Posted by: donmihaihai | September 27, 2008

Of Trusts.

With the amount of media coverage for all kind of Trusts listed locally, it is hard not to read about them but I have not been looking at them with the reason — will only do so if they are selling at an interesting discount. With the recent down in stock market, Trusts seem to be “interesting” as many are selling at double digit dividend yields. But there are many stocks that are selling at a price which I considered even more interesting.
The recently focus point of media are Trust debt level and raising capital through new units issued and “The Edge Singapore” latest issue devoted 2 pages on the interesting subject of raising capital. This make me ponder.

Everything is about raising capital.
Be it selling new units to new investors/unit holder, rights offer, warrant offer or even scrip dividends, every single move is about raising capital. New unit, rights and warrant are simple while scrip dividends are tricky.

For common stock, I think management of the any scrip dividends scheme is actually preying on minority shareholder on 1) on odd lot, and 2) unable to grid on valuation and how scrip dividends work. In reality, if the company is unable to pay dividends, don’t pretend, stop or reduce dividends.

The reason for setting up REIT and Trusts is to pay out 100% earnings(or a certain amount) whether it is mandate or having the intention of doing so. By paying out dividends and crawl them back is just another way of raising capital. Beside that, the “bads” of common stock also apply here.

The basic behind all scrip dividends is new unit creation with capital taken in or rather retained.

Net-net is scrip dividends a good deal at dividend yield of double digit?
Many factors are required for consideration. The 1st is seem to be on investor side which is how much we are paying for a new unit and what kind of return we are getting. As it is scrip dividends, unit holders are paying new unit through their dividends. Scrip dividends on FSL seem to be a good deal as shipping Trusts are selling at a yield of 15% to 20% as a group. It is even sweeter if the issued price is 10% discount to the market price of the Trust. I think MIIF is also issuing scrip dividends at a yield of double digit too.

But, if I turn the table around, by raising capital at a cheap valuation, double digit yield of 15% to 20%, the management is starting to have trouble. In order to maintain the same yield, these capitals must deploy out and getting a return, net of all expenses, matching the yield of 15% to 20%. Any return of below 15% is destroying unit holder value, future return of all units (old and new) will be lower, dilution of yield will happen. So the QUESTION is can management deploy these capital and generate a return higher than the price they paid for these capital. With yield at double digit or 15% to 20%, it is certainly more than challenging to do it unless on distressed assets, which seller will sell their prize assets at such a price? Which also mean, lower return is certain(almost).

Now, if it is not wise to do it, then why are these Trusts doing it at this point of time? While the reasons may vary across different Trusts, the bottom line is they NEED CAPITAL.

My answer after looking at both side of the coin on “Net-net is scrip dividends a good deal at dividend yield of double digit? ” is I don’t know. Especially so without looking into each Trust. I need some education here or just as what I think, there is no straight answer here.

On a further note, if the market price of the Trust/REIT is below the issue price, after taking the consideration that the Trust/REIT is still financially strong even without new capital, investor is better off by taking the dividends and buy any unit they need at the market price. Without taking transaction cost into consideration, not just that investors are getting higher yield, there is no creation of new units.

How to value REIT/Trust?

This is an interesting question. While there are many methods for different REIT/Trust, I think looking at dividend yield is enough rather than NAV or DCF.

But 1st of all, dividend yield or trust/REIT yield is not comparable to common stock or dividend paying stock. That is because stock retains part of their earnings while REIT/Trust pays out everything. And by paying out all earnings, dividend yield become earning yield and if an infrastructure assets is able to generate 13% annualise return in it whole life, without taking opportunity cost into consideration, a dividend yield of 13% is the fair price to pay. For property, if the annualise return is 13% with 7% from yield and 6% from property appreciation, then buying REIT at 7% is a fair price to pay. Add in margin of safety, my eyes only brighten up if the yield is 20% to 30% more than fair price.

And not every REIT, Trust and asset is the same. Another point that I will consider is how much more earnings that can be produce from these assets without much additional capital expenditure. Example is an infrastructure working at 50% utilisation or a property with below market rental of 50%. This will create a natural boost in the long run.

An unforgettable lesson.
The lesson that I learnt from current crisis is any business model that depend on the market will turn against them when market become unfavourable. Trust/REIT is certainly belong to this.

 

 

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Responses

  1. I’m starting to be interested in REITS since their prices got hammered recnelty, but no time to write anything. My scattered thoughts:
    1) Agree it is best to look at yield as main valuation tool: NAV is meaningless – just an accounting measurement – when Asian property prices are so volatile, and DCF adds no value as all FCF goes to yield anyway.
    2) Also look at gearing ratio ie: borrowings/NAV : must be 60% beacuse their NAV drops.
    3) If their gearing ratio is above a certain amount (I think 30%), they must be rated (by S&P or Moodys). What ratings are they given? A ratings downgrade can spark a chain of events which hurts them (like Allco (the S’pore one))
    4) Cyclical aspects. I would only go for REITS that had long predictable leases (eg: industrial leases usually 5 yrs, wheras commercial leases are 1 yr. Mabye healthcare too..?) Shorter lease means more cyclical means more chance of NAV dropping in future. We are now probably at the downturn stage of the business cycle so I’m more defensive
    5) For the borrowings they have, when do they have to be renewed. eg: Cambridge renews all its funding in 1Q09, will be interesting to see what terms they get. Ascendas has much better terms (renewable in several stages over the next 5 years, I think). Looking at the charts, it seems the REITS that recently got hammered the most are those with the most uncertain future funding.
    6) Your idea of utilization is interesting, but i’m more worried abt the reverse. I think most reits (across all sectors) have full capacity (90+% tennancy). If tennancy goes down (eg: due to bad economy and/or overbuilding in sector) then yield goes down. Again, end of business cycle…

    I’ll look for some REITS I find favourable, if I find any I’ll write on my blog to compare them in a few weeks. Lucky I have lotsof time since the market isnt going anywhere right now

  2. 2) should say “borrowings/NAV must be < 60% by law”.

  3. It is not interesting… it is just that I am always looking for safety. In another word, I won’t be buying stuffs at/near the peak of cycle unless I pay a cheap price for it.

    Enjoy yourself with REITs. I am still not looking it them…


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