NRA Capital Pte Ltd

Written by: Editor (Admin)

Thursday 22 Oct 2015

First REIT - Company update

New acquisition offers multiple merits

First REIT announced on 21 October 2015 the proposed redevelopment of Siloam Hospitals Surabaya (SHS) in East Java, Indonesia. Factoring this new development into our calculations, we estimate First REIT to be now worth S$1.52. This translates to upside of 13.7%, plus dividend yield of more than 6% per annum from the current unit price of S$1.335, bringing total return to about 20%.

Background. The entire transaction will comprise of several components.

  • The existing SHS site will be split into two parts, Plot B and Plot C. Plot B, comprising of land and certain unused temporary structures, will be sold to the sponsor PT Lippo Karawaci Tbk for S$8.2m.
  • The sponsor will develop the new hospital on Plot B and an adjacent plot of land Plot A.
  • After completion in mid-2019, First REIT will take possession of the new SHS for S$90m and sell Plot C to the sponsor for at least S$27.5m. The new SHS will commence operations first and Plot C will in turn be developed for other uses.

On full completion, Plots A, B and C will form an integrated development comprising of the new SHS, a private school, an ancillary mall, a hotel and apartment and adequate carparks.

 

Source: Company, NRA Capital

 

Merits of the transaction

  • Rental income growth. Assuming similar rental rates, the new SHS may generate rental income of about S$8.1m per annum, translating to a yield of about 9% on the consideration of S$90m. The current rental income for the existing SHS is about S$3.1m. Hence, the larger and new SHS will generate higher rental income by 161%.
  • Realize 99% gain from early investment in SHS. SHS was acquired by First REIT on 11 December 2006 for S$16.8m. As of 31 October 2014, SHS has an appraised value of S$33.2m. The divestment of both plots B and C will yield First REIT a total of S$35.7m, translating to an overall gain over purchase cost of 99.4%.
  • No loss of income for First REIT. As the development of the new SHS will take place on an adjacent plot of land, First REIT will continue to earn rental income from the existing SHS until it takes possession of the new SHS after completion.
  • Low dilution risk. The payment of the consideration of S$90m will be paid over the next three to five years based on project milestones. The first progress payment of 20% or S$18m will be made within 30 days from First REIT obtaining unitholders’ approval of the transaction. Thereafter, payments will be split into tranches spread over at least 3.5 years.
  • Rejuvenate property portfolio. The existing SHS was originally constructed in 1977. By divesting the old asset and acquiring a brand new hospital, First REIT’s weighted average age of properties in its portfolio will decrease from approximately 10.1 years to 8.2 years on completion.

Leaving headroom for growth. Based on First REIT’s balance sheet as of end 3Q FY15, we estimate that the REIT has additional borrowing capacity of up to S$26.5m. After the gearing limit is lifted to 45% in 2016, First REIT will be able to borrow up to S$149.1m, based on total assets of S$1.2 billion.

Therefore, First REIT is in a position to leverage on its balance sheet to fund this transaction. In fact, the net capital outlay for the entire project is only about S$54.3m, after including gross proceeds from the divestment of the old SHS. Nonetheless, spreading out the progress payments over the next few years will provide financial headroom for the REIT to embark on other acquisitions in the interim.

Borrowing Capacity

Description

Amt

Remarks

Total borrowings (S$m)

402.72

 incl. transaction costs

Total assets (S$m)

1226.25

 

 

Gearing

32.8%

 

 

Gearing Scenarios

35.0%

40.0%

45.0%

Max borrowings (S$m)

429.2

490.5

551.8

Incremental borrowing headroom (S$m)

26.5

87.8

149.1

Source: Company, NRA Capital

Multiple layers of protection. While First REIT will be progressively paying for the new SHS before taking possession, the transaction incorporates multiple caveats to shield First REIT from various risks. For instance, the sponsor will indemnify First REIT against losses if the construction of the new SHS is not completed for any reason, and it will also incur a 10% penalty for any delay after 3.5 years from commencement.

Put option. One risk pertains to the legal division and ownership of property, as the hospital will only form one part of the enlarged development that will be completed in phases, with the structure on Plot B split between the hospital and other facilities. Hence, the land titles pertaining to Plots A, B and C will have to be converted to proper “strata-title” form, which will take more time than the application for the relevant hospital operating permits and licenses.

Therefore, First REIT will take possession of the new SHS regardless of status of the land titles then. Should the sponsor fail to procure the proper titles for First REIT within one year from taking possession, First REIT has the right to exercise its put option to sell back the hospital to the sponsor at the higher of cost or valuation. Hence, downside to First REIT from this risk is limited.

Financing costs contained. We also noted that financing costs to First REIT is being minimized as the sponsor will compensate First REIT 6% per annum on progress payments made, until the new SHS is operational. This way, First REIT will not incur incremental interest cost not matched by new income.  

Expect more acquisitions. In our previous write-up, we valued First REIT at S$1.48 based on FY16 DPU growth of 10% and a cap rate of 6.17%. We had assumed 10% growth on the basis of several projects driving upside in 2016. Following the SHS project, we expect First REIT to make one more acquisition in the near term to add upside in FY16 based on the REIT’s financing capacity. As contribution from the new SHS will only kick in during 2019, we now expect FY16 DPU growth to be closer to 5%.

Valuation revised to S$1.52. To specifically model the financial and valuation impact of the new SHS on completion in 2019, we felt that applying a constant cap rate on estimated one-year forward DPU is no longer appropriate. Instead, we constructed a simple dividend discount model, where future DPU is assumed to grow by an average of 3.5% per annum from FY16 to FY19, before factoring 0.49 cents of additional DPU from the new SHS in FY20 (first full year of operation). In comparison, 9M FY15 DPU growth was 3.3%. Based on 8% cost of equity, we arrived at a valuation of S$1.52.

Valuation Table

 

Old SHS

New SHS

Remarks

Gross floor area (sqm)

9,227

24,246

 

 

 

 

 

No of beds

160

488

 

 

 

 

 

Annual rent (S$m)

3.1

8.1

Existing rent from AR2014, new SHS rent from page 23 of announcement

Number of units in issue (m)

749.32

786.77

Assuming 50% of S$90m funded by issuance of 45.1m new units

Annual rent per unit (cents)

0.41

1.03

at 10% discount from S$1.335

Change

 

0.62

 

Incremental DPU (cents)

 

0.49

Assuming 80% flow through to distribution

 

 

 

 

 

 

 

 

 

FY15F

FY16F

FY17F

FY18F

FY19F

FY20F

Terminal

Distribution per unit (cents)

8.30

8.59

8.89

9.20

9.52

10.02

170.29

Growth rate

 

3.5%

3.5%

3.5%

3.5%

5.2%

2.0%

Discount [(1+r)^years]

1.019

1.101

1.189

1.284

1.387

1.498

1.498

Present value (cents)

2.1

7.8

7.5

7.2

6.9

6.7

113.7

Valuation (S$)

1.52

 

 

Cost of Equity

8.0%

Price on 20 Oct (S$)

1.335

(upside ---------------->

13.7%)

 

 

 

Source: Company, NRA Capital


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