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Hercules - The Scrutiny begins 2014

One of the better movies that I am looking forward to watch in the new year is Hercules - The Legend begins.  Just as well, with every new year, the herculean task of reviewing and revamping one’s investment portfolio takes centre stage.

2014 is likely to see a harder sell for interest rate sensitive stocks, bonds and financial instruments as the market continue to shift to higher expectations of further QE tapering and possibly higher interest rates to follow.

There will certainly be an appetite for well-priced IPOs in the real estate investment trust, REITs and business trust sectors.  However, closer scrutiny should be paid to the quality of trust sponsors, growth profile of the underlying assets, valuation at which the assets were injected into the trust in addition to the underlying forecast yield and look out for financial engineering.

The leverage nature of REITs and business trusts lend themselves vulnerable to higher interest rates although a few well-capitalised REITs have stretched their loan maturities well into 2018 and fixed the interest rates of many of their loan tranches.

Many of the recent REITS IPOs in the past 2 years have not fared well.  Investors of recent listings like Far East HT, OUE HT, Soilbuilt Business Trust and Viva Industrial Trust continue to nurse their wounds as their current market prices are still below their respective IPO prices.

As I have warned before, its normal for markets to be flooded with new issues riding on the latest investment theme – in this case, it was yield-chasing REITS and Business Trusts.  However, when a market sector is saturated, the quality of listings will suffer.  Investors who had chased this sector in the past 2 years have certainly not hit home runs.  In fact, they would be bleeding at home.

How investors view REITs and business trusts will have e a major impact on the local IPO market in 2014 as funds raised from these sectors contributed close to 70% of the US$4.84 billion raised by the 25 IPOs on SGX up till end-November 2013.  This well surpassed the previous peak in 2010 when US$1.51 billion were raised from the IPOs of 3 REITs, namely Cache Logistics Trust, Mapletree Industrial Trust and Sabana Reit.

Corporates and sponsors with business divisions that generate stable recurrent incomes, have strong incentives to list and monetize their assets,    Asset classes that qualify include telecoms, train systems, toll roads, power assets, ports and utilities.  For example, Hong Kong Telecom Trust has done well while Thailand’s BTS skytrain has seen strong demand.

If these business divisions continue to sit within their listed corporate structure, they may not get to enjoy a higher valuation than if they were listed separately as a REIT or business trust.

In the case of Viva Industrial Trust priced at 78 cts for its IPO on 4th Nov, Viva would have an initial market capitalization of $463.3 million based on the total share capital of 594 million units.  It would and  still remained as the smallest Industrial REIT, a sub-sector already dominated by the big boys like Asendas Reit, Mapletree Logistics Trust, Mapletree Industrial Trust.  Among the smaller Industrial REIT competitors like Cache, Sabana, Cambridge and AIMPS, Viva offer yield of 8.8% was certainly not enticing enough to warrant a switch over.

But more importantly, a closer scrutiny of Viva’s underlying assets revealed that Viva could have overpaid for UE BizHub, a mixed-use business park-cum-hotel development.  Viva bought UE BizHub from listed United Engineers at $623 psf when an analysis of the latter’s 2Q2013 results reveal a valuation of only $293 million or about $300 psf for UE BizHub.  There is such a thing call Economies of Scales and fair price for transactions.  You don’t need to be a diva to understand such huge divergence of intrinsic valuations.

I am always skeptical of aspiring REITs looking for a quick listing by purchasing properties at premium prices when the market is no longer heading up.  In the case of Viva, UE  BizHub is one of its only 3 assets.  Clearly, without UE BizHub, I really doubt if Viva can even list in the first place.

Even the pricing of the IPO is an example of how close scrutiny would have told smart investors to stay away from the IPO.  The NAV was 74 cts which implied a P/NAV of 1.05x while its gearing was already 41%.  It is clear that if indeed Viva were to expand its portfolio in 2014 via acquisitions, they will be mostly be finance by equity as opposed to debt as its gearing is already high.  Would investors want to take on market risks of equity especially if new units are likely to be price at sharp discounts to ensure take up, like in the recent cases of Ascott Reit and Sabana Reit?

I shudder to think so.

So as we enter 2014, my main worries on the REITS sector which has seen a great boom since the ebbs of the Global Financial Crisis is that many REIT managers may buy low-quality assets, buy overseas assets at yields that do not compensate for different geographical risk premiums and those that overpay just to increase their portfolio size so that they can collect higher management fees.

At the same time, I am also weary of companies that list their foreign assets in Singapore especially if they come from a jurisdiction with its own REIT regime.  For example, Croesus Retail assets are all in Japan and there is already an established JREIT jurisdiction.  Of course, Croesus Retail explanation is that going forward, they are going to acquire assets in China, thus the rationale for the Singapore listing to hold a pan-Asian portfolio. 

What would Hercules say?

I am sure Hercules will tell the smart investor that he should always look beyond such marketing slick and ask if such rationale make sense and if the foreign assets are of the quality and at yields that would enable having such stocks in one’s investment portfolio that will out perform in the coming year.

Yes, shrewd investors should and need herculean brains to undertake closer scrutiny of IPOs and the capital markets in the coming year – The Scrutiny begins!  

Gabriel Yap
Gabriel Yap

Mr Gabriel Yap, CFA was Senior Dealing Director with various stockbroking organizations, including a 3-year stint in Wall Street, for 20 years before he retired in 2009 to devote his money and time to philanthropy.  He has donated and assisted the Charities Aid Foundation, Australia and Little Bird NGO, the largest NGO in China.  He also oversees the running of Golden Saint Resources Anti-Aids clinics, a humanitarian and charitable program for the people of Sierra Leone and Liberia.

He still appears in popular media like CNBC,Bloomberg TV, CNA and Mediacorp Radio on stock markets, capital markets and industry analysis and travels round the world to give investment seminars and conferences. He runs investment firm GCP Global which invest in global equities, bonds, reits, derivatives, real estate and commodities.  GCP Global is anchor investors in several IPOs in Asia and Australia.

Mr Yap anchored the Money Savvy column in the venerable Readers Digest magazine for 2 years.   Mr Yap also currently contributes to MillionaireAsia and The Independent newspapers on all things finance and investments.Mr Yap is also Special Advisor of London listed Golden Saints Resources, GSR which owns 340 sq km of diamond and gold mines in Sierra Leone.  GSR presently has a market capitalization of S$100 million.

Mr Yap splits his time between his home in Australia and Singapore as well as Europe, Hong Kong and China.