First REIT - OCBC Investment 2018-12-13: Not Quite Out Of The Woods

FIRST REAL ESTATE INV TRUST (SGX:AW9U)

First REIT - Not Quite Out Of The Woods

In Oct 2018, OUE Lippo Healthcare (OUELH, SGX:5WA) acquired 10.6% of First REIT (FREIT) from sponsor Lippo Karawaci (LK), leaving the latter with an approximately equal stake.
OUE Lippo Healthcare and OUE Limited (SGX:LJ3) have also acquired the manager from LK in a 40-60 split. First REIT will now have an enlarged pool of Right of First Refusal (ROFR) assets, comprising both OUE Lippo Healthcare’s and LK’s healthcare assets.

We attended an analyst briefing hosted by First REIT yesterday. One of the key concerns pertained to the current master leases between LK and First REIT, with the initial batch of leases due in 2021.
The risk of non-renewal by LK remains possible, since the current structure results in LK collecting less from Siloam Hospitals (First REIT’s Indonesian operator) than what it pays out to First REIT. In the event that LK should divest off its entire stake in First REIT, that possibility would loom even larger.
While Siloam Hospitals could theoretically take over the leases from LK, negotiated terms could leave First REIT in a less-than-favourable position.

First REIT is looking to rebalance its portfolio, where up to 50% of its assets will be located outside Indonesia within the next 3-5 years. Roadmap-wise, we are of the opinion that First REIT could be looking to acquire a significant portion of OUE Lippo Healthcare’s ~S$300m Japanese nursing home portfolio in 2019, with another 2-3 sizeable acquisitions thereafter, in the ballpark of S$300- 400m each. Debt, equity and divestments are avenues to fund these acquisitions.
Still, excluding divestments, management would only have ~S$102.4m of debt headroom before hitting its short-term tolerance of up to 42% gearing. Thus, we cannot rule out a substantial amount of equity fund raising, possibly through a rights issuance.
We note that management is focused on making any acquisition DPU-accretive, but see challenges to that, such as First REIT’s recent unit price plunge and presumably lower yields for OUE Lippo Healthcare’s Japanese healthcare assets (~5% NPI yield assumed, vs. First REIT’s current 8.8% 9M18 annualised portfolio NPI yield).
In light of the various risks as outlined above, we increase our Beta assumption and drop our terminal growth rate by 75 bps to 0.75%. Consequently, our Fair Value drops from S$1.34 to S$1.05.

Joseph Ng OCBC Investment Research | https://www.iocbc.com/ 2018-12-13

SGX Stock Analyst Report HOLD MAINTAIN HOLD 1.05 DOWN 1.340