We have gotten several queries from our readers regarding First Real Estate Investment Trust’s (FREIT) unexpected correction recently, where the stock plunged to S$0.96/share at one point, down 18% in a day. The sharp decline seems to be linked to the Fitch’s downgrade of PT Lippo Karawaci (LPKR) to CCC+ (down from B) on 5 Nov 2018. Lippo Karawaci is the sponsor and main master tenant of First REIT’s properties.
The knee jerk correction is probably due to concerns over LPKR’s liquidity issues and recent allegations of its corruption case pertaining to the Meikarta Project. LPKR’s liquidity is indeed tight, as it has to start selling off non-core assets to repay its debt given the weak property outlook in Indonesia. However, I felt this is largely an overreaction on FREIT and the repercussions may not be as dire as the situation shows. Let’s take a step back to rationally review the situation here.
Source: First REIT’s Presentation
I think First REIT can maintain its long-term master leases. To recap, FREIT’s Indonesian hospitals’ rent structure with LPKR is a fixed rent plus rental escalation based on Singapore CPI (capped at 2%) plus another variable rental growth component based on overall revenues. Indeed, there were concerns whether the master leases will be honoured should LPKR default. As mentioned, Fitch has already downgraded LPKR’s credit rating from B to CCC+; Moody’s has also placed LPKR on B- rating with a negative watch. However, I might argue while LPKR faces liquidity concerns, its cash flow is not parched. LPKR still has development assets and valuable land bank, in this case, it is what I call “asset rich, cash poor”.
These land under developments are well located in Lippo Village (Greater Jakarta) and Tanjung Bunga, Sulawesi where location continue to attract foreign investors (i.e. Hongkong Land in Jakarta Garden City and China Fortune Land in Pasar Kemis). This should allow LPKR’s relationship banks to maintain credit lines given the valuable assets. Though rent collections to FREIT were partially delayed, our call with First REIT’s management indicated that LPKR is actively addressing payments. Furthermore, there is also a banker’s guarantee of six months on FREIT rent collection should LPKR defaults.
First REIT is a critical chess piece to the Lippo Group. Lest we forget, the true function of FREIT is to monetize LPKR’s hospital assets, thereby reducing its development cycles. When these hospitals are completed, it is sold to FREIT, with proceeds to LPKR redeployed for future projects. As at Sep 2018, FREIT has right of refusal to 40 hospitals under development and another 33 hospitals under Siloam Hospitals (subsidiary of LPKR). It is easy to perceive LPKR’s possible default in rent payments as a logical outcome. But the situation is simply not that straightforward. FREIT’s Singapore listing gives LPKR access to sell assets at a fair valuation, so long the parent maintains the master leases on FREIT’s hospitals (broadly speaking, higher property valuation is a function of rising rental income). Furthermore, a Singapore listing attracts foreign institution monies, reinforcing FREIT’s property valuations. Thus, hospitals parked under FREIT can be financed at a much cheaper SGD Swap rate, compared to the more expensive domestic IDR rates. I believe LPKR will not want to lose such benefits in the future.
Financial position remains strong. Having reviewed 3Q2018 results, FREIT’s gross revenues, net property income and net profits have improved steadily y/y. Gearing ratio stood at 34.9% while interest coverage ratio stood at 4.8x, reflecting healthy operations. Though trade and other receivables have increased (due to some rent delays), this should be cured in the near term. Credit lines are intact. The Group recently secured a S$100 million six-month term loan facility plus an option to extend another six months till May 2019 to pay down its short-term debt of S$110 million.
For a long time, FREIT has been trading at a premium to book value and the recent price correction has brought it down to ~1.0x P/B ratio. The sell-off to me seemed unwarranted. Past dividend distributions have been fairly consistent and increasing. As long the integrity of the master leases is well managed, I am comfortable with FREIT at current prices. The dividend yield is approximately 8.2% (based on last 12 months), which looks like an attractive opportunity for a yield play.
Source: First REIT’s Presentation
The information provided is for general information purposes only and is not intended to be investment or financial advice. Value Invest Asia Co-Founder Willie Keng owns shares in First REIT.