CapitaLand - DBS Research 2019-05-27: Ain’t No Mountain High Enough

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CAPITALAND LIMITED (SGX:C31)

CapitaLand - Ain’t No Mountain High Enough

• Merger with Ascendas-Singbridge to herald a new era of growth.
• Group to benefit from a highly recurring earnings stream that is less susceptible to macro shocks.
• ROE to remain at a high of > 9.0%; managed REITs remain at the forefront to acquire and grow.
• Target Price raised to S$4.00 based on 25% discount to RNAV.

Maintain BUY, Target Price raised to S$4.00.

• The merger of CAPITALAND LIMITED (SGX:C31) and Ascendas-Singbridge (ASB) heralds a new era of growth for the group. We see a myriad of positives and see the combined entity emerging stronger financially and with an operational scale that puts it among the largest real estate managers globally.
• Our RNAV is revised upwards to S$5.42, accounting for Ascendas-Singbridge numbers and our Target Price is raised to S$4.00 on the back of a similar 25% discount to RNAV. BUY!

Where We Differ: Ability to drive sustainable ROE.

• We forecast CapitaLand-Ascendas-Singbridge to be able to deliver a return on equity (ROE) of between 8.9% and 9.4% over FY19-FY21F, driven by an efficient mix of
  1. higher proportion of recurring income derived from Ascendas-Singbridge’s higher-yielding properties,
  2. projected continued asset revaluations on the back of higher operating incomes, and
  3. projected gains on S$3bn of planned asset divestments annually.
• CapitaLand has been active in achieving those targets with S$1.3bn worth of assets divested to date, with the momentum expected to continue in 2H19 and in the following years.

Rebalancing its portfolio.

• Management has articulated a strategy to divest c. S$3.0bn worth of properties annually and we believe that its managed REITs, which are trading at an average implied yield of 4.9%, are poised to deliver accretive acquisitions. With ample debt-funded capacity and conducive capital markets, we believe that re-cycling properties into their REITs will be a win-win strategy.
• We believe that properties in the business parks, commercial properties (UK/Japan) coupled with potential listings of their US office and multi-family portfolios will be strategic moves that enhance ROE in the coming years.

Valuation:

• Our target price of S$4.00 is based on a 25% discount to our adjusted RNAV of S$5.42/share.

Key Risks to Our View:

• Slowdown in Asian economies. The risk to our view is if there is a slowdown in Asian economies, especially China, which could dampen demand for housing and private consumption.

What is next for CapitaLand?

Strong mandate to undertake Ascendas-Singbridge merger:

• With a resounding mandate from shareholders to undertake the Ascendas-Singbridge merger, this will herald a new era for the group when completed sometime in 2Q- 3Q19.Together with Ascendas-Singbridge, the enlarged group (CapitaLand-Ascendas-Singbridge) will emerge with a S$123bn platform that will rival that of global asset managers.
• With Ascendas-Singbridge, CapitaLand will deepen its footprint in its core markets of China and Singapore with an expansion of assets under management (AUM) by 41% and 6% to S$42bn and S$51bn respectively. Most importantly, the enlarged group will gain access into real estate sectors with exposure to mainly business parks, industrial and warehouses. In our view, these real estate sectors cater to firms in the new economy sectors of e-commerce, urbanisation and knowledge economies where firms are expanding steadily.

Cross pollination of expertise.

• We look forward to potential revenue and cost synergies that the group will be looking to extract over time as an enlarged combined entity. An insight that we gather will be from the most recent organisation structure unveiled by the group which showed that the key businesses in Ascendas-Singbridge have been integrated into the businesses within CapitaLand (i.e. the development businesses in Singapore, India and China and also the fund management division), which we see as a focus on integrating and in minimising the overlap of expertise and by grouping together, will drive efficiencies and tap experience and expertise across functions.
• We understand the key divisional heads are selected from key leaders from both CapitaLand and Ascendas-Singbridge which, in our view, provides investors with more confidence that the integration between the two groups will be smooth and not result in a “brain drain” especially from the target company, Ascendas-Singbridge. In our view, the ability to retain talent in the enlarged group from the leadership down to the operational staff will be key in preventing any disruption to the portfolio.

Potential value-enhancement opportunities?

• We also note that CapitaLand-Ascendas-Singbridge has placed the Lodging and Fund Management business as a separate standalone platform, which potentially highlight the significance of the value that business units bring to the overall group. Over the longer term, we do not rule out that CapitaLand-Ascendas-Singbridge might consider realising value from these platforms once they have achieved operational scale.
  • Lodging division. The lodging division comprises mainly The Ascott Singbridge. This is the global standalone platform which is present in more than 30 countries. While we note returns as of FY18 had been the weakest across business units (EBIT margin of c.2.3% vs average of 8.7%), Ascott harbours ambitions to grow, which will enhance its returns on equity (ROE), in our view. As of FY18, the operational units contribute c.S$186.9m in fee income and with a pipeline of 42,800 units under development, we see fee income growing strongly in the medium term. The Ascott Limited has also targeted to grow its units under management from 100,000 units to 160,000 units in the medium term. Once that target is achieved, we estimate fee income to rise as high as S$430m in the medium term.
  • Fund management division. The combined entity CapitaLand-Ascendas-Singbridge entity will be the leading REIT and real estate manager in Singapore, expanding its number of REITs and private equity funds to 31 (eight REITs/Business Trusts and 23 private funds). Most importantly, Ascendas-Singbridge will allow the group to expand its exposure and capabilities in fund management to new asset classes and geographies. Over time, we see more opportunities for differentiated products and mandates to be launched to attract new capital partners. Both Ascendas-Singbridge and CapitaLand have also over time established track records in cultivating relationships with capital partners who could be tapped on to further invest in other funds or upcoming platforms that the combined entity will look to create in the future. According to CapitaLand, the combined fees generated is expected to rise to S$337m, a c.40% increase.
• In the stable of seven REITs that are managed by CapitaLand-Ascendas-Singbridge, we estimate that the REIT generates close to S$191- 197m in annual management fees (REIT manager and property management). See attached PDF report for projected fees from each of the 7 REITs.

Development GFA in China to be extracted

• One of the potential synergies that could be extracted will come from the “in-housing” of residential development capabilities for the master-plan development sites that are currently in the books of Ascendas-Singbridge. Noteworthy is the China-Singapore Guangzhou Knowledge City (CSGKC). We understand that phase 1 has a developable GFA of c.434,000 sqm, currently in different phases of development and contributed c.S$109m to PATMI in FY18. The group has signed the memorandum of understanding (MOU) for phase 2 of this master-planned project which will be acquired in phases over the next few years. The development of these land plots will take time to materialise. Apart from CSGKC, the group is also developing the Raffles City Chongqing, which is co-invested with CapitaLand.
• According to CapitaLand, Raffles City Chongqing has done well with the residential towers 1, 2 and 6 achieving Rmb4.2bn in sales, implying a 75% sell-through rate for launched units. In addition, the retail mall with GFA of 235,000 sqm is projected to open in 2H19 and is also seeing favourable take-up from prospective clients.

Revisiting the India strategy; refuelling Ascendas India Trust to greater heights

Revisiting India.

• In recent meetings, we are heartened that Ascendas India Trust is one of the fastest-growing REITs with an excited about the potential from the recently launched Ascendas India Logistics Programme. This programme will be executed by Ascendas-Singbridge and Firstspace Realty (Firstspace) and aims to deliver modern logistics and industrial facilities across major warehousing and manufacturing hubs in India. Temasek and Ascendas-Singbridge have jointly committed INR20bn (c. S$400m) to the programme. The programme is expected to invest in projects in key warehousing and manufacturing hubs in Mumbai, National Capital Region, Pune, Chennai, Bangalore and Ahmadabad, among others. Over time, it targets to develop a portfolio of 13-15m sqft of space with two seed assets identified offering 1.25m sqft of operational space and over 4m sqft in development potential.
• Over time, once these assets are completed and stabilised, they will form a natural pipeline for Ascendas India Trust to acquire and bulk up.

Asset recycling to drive deleveraging target

• Managed CapitaLand-Ascendas-Singbridge REITs to bulk up and scale up over the next two years. Post acquisition, CapitaLand-Ascendas-Singbridge’s pro-forma gearing of 0.72x, while at the higher end of the group’s historical range, remains at a comfortable level, in our view. The group has also unveiled a plan to deleverage to 0.64x by end-2020 which could be achieved through asset recycling (annual target of S$3.0bn) and higher cash on operations.

Asset recycling and yield optimisation have been a consistent strategy for the group.

• CapitaLand, together with its REITs, had divested close to cS$485.6m worth of Near-term assets of the group that we believe may be available for sale include completed business parks/science parks in Singapore, completed commercial and hospitality properties in China and Europe that may be properties that its managed REITs can consider acquiring.

Ample capacity to acquire; implied yields of REITs are conducive for acquisitions.

• Looking at the balance sheets of a more flexible balance sheet coupled with realisation of asset values, the REITs should benefit from a growth in distributions. Based on our estimates, the positive yield spread between the market transaction yields against the REITs’ implied yields (net property income/enterprise value) means that acquisitions will likely be accretive to unitholders’ distributions.

Returns of Equity (ROE) to hit > 9.0% over FY20-21F

• With the merger expected to split equally between
  1. revaluation gains which we believe can be achieved supported by projected higher net operating income (NOIs) for the group’s investment properties. This is supported by higher rents driven by the supply squeeze especially for the group’s Singapore portfolio, and
  2. forecasted gain of c.10% on divestments, while subjective is dependent on the pace of asset-recycling activities that the group undertakes over the next couple of years.
• CapitaLand’s balance sheet position will also decline towards 0.6x by end-FY20F if no major re-investment is assumed. That said, we believe that reinvestment of the proceeds will be positive as it forms the foundation for higher returns in the medium term.

Derek TAN DBS Group Research | Rachel TAN DBS Research | https://www.dbsvickers.com/ 2019-05-27

SGX Stock Analyst Report BUY MAINTAIN BUY 4.00 UP 3.620