How Do We Analyse REITs - A detailed look at factors driving a REIT's value

Real Estate Investment Trusts (REITs) are highly favoured by investors here due to the steady stream of dividends paid out to shareholders. For the good part of the last decade, investors have viewed REITs as quasi-bond instruments, paying out a steady stream of dividends on a quarterly or semi-annual basis. Without much volatility for REITs throughout the last decade, except for the Eurozone debt crisis in 2011, the Fed’s Taper Tantrum in 2013 and the oil price crash in 2015, REITs have rewarded investors fairly well during this period, with a good number of REITs outperforming the Straits Times Index on a total return basis.

‘This time it’s different’ is an extremely dangerous phrase to use in the financial markets; an exceptional run up in prices over 2019 had pushed REIT prices sky high, and as recently as a few months back, some investors were seeing 3-4% yields from REITs as a ‘new normal’, fueled by low interest rates and an insatiable hunt for yield. So much so that some investors have taken this lack of volatility for granted, building up leveraged positions on REITs in order to extract higher income. Bear in mind that REITs are already leveraged vehicles themselves, usually around a 40% debt, 60% equity structure, hence, if one were to further leverage their position on a REIT, that would result in a double leveraged position for the investor. Resulting in one big fat margin call when prices crash. 

Given the keen interest on REITs among retail investors, especially with the sharp selloff over the past three weeks, I decided to write in greater detail about how I look at REITs.

The reason I picked LendLease Global Commercial Reit for this case study was simply because they only have two properties currently (313 Somerset and an office complex in Milan), hence it would be much easier to project the rental revenue with just two properties. Please note that I learnt these valuation methods on my own by reading books or from online sources, mostly before entering university (I’d say 90% of the concepts). Doing these valuation case studies in university probably only trained me to be more cognizant of the formatting, such as colour coding certain figures etc, because these would be relevant if you’re looking to pursue a career in buyside roles or investment banking. Thus, if I overlooked any areas, I’ll apologise in advance and please do point them out to me. 

Please note that the following case study is for informational and learning purposes only, and should not be taken as financial advice regarding LendLease REIT’s shares. All figures and estimations used in the following case study are for illustration purposes only is not a solicitation to transact in LendLease REIT’s shares. When in doubt, please approach a registered financial advisor for advice.

Let’s now take an in-depth look into a REIT’s financial statements:

Revenue Drivers

Firstly, a REIT’s current revenue is determined by these main factors:

1. The rental rates per square feet – usually expressed as per square foot per month (psf/month)

2. The total Net Lettable Area of the property (NLA) – usually expressed in square feet

3. The occupancy rate of the properties – as a percentage of the total NLA

The REIT’s rental revenue for each property can then be calculated by multiplying these three figures, on an annualised basis.

A REIT’s future revenue would mainly be driven by rental reversions, which may be positive or negative. Alternatively, the REIT may undertake acquisitions or asset enhancement initiatives (AEI) to increase their NLA, rental rates and/or occupancy rates. These would form the projections for the REIT’s future rental revenue.

In this example, LendLease’s Milan property has a 12+12 year lease with annual rental escalations tied to the ISTAT CPI growth rate in Italy. Hence, I used a 1% growth rate for projecting the annual rental growth rate. For 313 Somerset, due to the recent COVID-19 situation, I projected that rental rates would fall by 20% in 2020 before recovering in 2021. Do note that a 20% fall is an extremely bearish scenario, as typically a REIT would not renew all its leases in a single year. Hence, assuming a REIT renews 20% of its leases at a 20% decline in rental rates, the overall impact on the rental revenue would only be a 4% decline. However, I used a -20% figure just to get a sense of the impact of an extreme scenario.

Profit and Loss Statement

Once we have projected the REITs rental revenues, the next step would be to estimate the expenses that the properties and the REIT manager incurs.

Net Operating Income (NOI)

In real estate, net operating income is a key metric used to evaluate and value properties. NOI is calculated by deducting all property expenses from rental revenue. NOI margin is expressed as a percentage of total rental revenue. As seen from the financial projections above, the Milan Property has a much higher NOI margin than 313 Somerset. This is mainly because the Milan property is on a triple net lease, which means that the tenant pays for most of the property operating expenses.

Capitalisation Rates

Following on from the NOI discussed above, capitalisation (cap) rates are used to value properties, and cap rates can be compared across similar properties. Think of cap rates as being similar to earnings yield, which is the inverse of the price-to-earnings (P/E) ratio. Basically, when comparing two properties, the property with the lower cap rate means that it has a steeper valuation, assuming that they both have the same NOI. A caveat here would be that we should not simply take the cap rates of similar properties and apply it to the property we’re valuing, as in the case of leasehold properties, this method would not account for the remaining land lease tenure of each property.

For example, a property with a remaining lease tenure of 50 years, generating an NOI of 1mil, valued using a 5% cap rate would give a 20mil valuation. But if we have an adjacent property that also generates an NOI of 1mil but with a remaining lease tenure of 10 years, surely we won’t value that property at a 5% cap as well, and the cap rate used would have to be much higher to account for the extremely short lease tenure left.

In this case study, LendLease’s external valuers valued 313 Somerset at 4.25/4.50% cap rates. For a comparison, CapitaMall Trust’s Plaza Singapura is valued at a 4.50% cap rate. The reason I picked Plaza Sing for comparison is because both malls are in the Orchard Road area, and both malls sit above an MRT station, which gives them a premium. As 313 has a 99 year leasehold tenure commencing in 2006, while Plaza Sing is on a freehold tenure, taking into account the long lease tenure left, the variation isn’t that huge, and the cap rates for both properties might be said to be comparable, the slightly lower cap rate for 313 might be due to 313 being a much newer mall than Plaza Singapura.

Managers fees

This component is usually overlooked when investors discuss about REITs, but should be an important factor to consider as well. This Straits Times article has compared the manager’s fee structures of the various REITs here.

https://www.straitstimes.com/business/check-out-reit-managers-fee-not-just-dividend  

For LendLease REIT, the main recurring management fees are as follows:

1. Management fee of 0.3% of per annum of the value of Lendlease Global REIT’s Deposited Property

2. Performance fee of 5% of NPI

3. Trustee’s Fee of of up to 0.015% per annum of the value of the Deposited Property

The main reason for discussing manager’s fees would be the alignment of interest with shareholders. When the manager owns a stake in the REIT, it aligns their interest with shareholders as they are incentivised to see the REIT perform well. Managers usually take fees in the form of cash and shares, in this case, LendLease’s manager has elected to take 100% of the fees in shares for the first 2 years. However, managers taking fees in shares would also dilute existing shareholders, hence it is imperative that there is also DPU growth to offset the dilution effect. Here there’s a trade off between dilution and the alignment of interest.

Debt, Interest expense and Interest Coverage Ratio

Debt financing forms a huge part of a REIT’s capital structure – and has to be delicately managed. Too little debt, and it means that shareholders are not maximizing their income as more debt can be deployed to acquire more properties, in order to generate higher rental income. Too much debt, and the issue of servicing the debt and meeting regulatory requirements arises. Singapore REITs have a 45% gearing limit, which means that total debt cannot exceed 45% of the REIT’s total assets. There has been discussions about raising this 45% limit by MAS, but nothing is confirmed at this point. The issue of high leverage increases the risk of exceeding the 45% gearing limit if property prices were to crash, which was what happened during the Global Financial Crisis of 08/09. REITs would then have to turn to rights issues to raise capital. I have written an article on this as well. REITs during GFC.

http://alpacainvestments.blogspot.com/2020/03/what-happened-to-reits-during-gfc-brief.html

Interest expense here is calculated simply using the weighted average cost of debt multiplied by the total amount of outstanding debt. This is certainly a rough estimate of the interest expense, but if you’d want to be more specific, you may want to look at the individual financing sources and their specific interest rates. Regardless, REITs would ideally want to keep their funding costs low, as this means more income available for distribution to shareholders. On this point, most REITs would also hedge their interest rate exposure, mainly through swaps to ensure that they would not be affected by rising rates in the near future. Conversely, given the current direction which interest rates are heading, the lower rates means that REITs which have swapped their debt for fixed rates would benefit little from this trend.

The interest coverage ratio (ICR) measures how many times of interest expense can be covered by the REIT’s profits before interest and tax. In times like these, rental revenue is uncertain as some tenants may default, and a higher ICR is better as it gives the REIT a greater buffer in challenging times. LendLease has an extremely high ICR of 10.8x, mainly due to its low borrowing costs.

Outstanding shares

This is linked with the earlier section about management fees paid in units, as paying mangers in the form of units would enlarge the number of shares outstanding. This would dilute the existing shareholders, but ideally, rental growth is able to keep pace with the increase in number of shares to ensure that distributable income per share continues to grow.

Valuation – Dividend Discount Model

In a dividend discount model (DDM), we are basically valuing the future dividends that a REIT distributes and discounting them to their present value. I’d like to say that personally, I’m not exactly a fan of using a DDM, as the valuation is extremely subjective and sensitive to the inputs. For example, using a terminal growth rate of 1% or 2% makes a huge difference to the implied valuation. However, this method is still widely used in the industry, and to be honest, what’s a viable alternative?

https://www.investopedia.com/terms/d/ddm.asp

In this case study, I simply used a discount rate of 7.5% to 8.0%, and a terminal growth rate of 1.5%. One might also choose to use an exit cap rate method to obtain the terminal value, but I feel that method is slightly more difficult to appreciate and hence would not be elaborating on that here.

Additional factors beyond the financial statements

Lastly, there are additional qualitative and macro factors that might affect the valuation of the REIT.

1. Sponsor strength: REITs with reputable sponsors generally enjoy more stability, as the financial strength of their sponsors may give investors some assurance during challenging times. It is also important to look at the REIT’s pipeline of their right of first refusal (ROFR) properties. Basically, a ROFR clause means that if the sponsor wants to sell one of their properties, it would first have to offer the REIT the opportunity to purchase the property on a willing buyer, willing seller basis.

2. Macro factors: Is the REIT’s assets mainly in Australia? Or the UK? Or Europe? This would expose investors to FX volatility. You might want to take a view as to whether these economies would do well in the near future.

I hope this article has been informative, and do share it with someone who you think would find this useful as well!


Note: As of time of writing, I do not hold a position in LendLease Global Commercial REIT

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What Happened to REITs during the Global Financial Crisis (GFC): A Brief Look At History

"Those who fail to learn from history are condemned to repeat it." - Winston Churchill.

This article discuss the risks of investing in REITs – specifically due to extremely dilutive rights issues – by looking at how the Global Financial Crisis (GFC) in 2007 to 2009 unfolded. I believe it is good for us to understand the worst case scenarios that may play out again, be it over the next few months or sometime in the future. I would be taking a macro perspective in discussing the property cycles, and how debt can be a double edged sword – and linking these to the REIT sector. I would also take a look back into history, and summarise the key developments for REITs during the GFC period. Specifically, the rights issues undertaken by REITs during the GFC period are of great interest to me – and I have complied a few examples below as well.

Why have REITs been popular?

REITs are favoured by investors due to their steady dividend payouts, as well as their simple and straightforward business model which many investors can understand – buying properties and renting them out. REITs also provide leverage and liquidity for investors who may not have the capital to invest in physical properties. And indeed, the past decade had been incredibly rewarding for REIT investors, as low interest rates propped up asset prices while allowing REITs to borrow cheaply, and the hunt for yields resulted in more and more capital being poured into REITs.

With the past few weeks being extremely volatile, having witnessed prices of certain REITs swinging by more than 10% in a single day, I would like to better understand the worst case scenario that REITs may face in the event of a huge decline in asset prices and tight liquidity due to panic in the financial system.

How do rights issues work?

First of all, I would like to discuss the effects of a rights issue. A rights issue occurs when the REIT wants to raise equity capital from its shareholders. Typically, the intention of raising equity would be for acquisition purposes or to pay down debt. New units are usually issued at a discount to the last traded price, to entice shareholders to apply for the rights units. The discount to the last traded price can be anywhere between c.10% in good times, to even c.50% in the event that the REIT desperately needs to raise cash. In good times, rights issues are usually yield accretive, and shareholders may view the rights issue favourably, if it supports and acquisition of assets that increase DPU. However, in times of desperation, a rights issue results in a double whammy of shareholders being diluted and having to cough up cash to purchase the rights units.

Let’s illustrate an example of a rights issue for a REIT with 1 billion shares trading at $2 per share today. That gives us a current market capitalisation of $2 billion – a mid sized REIT. Assuming this REIT is in desperate need of cash, and due to a financial crisis, banks are unwilling to extend further credit to the company. Hence, the only option would be to raise equity capital via a rights issue. Given the depressed mood of the market, a huge discount to the last traded price would be required, in order to draw investors to subscribe. Let’s say that the discount in this case is 50% to the last traded price – a very steep discount – but very possible during a GFC situation. Let’s also say that the REIT is doing a 1-for-1 rights issue, which means you’re entitled to 1 rights share for every share you hold. Again, this is extreme, but not uncommon during the GFC, when large REITs like CapitaMall Trust did a 9-for-10 rights issue, while Starhill did a 1-for-1 rights issue.

Accordingly, this would be the calculation for this hypothetical example: The newly issued units are issued at $1 per share, and 1 billion new units are issued. For simplicity of calculations, we assume that the dampened market outlook means that the over allotment option is not exercised. Based on the enlarged number of outstanding shares, the theoretical ex rights price (TERP) would be $1.50 per share. Of course, this is only assuming that the REIT’s price does not decline after the announcement of the rights issue. Generally, the REIT prices decline after a rights issue is announced, especially if the rights issue is dilutive to shareholders. Hence, the TERP may be lower than $1.50. This would represent a paper loss of 25% for the shareholder who held the shares at $2, and would be slightly offset if the shareholder subscribes to the rights issue units at the discounted price of $1. But so long as the TERP is less than $1.50, the existing shareholder would have incurred a capital loss, notwithstanding that he or she would have to cough up a significant amount of cash to subscribe to the rights units.

Rationale for rights issues

Now that we are clear on the effects of a rights issue, let’s look at some actual examples of rights issues by REITs during the GFC. The overarching theme for carrying out a rights issue then was 1. To pay down debt; and 2. To build up cash for opportunities to acquire real estate at distressed prices.

I’ll address the Point 1 first. As we are well aware, REITs are leveraged vehicles which use a combination of equity and debt to acquire properties. Currently, the leverage limit for REITs is a 45% gearing ratio. Most REITs have gearing ratios of around 30 to 40%, which provides them with ample debt headroom should they require extra credit. In a GFC scenario, real estate prices would have declined sharply, due to distressed asset sales, falling rents and reduced occupancies, tenants going bankrupt and so on. This gives rise to the possibility that the real estate assets held by REITs would decline as well. In order to maintain the regulatory gearing limit of 45%, REITs may have to do a rights issue to raise equity capital.

A second scenario for Point 1 would be in the situation when the REIT has to pay off existing debt. In usual circumstances, REITs would simply refinance their existing loans with a new loan, and roll over the entire debt outstanding. However, in a financial crisis, banks may be less aggressive in lending, and may not be willing to extend as much credit to the REIT. In this case, the REIT may opt to sell perpetual securities, which might be costly as the yield would have to be attractive to entice investors during a financial crisis. Additionally, even though perps are classified as equity, there are more like debt instruments as they incur interest expenses as well. Hence, given the circumstances above, the REIT may look to raise equity via a rights issue or a private placement as a last resort.

As for Point 2, some REIT managers have cited the need to increase their warchest in anticipation of distressed opportunities that may arise. This is definitely a more positive outlook than point 1, and shareholders would have to place a lot of faith in the managers to identify good opportunities. If the REIT is indeed able to pick up real estate assets at distressed prices, then in the long run, shareholders still stand to benefit even though there is some short term pain. Again, this would benefit those who are able to come up with the cash to subscribe to the rights, to minimise dilution to their holdings.

Actual Examples during the GFC

Now that we’ve understood the rationale for carrying out rights issue, let’s look back into history and see real examples of highly dilutive rights issues during the Global Financial Crisis.

1. CapitaMall Trust (CMT)

CMT undertook a 9-for-10 rights issue in Feb 2009, raising $1.23 billion at a discount of 43% to the closing price of $1.45 per unit. The rights were priced at $0.82 per unit. The rationale stated was to “Strengthen CMT’s Balance Sheet and Enhance Financial Flexibility”, reducing aggregate leverage from 43.2% to 29.1%. The manager also indicated that it would be able capitalise on opportunities and secure debt on more competitive terms.

The announcement can be found here: 

https://investor.capitaland.com/news.html/id/468407

2. CapitaCommercial Trust (CCT)

CCT undertook a 1-for-1 rights issue in May 2009, raising $828 million at a 44.3% discount to the closing price of $1.06. The rights units were priced at $0.59 per unit. The rationales stated were to have a “Reduction of Borrowings consistent with the Manager’s proactive and prudent capital management strategy” and to “Strengthen CCT’s balance sheet, enhance financial flexibility and improve credit profile”.

The announcement can be found here: 

https://cct.listedcompany.com/news.html/id/330388

3. Mapletree Logistics Trust (MLT)

MLT undertook a 3-for-4 rights issue in June 2008 to raise $606 million, at a 21.4% discount to the closing price of $0.98. The rights units were offered at $0.73. The rationale was to “(i) Strengthen MapletreeLog’s balance sheet and capital structure; (ii) increase financial resources and flexibility for future acquisitions to capitalise on growth opportunities in logistics-related real estate in Asia; and (iii) provide Unitholders with pro-rata entitlement to Rights Units.”

The announcement can be found here: 

https://www.mapletreelogisticstrust.com/~/media/MLT/Newsroom/Announcements/2008/Jun/575914543_ProposedRightsIssue.pdf

Summary

Notwithstanding the possibility of a dilutive rights issue during a financial crisis, I still like the business model of REITs and am still looking to invest in them. Quality REITs have delivered strong returns which have outperformed the STI in recent years, and provide stable income to shareholders as well. As a general point, I target REITs with strong sponsors, and established track record, and owning quality properties.

As with every real estate investment, the three most important things are location, location and location.

I hope this article has been informative with regard to understanding REITs better. Do note that I am still looking to invest in REITs; I simply want to prepare for the worst case scenario.

If you're keen to learn more, I have written a follow up article on the factors driving a REIT's valuation here:
http://alpacainvestments.blogspot.com/2020/03/how-do-we-analyse-reits-detailed-look.html

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February has been a volatile month - Here's my game plan (MCT, SATS, DBS and more)

Please note that these articles are for discussion and informational purposes only and should not be relied upon as financial advice. Please read the full disclaimer available on the desktop version of my blog.

February has been an extremely volatile month with huge swings in the equity markets. Thousand point moves in the Dow Jones Index meant that volatility has shot up, and investors are worried and confused. Our Straits Times Index wasn’t spared either. With all the negative headlines dominating the news every day, you may be wondering – what’s next?

I would like to share with you the transactions I have made in the past month, as well as my game plan to navigate the volatile markets of today. I have made trades in four companies this month – I sold Eagle Hospitality Trust and Far East Orchard; while I bought SATS and Frasers Property. Companies on my watchlist – in the order of priority – include Mapletree Commercial Trust, DBS, ComfortDelgro and Hongkong Land.

Later in the article, I would also share my thoughts on Howard Marks’ latest memo, and how it ties in with my strategy in face of the volatility. Howard Marks is the co-founder and co-chairman of Oaktree Capital Management, which specialises in investing in distressed securities. He is also the author of ‘The Most Important Thing’, which I read early during my investing journey, and have applied the concepts discussed to my investing philosophy. I would highly recommend all investors to read this book.

February Transactions

Took profit on Eagle Hospitality Trust (EHT) at $0.52. Made a small gain from my entry price of $0.48. EHT was supposed to be a turnaround play for me back in November 2019, when it was sold off sharply due to uncertainties over its flagship asset, the Queen Mary. Subsequently, earlier in February, EHT missed its IPO forecasts for Net Operating Income and Distribution. Personally, missing IPO forecasts by a sizable margin would be a red flag for me, even though there were probably some valid reasons given by the management, including the hurricane which affected certain assets as well as the ongoing refurbishment works.

As a result, dividends declared for Q4 2019 of 1.179 cents missed the forecasted figure of 1.56 cents, a 24% variance. The recent resignation of the CFO also added to the uncertainty over the company, and I decided that it wasn’t ideal to hold on to a company with that much ambiguity involved. Additionally, I was also concerned of the coronavirus situation worsening. At the time of selling, the US wasn’t really affected by the virus yet, but subsequently, US hospitality assets have sold off sharply, as seen from ARA US Hospitality Trust’s decline as well. Thus, the recent decimation of the share price should not be entirely attributed to firm specific issues, as there has been a broader selloff in hospitality assets as well. If you’re keen to read about my reasons for buying EHT back in November, you may refer to this post: An in-depth look at Eagle Hospitality Trust's (EHT) Assets . Do note that the valuations would have changed slightly due to the lower NOI from the assets, as well as changes in cap rates.

Cut loss for Far East Orchard (FEO) at $1.14. This represents a 25% loss from my entry price of $1.52 back in late 2017, excluding the two years of dividends collected (6 cents annually). I felt that the share price has been on a constant decline since I bought in, and it this point of time, there are better opportunities to deploy my cash, and thus decided to cut my losses. Additionally, FEO is also exposed to managing and operating a number of hospitality assets in Singapore and abroad, hence I felt that while its share price has not sold off as steeply as other hospitality focused plays yet, I should exit while I can.

This investment gone wrong has also taught me the importance of not solely looking at the Net Asset Value of a real estate company when investing, and instead to consider the earnings visibility of a company as well. Evidently, investing while being overly fixated on the NAV of a company may mean that the earnings power of a company is overlooked, and this may result in declining earnings and dividends. I would candidly say that my level of analysis that I’ve did at that point of time in September 2017 was pretty superficial, when I was relatively still a newbie at analysing companies. Today, I am also focused on ensuring the sustainability of earnings from real estate assets, instead of solely focusing on the NAV of the company.

An additional thought that I had while divesting FEO was that ‘deep value’ companies trading at huge discounts to their NAV may take an extremely long time for their intrinsic value to be realised – or sometimes not at all. The problem with these small caps with low liquidity is that without many investors coming in to bid the price up, the company can stay undervalued for a long time. The low liquidity and small market capitalisation are also barriers for institutional investors to enter, and sometimes a privatisation may be the only hope for the value to be realised. An example would be Hanwell Holdings, which I have written about previously here: HANWELL HOLDINGS: NET CASH 70% OF MARKET CAP. Currently, its net cash position of c.20 cents per share is at the same level as its share price. However, due to high insider ownership and low liquidity, its value may take a long time to be unlocked. I am also thinking of the broader trends towards passive investing, indexing and ETFs, which means that index constituents continue to get more attention and trading volume, while small cap stocks continue to be neglected – even though from a fundamental point of view, these may be good investments.

Bought SATS at $4.49 in early February. This was intended to be a long term investment, and I felt the at that price it provided a good entry price. However, the subsequent worsening of the coronavirus situation and the further suspending of flights to South Korea and Northern Italy meant that SATS’ share price took a further beating. I still believe that my thesis holds – betting on the long term growth of air travel as a proxy for increasing affluence in the region -  a trend that I believe would play out over the next 5 to 10 years. As seen from previous epidemics, the rebound in demand for air travel and tourism is usually strong and quick once the epidemic blows over, hence I would expect passenger figures to rebound to normal levels within a year or two.

I guess the main concern now would be that the coronavirus situation would drag the global economy into a recession, which would mean a further drop in demand for air travel. A UK based airline, Flybe, as just went into administration as a result of the drop in demand for air travel. However, many airlines in the region are national flag carriers, and there major shareholders have vested interests in ensuring that they are able to stay in business. To account for the worsening situation, I have revised my assumptions on my discounted cash flow (DCF) calculations for SATS, with a revised expected fall in passenger numbers of 30% at Changi Airport this year, while also increasing the expected time taken for passenger numbers to rebound to last year’s figures. With my revised assumptions, I would be looking to average down at around $3.80. Do read my post on SATS here if you’re keen to understand more about its revenue drivers: A detailed look at how SATS earns its Revenue and Profits

Bought Frasers Property (FPL) at $1.66. Won’t elaborate much on this as I’ve recently wrote a post on FPL here: The Divergence of Performance between Frasers Property and its REITs. In short, I believe that FPL’s share price has significantly diverged from its underlying REITs – while its REITs have delivered strong performance, FPL as the holding company has languished. Additionally, FPL’s dividends are also well supported by recurring earnings from rental income. The lower interest rates going forward would also positively benefit REITs and developers.

Companies on my Watchlist

Mapletree Commercial Trust – the key thesis here would be that MCT stands to gain most from the proposed developments along the Greater Southern Waterfront. I would do a write up when time permits.

DBS – I am already holding DBS, but any further declines in share price presents an opportunity to me. DBS has the largest funding base and is the strongest in wealth management and digital banking among the three local banks, while having the highest ROE. Yet, it is trading at a c.100bps yield spread compared to the other local banks. That means the market is either pricing in a huge decline in DBS’ asset quality, a dividend cut, or both. Alternatively, one could simply make the conclusion that DBS is undervalued.

ComfortDelGro – In decline due to competition from private hire vehicles, while ridership for the public transport segment would definitely take a hit from the virus epidemic as more employees are having work from home arrangements. I have done a rough sum of the parts (SOTP) valuation for CDG, which seeks to value each business unit in isolation, providing greater clarity on the prospects and valuation of each segment. I would share more about my SOTP valuation in due time when I have consolidated the information available.

Hongkong Land – Landlord of prime commercial properties in HK and Singapore, which is facing headwinds due to the political situation and the epidemic in HK. HKL recently reported underlying earnings which increased marginally, while net profit declined 92% due to revaluation losses. To me, it seemed positive that rental rates in 2H2019 were able to hold up despite the protests which started in June. However, the market seems to take the results negatively, as HKL declined yesterday, post earnings release. One positive for me would be the privatisation of Wheelock & Company on the HKEX recently, which shows that the property magnates still have the appetite for buying. Perhaps the property magnates see an opportunity that the general market has overlooked?

Summary

After my transactions in February, my current cash level is at c.20% of my portfolio. I am looking to raise more cash by selling off some more positions. I also take this opportunity to review my portfolio, with the aim of consolidating my holdings to no more than 10 positions, so that I can dedicate more time to thoroughly research each of my portfolio companies. I am also looking to venture to the US market, with some big names including $MSFT and $MA catching my attention. I am still relatively unfamiliar with the US market, but I have friends who have a much better understanding of some of the companies there, and we would discuss before initiating positions.

At this point, I think that referencing Howard Marks’ memo on the coronavirus and markets today would be very apt. Marks’ view is that it is okay to do some buying now, because to be honest, no one knows what the future holds. Stocks may turn around, and you’ll be glad that you bought. Or stocks may continue down, and in that case, you’ll want to have money and the courage to buy more. “That’s life for people who accept that they don’t know what the future holds.”

You may read his full memo here: 
https://www.oaktreecapital.com/insights/howard-marks-memos

In practice, I can understand how retail investors may find it hard to apply this strategy. As a billionaire, it is relatively easy for Howard Marks to keep his conviction and stay with his strategy of averaging down when prices fall further. However, for retail investors like us, who have painstakingly scrimped and saved over the years to build up a warchest, seeing our positions tank right after we bought in may be very painful. Having sufficient funds is also another issue, as it is not like we have unlimited liquidity and are able to average down forever.

But another way to see this would be that if we have adequate rainy day funds set aside for any emergencies, and we only invest what we can afford to lose, then volatile stock prices should not have an effect on us. The long-term investor should not care about how wildly the price of a security swings throughout his holding period – what matters is that he has made a profit at the end of the period. This concept was shared by Howard Marks in his book “The Most Important Thing”, which I had read during my National Service days. I think the biggest takeaway for me was that volatility is not risk, and this greatest risk that investors should fear is permanent loss (think Hyflux, Noble, Swiber etc).

In fact, I am taking a class on investments this semester, and I think that the academic concept of using volatility to measure risk is completely ridiculous. Howard Marks purports that volatility is used by academics to measure risk as it is quantifiable and easily calculated. However, if you set yourself out to dive in depth into researching companies and select high quality, solid companies with the ability to ride out the storm, then you should not fear when prices decline in the short term – instead, it is an opportunity to buy.

In these volatile times, bear in mind that volatility and risk aren’t the same thing – do thorough due diligence, have a plan, and stick to it. Stay the course, and we will get through this together.

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