Frasers Commercial Trust DPU May Not Be Sustainable Even With New Tenant Google Coming On Board

Frasers Commercial Trust (“FCT”) recently announced the signing of a major tenant, Google, at Alexander Technopark. Of course, with this being a done deal, many folks including myself were thus expecting the DPU to increase upon commencement of the lease next year. Upon perusal of the financial announcements of FCT in the third quarter ending 30 June 2019 and examining it in details, I decided to reduce my shareholdings by half to mitigate any downside risk at the current high valuation of S$1.60-S$1.65 range. The free cashflow available to pay out quarterly distribution turns out to be unsustainable even if you add in the upcoming contribution from Google to replace the capital component in current distribution.

1. Free cashflow assessment

Screenshot 1: Cashflow Statement Extract

FCT financial year is from 1st October 2018 to 30th September 2019. Hence we need to annualise the cashflow from 1/10/2018 to 30/6/2019. To work out free cashflow available for distribution, use S$49.81Mil (cashflow from Ops activities subtotal), add net income from joint venture of S$4.5Mil and less off the CAPEX line item <S$21,39Mil>.  

Note that in the workings in screenshot 2 Free Cashflow template below, I have decided to exclude CAPEX of <S$21.39Mil> as I presume that they are relating to part of the asset enhancement work for China Square Retail Podium of S$38Mil and non-recurring in nature hence it will not be fair to include one-off items in the computation of available free cashflow for distribution.

1.1- Current free cashflow concept is inadequate- Need to take into account financing cost to complete the picture.

I will go on further to subtract the line item “financing cost paid” of <S$11.63Mil> from the aforesaid mentioned to assess whether sustainability stress test will hold out. The funny thing about the current “Free Cashflow” definition is that it only talks about “Cashflow from Operating Activities” less off “capital expenditure” as essential cash left for distribution activities but it has omitted the all very important financing cost to service debt. Bank loan and other perpetual securities makes up a substantial portion of the capital structure setup of every REITS and Business Trusts in order to get yield accretive assets for their shareholders. So how can Free Cashflow be free when this critical and substantial part of REITS and Business Trusts is missing from the consideration?

Hence taking into account the financing cost paid, the revised Free Cashfllow is S$56.96Mil as illustrated in screenshot 2 below.

1.2- Dividends paid and lack of cashflow generated from the business even if add back expected rental from Google

Based on annualized dividends payout of <S$86.67Mil> against Free Cashflow of S$56.96Mil, we are now staring at a colossal gap of <S$29.7Mil> per annum even when I have taken the liberty to assume zero CAPEX. 

For Google, it took up 344,100sqft of space at Alexandra Technopark. It is widely believe that the average price achieved is around S$4psf which translates to a forecasted annual contribution of S$16.5Mil Adding this S$16.5Mil into the free cashflow deficit <S$29.7Mil>, one will still need to plug the remaining deficit of <S$13.2Mil> per annum. 

Screenshot 2: Free Cashflow Computation

1.3- AEI completion at China Square retail podium

The lettable area post Asset Enhancement Initiative is expected to increase to 78,000sqft. Based on Commercial Guru, the asking psf is S$20. Hence monthly rental income contribution if fully leased out will be S$1.56Mil and annual income contribution will be S$18.72Mil. Therefore, the key assumption will be that FCT must ensure that they can lease out all retail space of 78,000sqft at the targeted rate of S$20psf per mth in order to maintain the distribution and plug the deficit of <S$13.2Mil> as alluded to Pt 1.2 aforesaid mentioned above.

1.4- How about other REITS and Business Trusts? Are they also in the same deficit state?

Nope, look at SPH REIT, even if one includes in financing cost repayment, its distributions are in a very healthy and sustainable range relative to FCT. 

For Business Trust, Netlink Trust is another problematic business that actually borrows from the bank to finance its current high dividend distribution of 5.7% and it will not be sustainable in the long run. The sustainable dividend yield is actually only around 4.02%. I will probably write another post on Netlink Trust which many folks are viewing as an extremely safe haven to park their cash. My personal thought is that this is another potential Asian Pay TV Trust waiting to self-implode. Short term holding on to this should be alright due to the current non-stable macro-economic environment against the perceived safe government regulated business activities but for the long term, one should re-look at whether the current yield is high enough to compensate for future downside risks. There is a big hole of <S$33Mil> per annum to plug for this one.

Conclusion

FCT pays out high distributions to its unitholders, ostensibly from its current businesses. On further evaluation and in actual fact, FCT seems to be paying the high quarterly distribution via the previous cash reserves built up from the (i) gain on disposal of S$144 Mil of 55 Market Street in August 2018 and (ii) Distribution Reinvestment Plan whereby investors opt to receive dividends in equivalent units instead of cash. 

The crucial points for investors are thus whether FCT management can continue to backfill the remaining unoccupied Alexander Technopark as well as finding tenants for the China Square retail podium post asset enhancement work in order to maintain the current distribution rate. Given the circumstances as it is, this can be quite challenging.

Should Retail Investors Continue To Invest In This Uncertain Macro-Economic Environment? Or Time For Exit and Wait Strategy?

Should retail investors continue to invest in this uncertain macro-economic environment? Or time for exit and wait strategy? During my last post, I have briefly mentioned that there are some groups of investor who have sold off most if not all their REIT portfolio as they believed that REITs are overvalued and have rallied too much against their fundamentals. Also, such groups believe that economic recession is imminent and have switched to bonds and gold. On the other hand, I have another group of obstinate friends who believed in the buy and hold forever camp who asked me why I started selling off my Mapletree Industrial REIT and Starhill Global a few weeks back. Long term always beat timing the market is the core belief of this group of folks.

1. State of the current marco economic situation

I think that the first question to ask is which part of the economic cycle are we in right now? For those who think that we are still at the peak, you will need to start catching up on the recent news. There is no doubt that we are in the downtrend with Singapore GDP falling. There are also various gloomy re-forecast of future GDP numbers by other countries. We also have various bad news from the big boys such as Deutsche bank and automaker Nissan laying off workers. Donald Trump trade war with China is ongoing. For those who thinks that Donald Trump has blinked and pulled back additional tariffs against China, note that this is only a temporary measure to postpone the event to the end of the year to appease the US electorate. Upcoming Brexit and Hong Kong never ending riots add further uncertainties to the regional economic situation. The inversion on short term and long term bond yield curve also created massive panic. Probability of further sells off are high based on the recent news.

2. Exit now and wait for lowest point of the next upcoming recession?

With regard to selling off everything right now to take advantage of market timing, there is a high risk of missed opportunity cost. Also, I have seen many expert economists and analysts declaring recessions after recessions every year and I have serious doubt over their crystal ball being able to pin-point the exact lowest point of the next upcoming recession. According to the Bloomberg Businessweek, economists are terribly bad at forecasting recession. They also tend to underestimate the magnitude of the slump until one year later before they can give such conclusion. 

3. Continue holding and investing?

For the buy and hold camp, this can filter down to even more sub-groups of strategies. I shall not delve into the details here. The only point I want to add here is make sure one does not get caught in forced liquidation of your stock portfolio during the worst trough of the crisis. If you suddenly need to come up with money for down payment of a new home or renovation, or if one is forced into margin call, then this is the worst nightmare that will destroy the opportunity of upsides when the market recover.

Just to sidetrack a bit, REITs are definitely not super defensive assets. The 2008/2009 Global Financial Crisis period saw a huge plunge in many of their value by more than 50%. Also, among REITs, the level of fluctuation also depends on which class of assets they belong to and also their leverage level.

There is also a misconception that during huge plunge in value of REITs, their dividend yield will also dropped by the same proportion. This is not true. The dividend yield at the lowest point could be in the double digit percentage yield due to the extreme low price. But many investors stayed away due to the high leverage employed by REITs and the fear of REITs going into liquidation if they cannot secure new bank loans. I guess the problem at this point in time is whether retail investors practice what they always advocate as common sense, that is, "buy low and sell high".  The irrational fear of losing one's hard earn money will be very real at that juncture where everyone is afraid that the great recession will worsen and evolve into a great depression similar to the 1930s during the most pessimistic period.

4. Summary
For myself, I have taken a hybrid approach. I sold off around 20% of my previous portfolio-mostly Industrial  REIT, office REIT and also Retail REIT (Starhill Global). My current holdings is now make up mainly of only Retail REITs, Healthcare REIT & stock and also business trust (Netlink). I hope that in the upcoming months, I will have an opportunity to accumulate some DBS, OCBC or UOB blue chips.

Love And Destiny- 三生三世宸汐缘

No time to blog recently as I was too busy watching and chasing "Love and Destiny". This fantasy drama series was so good that I was totally mesmerised by it. The beautiful backdrop and the tragic story line was just too awesome. This amazing series is being produced by the same production team behind the immensely popular "Eternal Love" series in 2017 starring Yang Mi. "Love and Destiny" is actually a prequel to it and in 2020, the sequel to "Eternal Love" which is in post production phase will be coming to viewers and fans.

The story goes like this: Fifty thousand years ago, Jiu Chen, the God of War and Protector of the 6 realms sacrificed  his life to seal away the powerful Demon Lord who intended to plague the world into chaos and destruction. Jiu Chen's body was then buried in the Sea of Eternal Slumber. Fifty thousand years later, a young fairy, named Ling Xi, accidentally ventured into his heavenly grave and awoke him from his eternal slumber. The mystery of how this young fairy could have brought the God of War back to life is the main story plot. The eternal fight between Good and Evil continues.

3 things I learnt from Love and Destiny that draws parallel to real life and our investment philosophy:

1. Similar to office politics at work, there are Sabo King/Queen out there that hatches schemes to harm others in order to discredit someone or to preserve one's status. If you naively think that all colleagues adore you and do not bother to watch your own back, you may get knifed without even knowing what happened until it is too late. While one should not practise office politics to harm others, one must always be aware of one's own working surroundings in order not to get played out by the Sabo King/Queen.

2. While we sometimes make bad decision or encounter great adversity, we should always look past that into the silver lining in such disastrous moment. What does not kill you only serves to make you stronger. Reflect and make yourself better. No one is perfect. There is no need to feel depress or sad or think that it is the end of the world. Being alive is wonderful in itself.

3. Many people think that they are always right. Just like investment style, there are people who stubbornly believe that the whole world should follow their own investment principle which is the best of the best. Such folks are just unable to see the viewpoints of others. For example, I have recently seen friends and other folks telling me that the recent rally in REITS make this asset class overpriced and have sold off all their REITS while awaiting the "Great Recession" to come and then buy at the bottom after 30% to 50% discount. They are asking me why I only sold off 20% while retaining the bulk of my retail REITS, namely SPH REITS and Frasers Centrepoint Trust.

Strangely, I have another group of obstinate friends who believed in the buy and hold forever camp who asked me why I started selling off my Mapletree industrial REIT and Starhill Global a few weeks back. Long term always beat timing the market is the core belief of this group of folks.

In my next post (after I finish watching Love and Destiny-I am eagerly awaiting the final 10 episodes next week), I want to pen down some of my thoughts regarding the current economic downtrend which has already started. Also, I want to point out that just like "Tao", we should follow the way of the universe in harmony and not just set some very detailed rules to follow blindly. Once you named something, it is no longer "Tao". Will also touch base on the topic of should we sell off our REITS now or should we continue holding on for their dividends? There are just too many totally conflicting viewpoints out there at this juncture.