation include a risk-free rate of 3.9%, a market risk premium of 9.0% and a beta of 0.75x which is higher than the 2-year adjusted 0.52-0.73x beta range for our China-focused retail REITs peer group. This implies a WACC of 10.7%.

Valuation undemanding relative to peers

• Our DDM-based valuation implies a distribution yield of 6.6% and 6.9% for FY18 and FY19 respectively. We believe that valuation is undemanding relative to comparable peers’ FY18E yields of 6.6-8.6%.
• We overlay this valuation against the S-REITs. They offer 2018E DPU yields of 4.7-8.5%, averaging 6.6%. Meanwhile, the retail-sector REITs offer DPU yields of 5.5-6.8%, which average 5.8%. China-focused retail REITs likewise offer DPU yields of 6.6-8.6%, which average 7.4%.

… Well-supported by stronger DPU growth

• In addition, we believe investors should focus on the total return of REITs. We overlay this with the estimated DPU growth rates for the other China-focused retail REITs. 
• Sasseur REIT is expected to deliver 11.9% in total return for investors, on dividend yield of 7.8%, with DPU growth in 2019E at 4.1%, according to distribution forecasts implied by the EMAs. This is the highest amongst its comparable peer group, and is significantly ahead of the weighted average 2.5% FY19E DPU growth rate of this peer group.

RISKS

Competition

• Sasseur REIT competes with various owners, operators and developers of outlet malls, as well as the other traditional retail formats and online platforms to grow its market share and sales revenue in China. While it has first-mover advantage in some Tier-2 cities, especially Chongqing, the city’s strong growth potential has prompted other players to develop their own outlets. Beijing Capital Land (2868 HK, HKD4.09, Not-rated), for instance, is launching a new outlet with an estimated GFA of 96,700 sqm on the west side of Tongjiang Avenue, Oulu Garden, Lujiao New Town, Banan District, which is targeted to open in Oct 2018. Beijing Capital Ju Da, which was spun off from its SOE parent, Beijing Capital Land in 2015, is now backed by about USD191m in fresh equity from strategic private equity partner KKR and the Sino-Ocean Group (3377 HK, HKD5.47, Not-rated). They have also articulated plans to expand from their existing four-outlet mall footprint in Fangshan (Beijing), Hangzhou, Nanchang, and Wuhan, to open 20 outlet malls in China by 2020. 
• Rising competition could affect the growth in occupancy and rental rates of Sasseur REIT’s assets, but we believe this will be mitigated by favourable demand and supply in the medium term, and the substantial gap between its addressable market and projected industry sales revenue.

Tenancy risks

• Sasseur’s business model is mostly driven by shorter leases. Hence, its average WALE by committed NLA is 3.2 years and by NPI, about 1.2 years. Its income is predominantly sales-based, unlike other REITs, which also typically report longer WALEs. This suggests that tenancy risks are less of a concern, given that we expect short-term vacancies to be quickly backfilled, while its cash collection system should mitigate specific customer credit risks. Sasseur’s tenant base is also well-diversified with its top 10 customers generating about 16-20% of total sales for each mall.

Currency risks

• Sasseur REIT's reporting currency for financial statements is in SGD, but it generates primarily CNY-denominated dividend income, to be converted into SGD for distribution payments. Its management fees are payable in SGD, and finance costs are mainly denominated in CNY, with about 25% of its debt in SGD due to lower borrowing costs. As such, Sasseur REIT is subject to foreign-exchange exposure due to a mismatch in the currencies of its receipts and payments.

Interest-rate risks

• Higher interest rates are a generic risk for the sector and may lead to lower capital values for the REIT’s assets as cap rates could soften with interest- rate shifts. A spike in interest rates in the absence of corresponding growth would diminish the attractiveness of the REIT and raise borrowing costs. Should the REIT be unable to grow in tandem with rising rates, distributions are likely to be affected, although the impact of this would be largely mitigated by a higher proportion of debt that is fixed or has been swapped into fixed rates.

Asset-level risks

• On an asset level, key risks for Sasseur REIT are its ability to renew the leasehold land use rights tenures of its China assets, which unless such duration is extended, will have an impact on the value of the properties with the passage of time. Sasseur also needs to maintain its strong relationships with the local governments in its key cities, as it pushes for
• approvals to progress with its expansion or redevelopment projects in Chongqing, Hefei and Kunming, as some of these have exceeded the indicative project deadlines. These redevelopment initiatives have not been factored into our forecasts.

Acquisition risks

• While acquisitions are a key source of growth, overpaying for assets is a risk. This applies both to third-party assets and related-party assets from the sponsor Sasseur based on ROFR. As a private company, Sasseur is not obliged to disclose detailed valuation metrics on its properties, while Sasseur REIT will be accountable to its unitholders in generating accretive deals. It is for this reason that we believe Sasseur’s first acquisition will be closely scrutinised.

Macro-economic risks

• Global and regional macro-economic shocks could discourage discretionary spending and hurt demand for retail properties, including outlet malls, resulting in lower occupancies and rents. This in turn could result in lower valuations for Sasseur REIT’s properties.

Chua Su Tye Maybank Kim Eng | https://www.maybank-ke.com.sg/ 2018-06-07

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