First REIT - OCBC Investment 2019-02-11: Mind The (Rental) Gap


First REIT - Mind The (Rental) Gap

  • Partial recovery from sell-off.
  • Putting numbers to our concern.
  • Valuations still not compelling.

Great 2019 thus far

  • FIRST REAL ESTATE INV TRUST (SGX:AW9U, First REIT) has had a stellar 2019 thus far, registering 18.2% in total returns on a YTD basis, outstripping that of the FTSE Straits Times REIT Index (+9.0%). This represents a partial recovery of the steep losses in late-2018, as the counter still remains down by 10.0% on a TTM basis.

Why a change in ownership matters

  • Based on Siloam’s 2017 Annual Report, rent expenses due to PT Lippo Karawaci Tbk (LK) amounted to 111,862m Rp. Assuming a generous Jan’17 SGDIDR conversion rate of 9,263.04, this amount comes up to ~S$12.1m. However, First REIT received ~S$91.5m of rental income from LK in 2017.
  • This stark contrast was not an issue previously as LK had ~21.25% stake in First REIT (or 28.25%, accounting for LK’s stake in the REIT manager). With the partial sale of its stake late last year, LK now retains a smaller 10.6% stake in First REIT. S&P Global has recently downgraded LK from B- to CCC+ with negative outlook, and has mentioned that they could lower the rating by one notch or more if LK does not raise IDR1tr in 3 months, alongside other conditions. This IDR1tr can be potentially satisfied by the sale of LK’s remaining stake in First REIT, in our view.
  • In such a scenario, it would not be unreasonable for LK to cease the above arrangement at the earliest opportunity, thus potentially requiring First REIT and Siloam to find some way to bridge the rental gap.
  • Still, we understand that the first three Indonesian hospitals coming up for expiry in 2021 are doing well operationally, and the amount of ‘subsidy’ from LK could therefore be less than that received by the other Indonesian hospitals in First REIT’s portfolio.

Valuations not cheap

  • With the recent First REIT share price rally, the forward yield spread of First REIT against PARKWAYLIFE REIT (SGX:C2PU) has dropped to 1.85 S.D. above the 7-year mean. This is similar to the spread last seen during the ‘taper tantrum’ in 2013, but the prospects are now arguably more disconcerting, with LK contributing a significant portion of First REIT’s rental income (~82.42% in FY17). Thus, we remain concerned on valuation grounds, as a mean reversion of the yield spread is unlikely in the near-term, given the unchartered waters. 
  • With the 18.2% YTD rally, we downgrade First REIT tactically from Hold to SELL on valuation grounds with an unchanged Fair Value of S$0.97.

Joseph Ng OCBC Investment Research | https://www.iocbc.com/ 2019-02-11
SGX Stock Analyst Report SELL DOWNGRADE HOLD 0.970 SAME 0.970