LendLease Global Commercial REIT: Trading at eye catching valuations
- Recent sell-down unwarranted for this Singapore-centric retail player with dominant presence across Singapore
- Balance sheet metrics have weakened but remain comfortably above loan covenants
- Sale of office assets likely better than equity raise if management decides to deleverage, which could bring gearing down to 32%
- BUY maintained, TP S$0.90
Lendlease Global Commercial REIT (“LREIT”) has underperformed its retail focused S-REIT peers lately, with its share price weakening by close to 15% while its peers have declined only around 3%. This is despite the REIT building more resilience and growth via its acquisitions of JEM mall (in Feb’22) and a 10% stake in Parkway Parade Mall in Jun’23. With these strategic acquisitions, LREIT’s earnings are more diversified and defensive in our view and the pivot to Singapore is a strong strategic move.
In FY23, Singapore contributed 88% of revenues and assets, mainly from the retail space, and we expect the REIT to deliver stable returns in the coming years. Despite the pivot to Singapore and increase in stability of returns, investors’ concerns revolve around its stretched financials (gearing of c.40%) and ICR ratio of 4.2x (or adjusted ICR ratio of 2.1x). Conversations centre on whether higher interest rates could cause further financial stress in the coming quarters, potentially requiring an equity recapitalization exercise if interest rates stay higher for longer.
LREIT currently trades at a FY24F yield of c.8% and at P/B of c.0.7x, which is -1 standard deviation of its historical mean and implies expectations of significant cuts to DPUs.
Asset values supported by improving cashflows; LREIT has buffer for a further 10% decline in asset value declines before gearing hits 45%.Overall gearing for the REIT has risen from an average of 32%-35%% in FY20/21 to the current c.40.6%, which remains manageable in our view. Our confidence stems from LREIT’s exposure being concentrated to Singapore and defensive retail assets. We believe these properties show capital value resilience, on the back of cashflow recovery. Valuation for Sky Complex has seen an expansion of cap rate from 5.0% to 5.75% in the recent financial year ending FY23, or approximating a c.10% decline in asset values, a re-rating that will buffer for further declines. Singapore assets (namely JEM and 313@Somerset) continue to see stable cap rates and higher valuations on the back of cash flow transactions and supported by market transactions.
We believe the strong cashflow improvement, coupled with recent retail asset transactions at cap rates of 4.5%-4.9% support capital values during this stage of the interest rate cycle. Based on our estimates, LREIT has a buffer against further softening of assets prices of c.10% before it hits the c.45% gearing limit. This implies a cap rate expansion of 50 basis points, a scenario we believe is unlikely for now within both its Singapore and Italy assets, unless interest rates continue to rise unabatedly.
Interest coverage ratio likely to have stabilized in our view, perpetual securities call dates are not a near term concern.
LREIT’s interest coverage ratio (“ICR”) has been declining over time and as of Jun’23, stands at 4.2x (or 2.7x based on MAS computation of ICR ratio). This drop in ICR ratio is mainly due to higher interest costs, which is projected to settle around 3.3%-3.5% in FY24-25F after refinancing of its EUR285m (or c.S$421m loan) loan sometime in Oct’23 (2QFY24), its only debt that is expiring in this financial year. FY25 (from Jul’25) will be the year to monitor as LREIT looks to refinance close to S$400m of SGD loans taken to partly fund the acquisition of its Singapore properties. Depending on the interest rate environment then, cost of renewal could be stable from current levels or see a softening of interest rate environment which will benefit LREIT’s loan renewal given its c.61% loan hedge ratio.
We note that LREIT will be looking to refinance 2 tranches of perpetual securities (S$200m 5.25 PNC25) in April’25 and S$200m 4.2% PNC26 (call in Jun’26). These will be reset at the prevailing swap rates with a spread of 3.043% and 3.24% respectively. These reset in perpetual securities has not been priced into our estimates given that recall dates are >1.5 years away.
Factoring in impacts of a reset in perpetual securities via a sensitivity analysis, we note that near-term concerns in FY25/FY26 on perpetual renewals will be at a -1% and -5% impact to DPUs respectively.
In the rare event that we do see high interest rates lasting more than 3-years into FY27, the cumulative impact of a reset of both perpetuals will see a 7% impact to our FY27 DPUs. We believe that the current share price has more than priced in impact of the renewal of perpetuals, even in the worst-case scenario.
Steady organic growth from its dominant malls
We project overall EBITDA growth CAGR of c.7% over FY23-25F, mainly driven by further positive rental reversions for its key assets – 313@Somerset and JEM - of 5% to 15%. Based on our estimates, average passing rent for 313@Somerset is steady at c.S$ 15-16 psf per month, which is below that of the Orchard Road malls while JEM’s average rent of c.S$13 psf per month has potential to be raised.
Tenant sales have rebounded strongly in recent quarters and are 18% above pre-COVID levels. This strong momentum is expected to underpin higher rental reversions of close to c.11% (by gross rental income) for leases that will be renewed in the coming financial year. While the additional boost from its 10% stake in Parkway Parade is likely to be marginal, Sky Complex’s annual rental escalation of c.4% will contribute positively to growth in the coming years. With LREIT achieving its projected EBTIDA growth of 7%, the impact of higher interest rates would be manageable.
Equity fund raising not a near term risk.
While investors are concerned if LREIT could be pressed to do a capital raise to address perceived balance sheet weakness, we believe management is unlikely to pursue this strategy, given that raising equity at 0.6x – 0.7x P/B with forward yields reaching 9% will wreck the goodwill and track record that management has built over time. We believe that any fund raising being considered by the management is likely to be on the back of an accompanying acquisition that will be DPU accretive. While LREIT has an attractive acquisition pipeline in Paya Lebar Quarters and the remaining stake in Parkway Parade, we believe these are likely to be medium term opportunities, after the interest rates environment stabilises.
In the worse-case scenario of management requiring to bring down its gearing, we believe that an asset sale of JEM Tower or Sky Complex could be the more likely route. Based on our estimates, either property could fetch c.S$430-480m. Assuming an asset sale of either of these 2 properties at book value with proceeds used for debt repayment, this could result in an accretion of c.1.0%-1.1% (sale of JEM Tower that is on tight cap rates of 3.5%) or a dilution of up to 6% for Sky Complex. In both instances, gearing could fall to a conservative c.32%. These initiatives, if executed upon, would preserve investors’ capital in the REIT.
FY Jun | 2H2022 | 1H2023 | 2H2023 | % chg yoy | % chg hoh |
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Gross revenue | 62.5 | 102 | 103 | 65.1 | 1.4 |
Property expenses | (16.6) | (25.3) | (25.6) | 54.3 | 1.3 |
Net Property Income | 45.9 | 76.4 | 77.5 | 69.0 | 1.4 |
Other Operating expenses | (4.0) | (1.4) | (3.2) | (20.3) | 123.4 |
Other Non Opg (Exp)/Inc | 0.0 | 0.0 | 0.0 | - | - |
Associates & JV Inc | (2.7) | 0.67 | 0.39 | nm | (42.3) |
Net Interest (Exp)/Inc | (10.2) | (23.5) | (27.2) | (166.4) | (15.5) |
Exceptional Gain/(Loss) | 84.0 | 15.6 | 21.7 | nm | nm |
Net Income | 107 | 58.3 | 60.1 | (43.7) | 3.1 |
Tax | 0.0 | 0.0 | 0.0 | - | - |
Minority Interest | 0.65 | (0.1) | 0.44 | (31.6) | (595.5) |
Net Income after Tax | 101 | 48.7 | 51.2 | (49.3) | 5.1 |
Total Return | 101 | 48.7 | 51.2 | (49.3) | 5.1 |
Non-tax deductible Items | (58.1) | 7.30 | 0.98 | (101.7) | (86.6) |
Net Inc available for Dist. | 42.9 | 56.0 | 52.2 | 21.6 | (6.9) |
Ratio (%) |
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Net Prop Inc Margin | 73.4 | 75.1 | 75.2 |
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Dist. Payout Ratio | 100.0 | 100.0 | 100.0 |
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