Potential acquisition for Capitaland Retail China Trust (CRCT)?


Capitaland Retail China Trust (CRCT) released their third quarter 2017 results a few days ago.

DBS produced an equity research note that a potential acquisition is on the cards. Do they know something the retail investors don’t? Nevertheless, this post will go through how the third quarter 2017 financial statement looked like, and how the REIT is positioned to go forward.

At an annualiezd yield of 5.9% based on 3Q2017’s closing price, CRCT’s yield is slightly short of the psychological comfortable zone of 6%. However, this REIT appears to be well run and in my opinion deserves a second look. I personally prefer to stick to REITs serving up 6% yields and more, but given the lack of choice with regards to China Retail REITs listed on the Singapore Stock Exchange (the only other REIT is BHG Retail REIT), this counter would be well worth considering.

CRCT’s headline numbers

Headline numbers show that the REIT continues to do well, with quarterly metrics of revenue, net property income, distributable income and distribution per unit all rising.

Let’s look at the statement of total return.

Gross rental income rose 10.5% on a yearly basis in RMB terms but 9.3% in SGD terms, indicating a depreciation of the RMB or appreciation of the SGD.

Other income consisting of atrium space, trolley carts and advertisement panels rose 27.8% in SGD terms. Though growth is large, the contribution of “Other income” to gross revenue is not large at about 8.2% in 3Q2017. Nevertheless, it is good there is an increase in this category.

On the expenses side, there were no savings i.e. expenses all rose, leading to a 12.3% increase in Total Property Operating Expenses.

The biggest expense increase came from Business Tax at a 58.9% increase, but this component is not a major contributor to Total Property Operating Expense. The biggest contributor is actually Other Property Operating Expenses, of which the biggest contributor is Depreciation and Amortization.

Even though the Depreciation and Amortization amount is large, it is a non-cash item meaning that there will be adjustments made to the financial statement such that the income received by unitholders will not be reduced by that amount.

CRCT statement of total return
CRCT statement of total return

For unitholders, this section is more relevant because it removes the effect of all the non-cash items to arrive at a line called “Income available for distribution to unitholders”.

The amount has grown by 4.2% in 3Q2017 compared to 3Q2016. On a Y-T-Sept 2017 basis, the income available for distribution to unitholders has also increased at 4.5% compared to the Y-T-Sept 2016 period.

This indicates that growth was actually faster in the first half of the year.

CRCT income available for distribution
CRCT income available for distribution

Also read: Interested in other REITs? Check out a review of Soilbuild and Keppel DC REIT.

After the sale of Capitamall Anzhen, the amount of investment properties in the statement of financial position fell 7.5% to S$2.4 from S$2.6b. On this basis alone, this is not good as the NAV per unit will be reduced.

However, the cash and cash equivalent amount increased mainly due to the proceeds from the sale of Capitamall Anzhen.

In this case, the increase of cash and cash equivalents is larger than the fall in investment properties, which will be accretive to the Net Asset Value (NAV) per unit.

From Capitaland, they report the following for the Capitamall Anzhen divestment.

“The transaction price is based on the company’s adjusted net asset value, including but not limited to its interest in CapitaMall Anzhen of RMB1,129.5 million (S$230.0 million), which is 12.9% above valuation. Targeted for completion in 4Q this year, the divestment is expected to generate net proceeds of RMB888.5 million (S$180.9 million) and a net gain of RMB154.6 million (S$31.5 million).”

Important to the REIT and unitholders is the sale above valuation and net gain.

CRCT statement of financial position
CRCT statement of financial position

The sale of Capitamall Anzhen is unlikely to be a big loss to CRCT because the mall was originally master-leased to BHG (Beijing) Department Ltd. While a master lease arrangement provides certainty of income and a long Weighted Average Lease term to Expiry (WALE) to CRCT, they will not be able to partake in positive rental reversions, if any.

With the cash proceeds from the Capitamall Anzhen sale, CRCT has a substantial amount of money available to buy another mall in China. But with cap rates being quite compressed (CRCT bought Galleria Chengdu in Aug 2016 at a Net Property Income yield of 5.4%), the manager may find it difficult to do an accretive acquisition unless they utilize their debt headroom.

DBS actually builds into their model a S$250m acquisition in 4Q2017. No other analyst has made such an assumption. Could DBS know something? While it seems tempting to buy CRCT’s stock ahead of this assumed acquisition, I myself have not heard anything in the market about an acquisition. Furthermore, we do not know yet if the acquisition will be accretive to CRCT and unitholders. At this point of time, investors can only trust in management’s judgment to run the business well.

Looking at CRCT’s statement of cash flows, the largest contributor to the expansion of their cash war chest is the S$217m of Proceeds from Disposal of Subsidiary, Net of Tax.

The () or negative figure regarding Gain on Disposal of Subsidiary is related to the “…gain arising from the disposal of equity interest in Anzhen SPV on 27 July 2017.”

This is a negative figure because this gain that boosted Total Return After Taxation isn’t actually a Operating Activity. The Total Return After Taxation needs to be reduced by this amount to get to the amount of cash actually generated by operating activites.

CRCT statement of cash flows operating and investing activities
CRCT statement of cash flows operating and investing activities

Also read: SPH REIT’s stable outlook

In the Financing Activities section of the Statement of Total Cash Flows, the largest items are Proceeds from Draw Down of Interest-Bearing Borrowings and Repayment of Interest-Bearing Borrowings of S$435m and S$405m respectively.

These 2 items net each other off because CRCT is taking one loan to repay another. The repayment of one with another is a common practice among all REITs.

After all the adjustments, CRCT’s total Cash and Cash Equivalents is S$353m.

Quite a hefty amount of cash available for their next acquisition. If this amount of money is well utilized, the gearing ratio of CRCT would be kept low at the current 35.4%.

CRCT statement of cash flows financing activities
CRCT statement of cash flows financing activities

On the analyst side of things, OCBC maintains their hold call at S$1.61 while DBS has increased their target price to S$1.8.

After speaking to management, DBS notes that CRCT is willing to push gearing up to 40% for their next acquisition. I personally feel that any gearing ratio at 40% and above will require hands on effort by the management to ensure financing costs do not get out of hand. This would entail speaking to financiers and trying to press down the rate on bank loans. I don’t have a view on where interest rates will head (nobody knows the future), but on the face of it, 40% is higher than the S-REIT average.

This post consist of views of the author only and is not meant to be investment advice.