CapitaLand Limited & REITs - DBS Research 2018-08-30: Time To Fly


CapitaLand Limited & REITs - Time To Fly

  • Management of CapitaLand and its managed REITs spent a fruitful day in Bangkok meeting investors.
  • Business conditions remain conducive; the group stands ready to capitalise on any opportunities that may arise.
  • The REITs are reviving their growth engines and hungry for growth.

CapitaLand and REITs Bangkok Day.

  • We hosted the management of CapitaLand (CAPL) and its managed REITs to a bespoke investor outreach conference in Bangkok. Building on a successful conference last year (see report: CapitaLand Limited & REITs - Ready For The Next Leap dated 16-Aug-2017), the 2018 version was even bigger with more investor meetings.
  • The meetings were engaging and focused generally on the outlook and CapitaLand and its REITs ability to ride through the current market uncertainties owing to heightened global trade tensions, which might weigh on business sentiment and operations.

Business condition remains conducive; group stands ready to capitalise on any acquisition opportunities that may arise.

  • A common theme that we gather from the meetings with management of CapitaLand and its REITs is that operational outlook for most business segments are turning up, supporting higher earnings growth in 2H18 and 2019. For CapitaLand, the group looks to keep an even balance between developed and emerging market exposures, so as to achieve resilience against business cycles across different geographies.
  • With close to c.80% of its assets in commercial and lodging properties churning out consistent cashflows, we believe that CapitaLand remains on a strong footing to weather through any market dislocations and seize opportunities when they arise. In addition, a boost to returns will come from regularly reconstituting its portfolio, which we believe will plot CapitaLand’s path towards delivering its target sustainable return of equity (ROE) of 8.0-8.5%. 

~ SGinvestors.io ~ Where SG investors share

The REITs are reviving their growth engines.

  • The group (CapitaLand and its REITs) takes an active role in reviewing and optimising portfolio returns on an annual basis. Capital recycling aside, asset enhancements (AEI) and M&A are also key pillars of value creation for the group. Over the past year, ASCOTT RESIDENCE TRUST (SGX:A68U), CAPITALAND RETAIL CHINA TRUST (SGX:AU8U), CAPITALAND COMMERCIAL TRUST (SGX:C61U) and CAPITALAND MALL TRUST (SGX:C38U) have divested non-core assets at good prices, recapitalising their balance sheets in the process.
  • Looking forward, these REITs remain on the hunt for more acquisitions to further diversify their exposures and with an aim to deliver accelerating DPU growth profiles. 
  • CapitaLand Malaysia Mall Trust has also undertaken a major AEI at Sungei Wang to reposition the asset and underpin its dominant position in the submarket.

CapitaLand Limited (SGX:C31)

Rebalancing the portfolio to enhance resilience against market cycles.

  • Business cycles across its different geographies may not move in sync, and management targets to achieve resilience in operational performance with a 50%-50% balance through exposures in developed markets (DM) and emerging markets (EM), which will plot CapitaLand’s path towards delivering its target ROE of 8.0-8.5%. In addition, CapitaLand, having 70-80% of its income anchored from its commercial portfolio, should boost income visibility and resilience across market fluctuations.
  • We believe that the group’s strategy of optimising portfolio returns through active management and deployment of capital will help to boost ROE towards the management’s longer-term target of c.8%.

China remains a key market; adding selectively to land bank to boost income visibility and returns.

  • China is still showing signs of stabilisation in recent times. CapitaLand’s fortunes are closely tied to the operational outlook for the residential and retail markets there. The group has RMB16.2bn of unrecognised pre-sales; of which > 50% will be recognised in 2H18. Most recently, CapitaLand secured development sites in Guangzhou and Chongqing, adding another c.2,400 homes to its pipeline.
  • In the retail space, tenant sales growth has remained strong, achieving a high of 20.2% in 1H18, while same-store mall net property income (NPI) grew by 7.2% in 1H18, building on the strength in 2017. With a number of newly opened malls which have yet to achieve stabilisation, we believe that tenant sales will continue to grow.

Asset recycling to optimise returns.

  • CapitaLand continues to look to recycle its capital to optimise portfolio returns and crystallise value from past investments or developments to drive returns. 
  • In 1H18, CapitaLand and its REITs had divested S$3.1bn of assets and will be redeploying the proceeds into close to S$1.8bn worth of income-producing and development projects in China (sites in Guangzhou and Chongqing) and Singapore (Peal Bank en bloc) and more investments are expected in 2H18 as CapitaLand looks to replenishing its land bank of trading properties and grow its commercial portfolio opportunistically.

Scaling up Vietnam.

  • Building on the positive sales momentum at its residential projects in Vietnam, management remains positive and see significant opportunities to scale up its business and targets the country to reach a high of c.10% of exposure (2% currently) in the longer term. 
  • Key supporting factors fuelling demand for homes include
    1. positive macroeconomic environment (combination of stable GDP growth, inflation and currency) supported by foreign investment, and
    2. a fast urbanisation rate coupled with a young and dynamic workforce contributing to housing demand.

Ascott Residence Trust (SGX:A68U)

Undervalued gem offering downside protection with upside participation.

  • Part of The Ascott Limited, Ascott Residence Trust (ART) is a dominant player with an industry-leading S$5.3bn asset portfolio comprising serviced residences, rental housing properties and other income-producing hospital assets.
  • Ascott Residence Trust’s resilience is anchored by its diversified network of c.11,430 units (and growing) over 73 properties across 37 gateway cities currently. Balanced stable (c.46% of gross profit) vs growth-oriented contract profiles further underpin income stability while enabling upside participation. Growth via acquisitions would further cement the group’s position as a leading global serviced residence operator.

Crystallising value through active asset recycling.

  • Over the past year, Ascott Residence Trust has successfully divested two assets in China at low cap rates of c.2%, implying conservative portfolio valuations. Despite this, Ascott Residence Trust continues to trade at a discount to book, at c.0.9x NAV, which we mainly attribute to investors’ more cautious stance towards hospitality REITs and Ascott Residence Trust’s weaker-than-expected 2Q18 results.
  • To crystallise value, capital recycling is set to remain a core focus for the group as proceeds from the divestment of assets with limited growth are redeployed towards higher-yielding properties, which could restore investors' confidence in Ascott Residence Trust ahead of a pick-up in its core markets.

Acquisitions and AEI to drive DPU recovery over medium term.

  • Capital recycling aside, AEI and M&A are also key pillars of value creation for Ascott Residence Trust. AEIs are typically undertaken every seven years and have unlocked double-digit ADR (average daily rate) growth for the REIT post-refurbishment historically.

Opportunities are also abound on the acquisition front from both the Sponsor and third parties.

  • This includes “lyf”, a new co-living concept slated for launch by the Sponsor in 2020, which if acquired, could provide Ascott Residence Trust with inroads into an exciting new segment. 
  • Currently low gearing of 35.7% also provides Ascott Residence Trust with the financial flexibility to pursue these accretive opportunities as they arise, and drive DPUs higher over the medium term.
  • The manager is also casting an eye on 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 (SGX:C61U)

Riding on the upturn.

  • CapitaLand Commercial Trust (CCT) remains on track to benefit from the office upturn over 2018-2020 with the planned new office completions falling to c.0.8m sqft per annum, which is below the average demand of 0.7m sqft per annum (5-year average). In addition, in the near term, with new office supply completing in 2018, Frasers Towers and 18 Robinson Road reported c.80% and c.55% take-ups respectively.
  • We project Grade A office rents to rise by up to S$13-14psf by 2020, implying up to a 40% rise over the next three years, from the S$10.10psf as of 2Q18.
  • In the longer term, as the government focuses on decentralising the central business district (CBD), there will likely be more supply in the fringe and suburban areas compared to CBD, which should keep further supply risk in check.

Overseas exposure – adding a lever of growth.

  • The key consideration in heading overseas is to diversify CapitaLand Commercial Trust’s earnings and exposure in order to reduce its reliance cyclicality to the Singapore office cycle. With the acquisition of Gallileo in Frankfurt, we believe that the long asset WALE of 10.6 years will infuse CapitaLand Commercial Trust with greater income visibility and stability. Management’s choice to expand into Germany is supported by robust property market fundamentals with expectations that market rents will continue to rise in the future on the back of low vacancy levels and limited new builds in the future.

Asset recycling strategy to crystallise value and CapitaSpring redevelopment to underpin longer-term upside.

  • Management has taken advantage of the demand for commercial assets by selling non-core assets in Singapore at good premiums above book values. 
  • The redevelopment of golden shoe car park into a Grade A office building CapitaSpring saw its first tenant in JP Morgan which has committed to take up 25% of the office tower. The S$1.82bn integrated development, when completed in 2021 will be an earnings driver to CapitaLand Commercial Trust. 
  • With a target yield on cost of 5.0% and with an option to acquire the property post completion, we believe that there are ample opportunities to cement CapitaLand Commercial Trust’s position as one of Singapore’s premier office landlords in the CBD.

CapitaLand Mall Trust (SGX:C38U)

Resilient in the face of competition.

  • With a balanced portfolio of suburban and downtown-centric assets catering to the mass-market segment, CapitaLand Mall Trust (CMT) serves as a strong proxy to the Singapore retail scene and has emerged as a leader with a c.14% market share. 
  • While supply remains a key risk for the sector, we see two potential “disruptors” in Paya Lebar Quarter and Jewel Changi Airport which will complete in 2019. Given their sheer size, the manager acknowledges that visitor traffic could see temporal disruptions in favour of these new assets in their first year of launch but reckons that the positive rental reversionary outlook will likely remain intact given high pre-commitments for upcoming supply and CapitaLand Mall Trust’s well-located assets.
  • Coupled with strategies to cluster retailers with complimentary offerings and introduce new, experiential concepts, these should further augment CapitaLand Mall Trust’s resilience and premium positioning ahead.

Funan mall when completed in 2H19 will be a re-rating catalyst.

  • With Funan still undergoing redevelopment, only 14 of CapitaLand Mall Trust’s 15 assets are in operation currently. 
  • Regarding the progress on Funan, the manager shared that it could be ready for launch in the earlier part of 2H19, ahead of initial expectations. Pre-commitment for the retail podium has risen beyond 50%, in line with the manager’s goal of 80% by year-end. While take-up for office space has been more modest at c.20%, the manager has been seeing an uptick in enquiries in recent months and remains cautiously optimistic that its goal of 70% by end-2018 is achievable.
  • Post launch, we estimate that Funan alone could contribute c.9-10% of NPI (vs FY17 levels) - a substantial earnings catalyst which could spur a re- rating in the stock over the near term.

Positioning ahead for the future - Westgate acquisition to drive growth.

  • Given substantial debt headroom of > S$1bn (based on 2Q18 gearing of 31.5%), CapitaLand Mall Trust could be on the lookout for value-accretive assets and announced the proposed acquisition of a 70% stake in Westgate mall for S$805m (all in cost), implying a S$2,745 psf. At a 4.3% yield compared to funding cost of 3.2%, the deal is expected to be accretive to earnings.
  • Management shared that full ownership of the mall could be interesting for CapitaLand Mall Trust given longer-term benefits and operationally, reversions and occupancy rates appear to be bottoming out.

CapitaLand Retail China Trust (SGX:AU8U)

Proxy to the Chinese consumption story.

  • The first S-REIT to invest in Chinese malls in 2006, CapitaLand Retail China Trust (CRCT) has come a long way since. Through a combination of organic and inorganic growth initiatives, distributable income has nearly tripled on the back of a fourfold increase in assets. Except for partially-closed CapitaMall Wuhu, the 11 malls in CapitaLand Retail China Trust’s portfolio are generally well located within China’s key cities – each serving a unique catchment area and well connected via major transportation access.
  • Given its premium offering and positioning, we see CapitaLand Retail China Trust as a beneficiary of China’s burgeoning middle-class population – a trend which is set to continue ahead.

Capturing higher wallet share amid e-commerce threats.

  • Discussions on the operating environment were mainly centred around e-commerce, which has been gaining market share quickly in China. Addressing this, the manager noted that opportunities for landlords remain as ground observations reveal that physical channels continue to dominate and are still on growth mode.
  • To capture greater wallet share, CapitaLand Retail China Trust has been revamping its existing mall offerings through selective AEI and active tenant remixing to cater to evolving consumption patterns. This includes deliberate shifts away from department stores – traditional strongholds towards more experiential offerings and standalone brands with strong brand equity. Tenant exposures have also risen in favour of the beauty, wellness and services segments, which are harder to replicate online.

Portfolio reconstitution underway; potential acceleration of growth via acquisitions.

  • CapitaMall Wuhu has been operationally challenged post the resettlement of its immediate catchment population and lacks growth catalysts. To be objective, the manager has taken steps to partially close the asset and is on the lookout for opportunities to monetise and exit from this market.
  • The management has also expressed intent to acquire assets with growth potential in tier-1/2 cities such as Guangzhou and Chengdu. Provincial cities with positive demographic trends, particularly cities where the Sponsor already has a presence, will also be of interest to the group.

Derek TAN DBS Group Research | Carmen TAY DBS Research | https://www.dbsvickers.com/ 2018-08-30
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