Tuesday, April 9, 2019

First Reit FY2018 - My Thoughts On The AGM

I had the opportunity to attend the AGM which was held this evening at the Mandarin Orchard Grand Ballroom at 2.30pm.

I arrived sometime around 15 minutes and there were already long queues forming for the registration. The AGM was packed and there were a few folks who had to stand when they arrived a bit later.

The door gift was a nice running tracker watch, courtesy of the printed First Real Estate Investment Trust. I think this is a similar model when the government distributed it out last year to the citizens during the health board promotion.

There were new faces across the Board, and one of the prominent ones was Mr. Christopher James Williams, who became the new appointed Chairman and Non-Executive Director in late 2018. This was his first First Reit AGM.

Ok, let's see what I can gather from my notes.

FY2018 Performance and Performance Since IPO

Mr. Victor Tan (CEO) started off by giving us an overview presentation of their full year 2018 performance.

Both operational performance metrics and distributions increased year on year in 2018 as compared to 2017, which capped off another good year for First Reit.

However, share price didn't fare so well.

It tumbled from the high of $1.42 in 2018 to the closing low of $0.92 at one point, which translates to about 40% drop in the share price.

Knowing the share price didn't fare well in 2018, the CEO diverted their attention away from a single year share price and reminded investors that had they held on from IPO in 2006 until end of 2018, they would have earned an annualized return of 15.9%, which is still one of the highest in the S-Reit universe. That alone is one remarkable achievement feat investors should not forget about.

During the period from 2006 to 2018, total AUM has also increased by a remarkable 13.8% CAGR to $1.35b, while Net Property income has risen by 13.7%.

In the last 8 years, they had made yield accretive acquisitions one after another, which includes 10 hospitals, 2 integrated hospitals + malls and 1 integrated hospital + hotel (more updates on these below).

Since IPO, they had also only did one rights issue in 2010 and a small placement in 2012. Both are for yield accretive acquisitions properties they bought.

I'll break into each segment separately to make it neater to organize.

Extraordinary Resolution 4

There was an extraordinary resolution that needs to be passed on the alignment of the admin and logistical operations with OUE after OUE and OUELH become a major stakeholder.

One of the example given was the the current distribution practice which First Reit typically distributes within 60 days after the distribution payment period. To align this with the rest, they will change it to within 90 days after the distribution payment period.

This will be one-off so the next quarter distributions will be slower than normal then the frequencies follow back the quarterly norm payment.

Surabaya Hospital Development

There was a shareholder who asked on the updates on the Surabaya hospital development.

Not many people knows about this but LK is actually building a new hospital, sort of an extension beside the current Surabaya Hospital which is owned by First Reit.

The intended target is to have this built ready by 2019 then have it injected into First Reit portfolio.

There was an incident last year regarding sinkhole which prevents it to be completed by this year and instead this project has been postponed for completion to 2021.

The existing Surabaya hospital will still follow the current lease with LK which expires in 2021, so once the new hospital is injected it will follow a separate lease agreement than the current.

Growth Strategy

The management and Board gave a subtle strong hint of an acquisition target they are working at and it is most likely coming from Japan.

One reason for this is they highlighted Itochu as a strategic partner with OUELH which has pipelines in the Japanese market.

For Japan, we can take reference from Plife Reit when they made acquisitions for Japan nursing homes, which has a net property yield of 6.7%.

They also mentioned the possibility of Malaysia, China and Myanmar in a bid to diversify their portfolio away from the Indonesian geographical so we should see upcoming acquisitions targeted in these areas.

Divesting of Non-Core Assets

The CEO also gave a strong hint on a few potential divesting of non-core assets.

He specifically picked out the Imperial Aryaduta Country Club, one of the 5 properties which have their current lease expiring in 2021. He mentioned that while the hotels are doing well, the Country Club is not doing well as he often see unutilized tennis courts being used.

In addition, this property is currently sitting on a large parcel of land as much as 54,410 square meters, so they are looking into divesting this. The current valuation of this property can fetch them approximately $40.6m.

Another property they are working to divest is also Sarang Hospital in Korea, which is a very small part of their portfolio.

The management also gave hints that they are working on separating the strata title for the 2 integrated hospital + malls and hospital + hotels, so they can divest the malls and hotels portion, but that is still work in progress.

Gearing & Funding Options

They have a total debt borrowings of $503m, which translates into a current gearing of 35%, which is well below the statutory requirement of 45% threshold.

They are currently paying around $17m a year on interest costs at a weighted average cost of debt at 3.84%.

$110m of the $503m debt profile will be due in 2019 while the rest will be due in 2021 and beyond.

The CEO gave an update that they have paid off $10m via internal cash funding while the $100m has been approved by the bank for further extension.

One of the shareholders asked if the management will be reducing or increasing the gearing and Victor said while the long term optimal allocation is to remain the gearing at 35%, in the short term the gearing may rise to 40%. This gives a strong hint of an acquisition coming that would be funded via debt or debt + equity.

LK's Rental Leases and The Lease Expiry in 2021

I'm leaving this for the last because I think this is what everyone goes to AGM to find out more.

There are 5 properties that will have their leases expiring in 2021:

- Siloam Lippo Village
- Siloam Kebon Jeruk
- Siloam Surabaya
- Sarang Hospital
- Imperial Aryaduta Country Club

I've detailed the last 2 properties in my above "divesting" section that they are looking to potentially divest so I think we won't be overly concerned with that.

The other 3 is their most matured and biggest portfolio, and has their leases contract with LK.

Currently 82.2% of their rental income comes from LK, while the rest comes from Metropolis (12.4%) and a few smaller ones.

Obviously, the biggest concern is surrounding the ability of LK to i.) pay their rental and ii.) re-negotiation of the lease expiry coming 2021.

LK's Timeliness Payment of Rental

If you look under the Notes 16 of the Trade Receivables portion in page 118 of the Annual report, you will see that the related parties receivables have increased in 2018 from $14m to $23m.

The CEO mentioned that LK used to pay 3 months in advance of deposit for the rental but last year they decided to do away with it. While they still pay their due rental payment, they have never defaulted and Victor believes that 2018 was a year they had problems with their cashflow, which is also all over the news by the way, and that given their recent fund raising activities, that is no longer a going concern (also confirmed by the auditor).

One of the Director also pointed out that the capital market appreciates the fund raising and restructuring of the LK which shows their bonds recovering from a 17% yield to the current par yield at 7%.

The credit rating was also upgraded by Moody in the most recent exercise.

Re-negotiation of Lease Expiry in 2021

This is perhaps the bigger concerns for investors.

There are 5 properties that will have their leases up in 2021, and 3 of them are matured properties lease with LK.

LK provides 80% of income support that they will receive from Siloam to operate the hospitals and pay to First Reit and the concern is if LK can provide similar income support once the current leases expiry.

One of the shareholders highlighted an important point when he mentioned given LK's lower shareholding interest than the now OUE and OUELH whether it gives bargaining power more to LK than to First Reit.

The CEO and Chairman gave a confident answer that First Reit is in no inferior position to negotiate with LK because first the current lease agreement they have in below the market rate and second it is in LK and Siloam's interest to continue operating the hospitals because First Reit only owned the land and building while LK and Siloam have vested interests in the equipment, doctors, nurses that they have invested over the years. Third, the hospitals are also doing very well with operational metrics and occupancies up year on year so LK will want to keep that momentum going.

My Thoughts

First, I will share my thoughts on the LK's concerns.

I don't think LK will go into default simply because while they have $1b liabilities on their books , they also have $5b on their assets. In other words, they can divest their properties like they did in the recent exercise to raise funds should it comes to that stage.

On the renegotiation of the leases with LK, I think it'll come to a stage where it becomes too important to neglect for both parties because LK still ultimately has 10% vested interest in First Reit so as a related party and vested interest in the operations, they would want to make sure they have cakes on the share too. The most likelihood scenario is that they would follow the current lease agreement structure which would continue for the next few years.

Based on the subtle hint they gave during the agm on the gearing, growth and divestment plan, it seems that we are going to see some corporate action soonest.

There are 2 likely scenarios.

Option 1: Divest the non-core assets first at a profit, share price recovers, then do a debt + equity placement (I think debt + rights would be overkilling) to purchase a yield accretive acquisitions.

Option 2: Straight away do a debt + equity placement (since CEO gave hints of a 40% gearing in short term) for a yield accretive acquisition, then subsequently divest the non-core assets to reduce gearing.

The two key words here which I noticed throughout the agm is yield accretive acquisitions and whether the divestment or acquisitions will come first, albeit both will come at one stage after another.

It is Not easy to do a yield accretive deals when your mother shares are trading at 8.7% yield. Chances are you find a 6.7% npi Japanese nursing home then fund it as much as possible with debt. Either that or go with some income support from sponsor to boost the deal. 

First Reit will be announcing their Q1FY19 results tomorrow morning, so maybe there's a good surprise soon now that the resolution on the agm has been passed.

Thanks for reading.

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  1. Many thanks Brian for sharing the First REIT AGM updates.....really appreciate it! I am also vested in First REIT. I have one weirdo who left comment on my blog that "I will regret" ever investing in First REIT. Maybe most folks these days thinking that Lippo Karwaci will default on its rental commitment to First REIT due to the liquidity crisis it is facing.

    1. You will regret

    2. Hi BK

      Haha like you I don't think they will default but the risk still remain on whether the upcoming deal will be anything like the current deal.

    3. You will regret too

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  2. Very useful summary as always. Thanks B.

  3. Glad to be here reading this summary on your amazing blog. Keep it up !!

  4. Regarding " they have paid off $10m via internal cash funding..." as i know REIT need to pay out at least 90% income to unit holder , where the $10m came from ??

    1. Hi ml

      It comes from their internal cash. There are many ways a reit can conserve cash for e.g drip or taking management fees in units.

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