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| Figure 1, Source: Yahoo Finance |
Frasers Property Limited’s (FPL) one-year performance of -11.5%
means that it has diverged significantly from its underlying REIT holdings -
Frasers Centerpoint Trust, Frasers Commerical Trust, Frasers Logistic Trust and
Frasers Hospitality Trust. The strongest performer is FCT, with a one year
return of 23.04% (so much for the death of retail), while FLT and FCOT, which
are set to merge, returned c.10%. The only underperformer is FHT with a c.-10%
return, and evidently the current virus situation isn’t helping. Refer to
Figure 1 above for the performance comparison.
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| Figure 2, Source: Yahoo Finance |
Furthermore, Frasers Property has underperformed its
developer peers listed on the SGX during the past 12 months, including
CapitaLand (+3%), CDL (+10%), and UOL (+10%), as seen from the chart above
(Figure 2). While the local residential property market has been rather muted
due to the oversupply, FPL’s peers still delivered a strong return in 2019,
while FPL’s share price had lagged. As for the REIT sector, S-REITs have
delivered an overwhelming return in 2019, and Fraser’s stable of REITs have
performed well too. Investors continue to pile into REITs due to the attractive
yields amid low interest rates. This article will discuss whether the
divergence in performance between FPL’s REITs and FPL is warranted, and how
recurring income streams and building a sizable assets under management (AUM)
base would be a key drivers as FPL plays catch up with its larger peers such as
CapitaLand and Mapletree in terms of scale and quality.
Business Overview
Frasers Property is an integrated property developer with
operations across Singapore, Australia, China, UK, Thailand and others. It
spans across the residential, commercial, hospitality, industrial and retail
sectors. As of Q1 2020, FPL owns or manages a total of S$38.8 billion of real
estate assets. FPL also has interests in 6 REITs, 4 of which are listed on the
SGX.
Recurring Income Streams
FPL’s management has put increasing emphasis on building
recurring income streams. In its latest annual report, FPL’s management has
highlighted that recurring income makes up approximately 75% of its profit
before interest and tax (PBIT) (see figure 3 below). The proportion of recurring income as a
percentage of PBIT has been increasing steadily over the years, and this can be
attribute to the management’s efforts to build and grow its recurring income
base.
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| Figure 3, Source: FPL Q1 2020 Report |
To me, this is a positive development as recurring income is
more predictable that development income, which is lumpy. Furthermore,
developing new projects exposes the company to more unpredictable risks – for
example, the earnings of developers are highly affected by government policies
– case in point when the expected Singapore residential property cooling
measures resulted in a rally in 2017, while a change in rule on the ABSD triggered
a selloff in 2018. Whereas deriving rental income from investment properties is
a lot more straightforward, with rental escalation clauses usually embedded in
the rental agreements.
Dividends from 4 Frasers REITs listed on SGX
Looking deeper into FPL’s recurring income streams, a key
component comes from the equity stake that FPL retains in the Frasers branded
REITs as the Sponsor. FPL holds sizable stakes in each of the 4 REITs, which
provides FPL with a steady stream of dividends throughout the year. I did a
rough calculation of the dividends FPL receives from its REITs each year, based
on the proportionate stake that FPL has in each REIT. FPL has a 36.5% stake in
Frasers Centerpoint Trust, 25.9% stake in Frasers Commercial Trust, 19.2% in
Frasers Logistics Trust, and 25.2% in Frasers Hospitality Trust. These four
REITs combined provides FPL with an annual dividend of c.123m, which translates
into 4.22 cents per FPL share annually. Furthermore, these four REITs are
diversified across sectors and geographies, which mitigates against any sector or
geographical specific risk.
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| Figure 4 |
In addition, as the sponsor and manager of these REITs, FPL
also earns management fees from these REITs. Management fees are usually paid
in the form of cash and shares of the REIT, which further increases FPL’s stake
in these REITs. While the company does not provide the exact earnings from
management fees, based on its Q1 presentation, FPL get around 30m in PBIT from
management fees on an annualised basis.
Recurring Income from Investment Properties and PGIM Retail
Fund
Additionally, there are also the recurring income streams
from the investment properties FPL owns. FPL owns investment properties in
Singapore, UK, Australia and Thailand. These include Frasers Tower (50% stake)
and Waterway Point. FPL also has a majority stake in PGIM’s Retail Fund, which
owns multiple suburban malls such as Tampines 1 and Century Square.
Taking into account the dividends from the 4 REITs, fee
income, rental income from its investment properties, and distributions from
the PGIM fund, I think these recurring income sources would probably be able to
cover the 6.0c dividend annually. Do note that I have not done the exact
calculations here, because FPL only provides PBIT for certain figures. Sure,
FPL has cut their dividend payout from 8.6c for the past 4 years to 6.0c
currently. But more importantly, we want to know whether the payout is
sustainable.
Benefiting from the merger of FLT and FCOT
Personally, I think this is a bad move for both sets of
shareholders. With the merger, the new REIT may offer diversification, but it would
not have a specific focus on commercial or logistics assets. I think FCOT
shareholders are getting a slightly better deal, as the quality of the FCOT’s
assets don’t seem as fantastic as compared to that of other commercial REITs
like MCT or CCT for instance.
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| Figure 5, Source: FPL Investor Presentation |
However, as the sponsor and manager, FPL stands to gain the
most from the merger in two ways: 1. Higher fee income - being the parent and
REIT manager, FPL still continues to earn fee income (which is usually based on
a % of assets and earnings) while enjoying the synergies of merging, resulting
in cost savings. 2. Capital recycling from selling assets to the enlarged REIT
– the merged REIT would become one of the bigger REITs in the SGX – potentially
lowering borrowing costs. This also means a higher debt headroom for more
acquisitions, and more opportunities for FPL to inject assets into the REIT (see Figure 5 above for capital recycling numbers).
This capital recycling would potentially narrow the discount of FPL’s shares to
NAV – and earning higher fee income in the future from a larger pool of managed
assets.
Downsides
High debt to equity ratio: FPL is said to have one of the
highest gearing ratios among the developers, but I believe that this may be a
result of consolidating the balance sheets of its underlying REITs. Hence, a
high debt to equity ratio may not be that much of a red flag for FPL.
Low liquidity and not being included in the STI: These are
downsides to me, not because of the thin liquidity that affects my position
itself (my portfolio isn’t that big). Rather, this is a chicken and egg
situation to me because 1. With low liquidity, FPL would not be added to major
indices, and 2. Without being on the STI/indices, large fund managers may not
be able to hold it due to mandate restrictions, and hence resulting in a
vicious cycle of being illiquid. This is also a consequence of the low free
float of c.12% for FPL.
On this point, I think CapitaLand has outperformed over the
past year partly due to its higher liquidity which attracts investors. I
personally prefer CapitaLand as well, due to the large number of Capita- and
Ascendas- branded REITs that they manage, as well as the Temasek backing, but
at this point I think FPL is more attractive based from a valuation point of
view. CapitaLand has been robust recently, notwithstanding their >50%
exposure to China and the virus situation.
Conclusion
I accept that there would be a holdco discount for FPL due
to conglomerate inefficiencies, as well as a discount for the lower liquidity
in FPL shares. But at the current price of $1.53, FPL trades at a 3.8% yield,
which is probably well supported by recurring income. Furthermore, the
relatively low payout ratio of 50% of attributable profit before fair value
gains means that the management is being conservative with the dividends, which
may not be a bad move in this current situation. I believe that the payout may
potentially be revised upwards again when results from its property development
arm improves. For a comparison, quite a number of S-REITS are trading at yields
of just above 4%. Investors have been pushing REIT yields lower and lower that
FPL’s yield (at just a 50% payout) may be comparable soon.
FPL has lagged its peers such as CapitaLand, CDL, UOL over
the past year, as well as its own underlying REITs. Is it time for FPL to play
catch up? I certainly hope so.
Do let me know in the comments if you have identified
anything notable about FPL that I may have missed out!
Note: As of writing, I hold a position in FPL at $1.66.
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Note: As of writing, I hold a position in FPL at $1.66.
Please read the disclaimer available on the desktop version of my blog.