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CICT (SGX:C38U): Should there be Concerns over Gearing and Asset Valuations?

In March this year, I wrote about the possibility of REITs having to raise capital through rights issues if Covid-19 were to cause severe declines in asset valuations (What Happened to REITs during the GFC?). Eight months on, this has not occurred, and although I believe that the likelihood of this has diminished, we cannot completely ignore it. In October, I initiated a position in Capitaland Mall Trust (CMT) at a price of $1.91, which has now merged with Capitaland Commercial Trust (CCT) to form Capitaland Integrated Commercial Trust (CICT). As a shareholder, I was curious to assess the likelihood of CICT having to raise capital through a rights issue, by analysing its gearing ratio and asset valuations.

I have not ran the numbers to determine the gearing ratio of the merged entity, although Kah Kiat at Dr Wealth has calculated that the pro-forma gearing for CICT would be 38.3% post-merger. However, these figures were calculated based on the valuation of CMT’s and CCT’s assets as of 31 Dec 2019. Thus, it would be appropriate to note that as of 30 June 2020, CMT’s portfolio valuation has declined by around 2.7%, while CCT’s portfolio valuation has declined by 1.7% (refer to screenshots below). Thus, the gearing ratio of the merged entity would be slightly higher than the 38.3% calculated as of Jan 2020.

Given that we’re in the midst of a global pandemic that has resulted in an economic fallout rivalling the Global Financial Crisis in 2009, I decided to take a look into history to understand how CMT’s and CCT’s asset valuations were impacted during the GFC. As I had written in my previous article, CMT and CCT both had to undertake rights issues at heavily discounted prices, which resulted in existing shareholders being severely diluted if they did not participate in the rights issue. CMT undertook a 9-for-10 rights issue in Feb 2009, raising $1.23 billion through rights priced at $0.82 per unit, a discount of 43% to the closing price of $1.45 per unit. CCT undertook a 1-for-1 rights issue in May 2009, raising $828 million through rights priced at $0.59 per unit, a 44.3% discount to the closing price of $1.06. The rationale provided for the rights issues were to reduce leverage and strengthen the REITs’ balance sheets.

I went through both CMT’s and CCT’s quarterly financial statements from 2004 till 2011, to get a deeper understanding of the economic climate leading up to the GFC, the turmoil during the GFC itself, and the recovery post-GFC. In particular, I was curious to analyse how the valuations of the REITs’ properties had changed during the entire period, and how excessive leverage was a double edged sword that worked well in good times, but detrimental to the REITs during the crisis. What I have found was pretty interesting, and I have summarised my takeaways below. On a side note, I just want to add that the Powerpoint slides back in those days were indeed hideous.


Irrational exuberance leading up to the real estate bubble: My first observation was that the run up to the GFC was indeed a crazy period. Asset valuations had increased by double digits over 6-month periods – just look at that increase in valuation of 35.1% for CCT’s Capital Tower (Currently occupied by GIC, JP Morgan and Capitaland) from Dec ’06 to Jun ’07. To compare that against our current situation, I don’t think there has been a run up in valuations of a similar scale relative to pre-GFC, thus a spectacular fall in real estate prices may be less likely. Nonetheless, even without the irrational exuberance causing a real estate bubble, we have to be cognizant of the demand side shock affecting certain classes of real estate, which may drive valuations down.

Acquiring properties during the initial stages of a crisis is generally a bad idea: As seen from the valuation figures, real estate prices are generally a lagging indicator of a crisis. Stock prices adjust downward much faster to negative future expectations as compared to illiquid assets like real estate. Thus, there is the likelihood of overpaying for real estate when making acquisitions during the initial stages of a crisis. For example, CCT’s share price peaked in May ’07, and by Jun ’08 had fallen significantly from its peak. Yet, the valuations of CCT’s assets continued to climb, as seen from the broad increase in valuations across all properties from Dec ’07 to Jun ’08, which was when the asset valuations peaked.

Acquisitions made during the GFC proved to be poor deals, as evident from the valuations of One George Street and Wilkie Edge by CCT, and the acquisition of Atrium@Orchard by CMT. The valuations of these properties declined significantly after they were acquired, thus on hindsight, if the REITs had waited a year or two, they might have been able to acquire these properties at much more attractive valuations. Thus, for REITs which have been going on a shopping spree recently (think of private placement/preferential offerings from Ascendas REIT, MLT and FCT), I am skeptical as to whether this is the right strategy.

Gearing and access to credit has to be viewed together: CCT’s gearing increased from c.30% in Dec ’04 to 42.3% in May ’09, just before it raised equity to deleverage down to 31%. On this point, I am not exactly sure on the urgent need to deleverage at that point of time in May ‘09. From my understanding, before 2015, MAS’ rules for REITs was that gearing was capped at 35%, but allowed up to 60% for REITs with credit ratings from Fitch, Moody’s or S&P. CMT and CCT had ratings from Moody’s, thus would have been able to leverage up to 60% of their asset value. Thus, with their gearing ratios at 42-43% in early 2009, I am unsure of the urgent need to deleverage through rights issues.

My guess is that it was a combination of two main factors – 1. It was extremely difficult to refinance existing debt during the GFC, as banks were wary of extending credit to REITs when the global real estate market was crashing. Thus, CMT and CCT had to raise equity to pay off the debt. 2. Perhaps REIT managers expected the sharp decline in asset valuations to continue (as seen from the double digit declines in asset values in ’09), thus they wanted to pre-empt this (even though their gearing was some distance away from 60%) in order to stay within MAS’ gearing limits.

During the GFC, I was still an oblivious primary school kid, so perhaps if you’ve invested through the GFC and have better insights on the need for REITs to deleverage during that time, please let me know in the comments below, or feel free to drop me a direct message on my Instagram page and we can have a chat. Would greatly appreciate any additional insights on this matter!

Retail properties more resilient than office properties: As seen from the changes in valuations for both CMT’s and CCT’s portfolios, CMT’s assets only recorded one period of decline in valuations, from Dec ’08 to Jun ’09. Whereas CCT’s portfolio was hit much harder, with asset values falling >20% from ’08 to ’09. To compare that against CICT’s current gearing and asset valuations, assuming CICT has a gearing of 40% currently, asset valuations would have to decline by 20% for it to breach MAS’ gearing limit of 50%. Going by history, the risk may be greater for office properties instead of retail properties. Of course, we are in an unprecedented pandemic, and the impact on retail and office properties may still surpass that of the GFC.

Closing Thoughts

I think a key distinction to make between the GFC and our current situation would be that the GFC was primarily a real estate bubble that led to a financial crisis, whereas what we are currently facing is a demand side problem cause by movement restrictions due to Covid-19. Of course, there is the possibility of the domino effect causing a real estate crisis, especially for sectors such as hospitality, retail and office, whereas sectors such as logistics and data centres have been doing well.

A mitigating factor for CICT would be that the enlarged asset base provides some form of diversification, as retail properties have shown to hold their assets values better than office properties during the GFC. With regard to the impact of WFH policies on commercial property valuations, my view is that the downside would be limited. As we have seen, tech firms have still been taking up prime office space in the CBD, and ultimately, I believe that there would be some form of equilibrium between WFO and WFH. Offices would not be redundant so soon. Additionally, as I have written in my previous article – Will WFH change real estate trends? – I believe that the land that commercial properties occupy still hold significant value. As we have seen from the redevelopment of Funan Mall, integrated developments seem to be the way forward, and office properties may potentially be converted to integrated developments (subject to zoning restrictions) if remote working does indeed threaten the existence of office buildings.

To conclude, with CICT’s gearing level at approximately 39%, I am slightly concerned as it is a relatively high level compared to its historical average. Recently, we have seen FCT using part of its $575m raised from its private placement to pay of a $325m revolving credit facility and an $80m bank loan. Personally, I would prefer that the REIT manager acts to reduce CICT’s gearing ratio, perhaps via a private placement to reduce its debt position slightly, even though the MAS gearing limit for REITs was recently increased from 45% to 50%.

If you've read to this point, and are still keen to learn more about REITs, I have written two other posts about Singapore REITs here:

1. How do we analyse REITs?

2. Do leasehold land tenures matter for valuations? 

Note: As of writing, hold a long position in CICT at an average price of $1.91. 

Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

If you enjoy my articles, please 'Like' my Facebook Page at: 

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Thoughts on SATS' 1Q results (SGX:S58)

SATS released their 1Q FY2021 business updates on 24 August, which was for the period of 1 April 2020 to 30 June 2020. Headline numbers were a 55% fall in revenue to $209.4m, and a net loss of $43.7m. Aviation revenue decreased 72.9% to 110.6m while non aviation revenue rose by 73.3% to 96.9m.

Despite the challenging operating environment, I believe that the long term outlook for the aviation industry is still positive. In short, as the middle class gets wealthier, demand for air travel should increase as well. I believe that this is a long term secular trend that has only been temporarily disrupted by Covid. While Covid has probably resulted in many executives re-thinking the necessity for business travel, I believe that leisure travel would still recover strongly due to all the pent up demand. Even if business travel were to never recover to pre-Covid levels, I believe that growth in leisure travel would more than offset the fall in business travel. Furthermore, falling business travel volumes would hurt airlines more, as compared to a ground handler like SATS, because airlines earn a significant proportion of their revenue from business class passengers, whereas I believe that the differential in revenue to SATS from a business class traveler and an economy class passenger is much lower. 

Current projections are that the aviation volume would only return to pre-Covid levels by 2024. Hence, I think the key question that we should be asking ourselves as investors or potential investors would be - at the current level of losses, can the company's cash burn rate be sustainable until 2024?

The answer to this question is by no means straightforward. In addition to economic factors, there are regulatory and policy decisions, as well as the likelihood of an effective vaccine, that would affect our projections. But looking at SATS' cost structure and cash burn rate would be a good start.

Cost structure 

Staff costs make up the largest proportion of operating costs for SATS, at 39% for this quarter. This compares with 57% in ordinary times. One reason for the reduced staff costs was the $61.7m of government reliefs received from the Jobs Support Scheme (JSS). The JSS was extended in August to cover wages up to March 2021, but the co-funding was reduced to 50% of wages (capped at gross wage of $4,600) instead of 75% previously for the aviation industry. 

Depreciation costs are mostly non-cash in nature, however, with the change in accounting standards due to IFRS 16, right-of-use assets are depreciated as well, hence a portion of the depreciation costs actually represent an outflow of cash for the current year.  

Operating cash flow was -$61.1m for the quarter. Comparing this to PATMI of -43.7m, and accounting for depreciation of $33.5m (largely non-cash expense apart from IFRS 16 changes), I believe that the difference may be due to the timing of receiving the JSS grants of $61.7m. For example, the JSS payout computed based on wages in June to August 2020 would only be paid out in October 2020. Capex came in at $10.4m, comparable to Q1 FY20 which was also $10.4m. Hence, we are looking at a free cash flow of around -30m to -40m for this quarter if the cash received from the JSS payouts were adjusted for.

Cash position

SATS currently has a cash position of $723.5m, an increase which is mainly due to the increased borrowings. Debt to equity ratio of 42% (55% if IFRS 16 was considered) as compared to 26% the previous quarter seems moderately high to me, but the total debt of $876.1m as compared to the cash position of $723.5m puts things into perspective. 

Assuming SATS continues a cash burn of around 30m to 40m per quarter (this assumption largely hinges on JSS payouts), then it seems possible that the company would be able to ride out the storm, given that hopefully, the worst quarter is behind us, and aviation volume gradually increases.

Closing thoughts

The aviation industry's troubles are unlikely to go away soon. Airlines are still in trouble. SIA reported that within 2 months, it has burnt through half of the $8.8 billion raised through their rights issue in June. 

Budget carriers may be at greater risk as compared to national flag carriers, due to the lack of state support - governments have vested interest to bail out their national flag carriers as opposed to budget carriers. Would this bode well for SATS when demand returns? Possibly, given that budget carriers, without the inflight meals, SATS earns less per passenger.

For me, I would prefer to bet on SATS for a recovery in aviation, rather than on airlines, mainly due to the differences in cost structure and cash burn rate.

Note: As of writing, hold a long position in SATS at an average price of $3.41. 

Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

If you enjoy my articles, please 'Like' my Facebook Page at: 

Follow me on Instagram at @AlpacaInvestments