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.