by: Tam Ging Wien
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First REIT – a Singapore listed Real Estate Investment Trust that is mandated to invest in healthcare assets such as hospitals and nursing homes around the region; experienced one of the most dramatic plunges in REIT share price ever witnessed in recent years. This sort of share price movements are unusual among Singapore listed REITs and certainly generated a flurry of questions, comments, uncertainties and doubts in the market.
From a high of $1.42 this in January this year, it plunged to an intraday low of $0.925 on 20-Nov-2018. It’s share price has quickly recovered to close this week at $1.04.
The media has been abuzz with news of First REIT’s sponsor Lippo Karawaci experiencing a downgrade of its credit ratings from various rating agencies. Certainly, the rating agencies see clear and present risk with regards to First REIT’s parent and this will no doubt affect the sentiments of the child.
With more information now coming to light, what are the key risk that investors should take note of? Is investing in First REIT now worth the risk or should investors stay clear as risk surrounding First REIT abounds? What caused the recent shareprice decline? It is now worth a second look?
We try to answer all these questions in this 2 part series article:
[2018-Nov-27 - Clarification: Majority of the rental agreement is between First REIT and Lippo Karawaci, not between First REIT and Siloam Hospitals as this section may suggest. First REIT receives rental income from both Siloam Hospitals and also directly from Lippo Karawaci; with the later accounting for a significant proportion of the rental income.]
With the news of Lippo Karawaci’s credit downgrade by all 3 rating agencies, the first fear that investors have is First REIT’s exposure to Siloam Hospitals & Lippo Karawaci. Lippo Karawaci is the mutual parent of both Siloam Hospitals and First REIT and hospitals run by the former accounts for approximately 96.7% of First REIT’s asset value.
To assess the likelihood of this default, we need to take a closer look at both Siloam Hospitals and Lippo Karawaci’s cash flow.
From an Operational Cash Flow and Free Cash Flow perspective, it would seem to us that Siloam Hospitals is quite comfortable with meeting all its operational obligations. As along as they are able to continue to maintain positive operational cash flow, they should be able to continue to service the rental payments to First REIT.
Interestingly, we seem to notice that Siloam Hospitals seem to be spending a large amount of its cash on acquisitions. As a result of this line item, it depletes a large amount of its cash reserve.
From a Balance Sheet perspective, Siloam Hospitals has a fairly low debt-to-asset ratio of about 5%. Its current ratio is 1.76 and its quick ratio is 1.58. While not highly geared, Siloam Hospitals is still cutting it a little thin on its liquidity ratios, though that does not mean that it is in any immediate danger of defaulting on its rental obligations to First REIT.
Now moving on to Lippo Karawaci, we notice that while they are still profitable, their Cash Flow is negative! So certainly all the concerns surrounding Lippo Karawaci's credit rating would spook investors!
A company cannot continue to remain solvent without cash flow as cash flow is a the lifeblood of a business! So certainly the risk surrounding Lippo Karawaci's ability to service its rental obligations to First REIT would play a significant part in appreciating impact to investors going forward.
Should a default occur, the contagion risk of a default could also flow over to other Lippo and OUE Group related entities as well as its suppliers and customers. A default on First REIT’s rental obligation would be a absolute PR and credit rating disaster for Lippo Karawaci and we think that Lippo Karawaci is unlikely to allow that to happen.
Considering Lippo Karawaci's recent effort spent on fund raising, we think that the parent is taking significant steps to ensure that this does not occur. Unlike Noble Group, Lippo Karawaci has a large amount of physical real estate assets that it could dispose off to raise cash.
Our Verdict: Certainly a risk, but not High as Lippo Karawaci has been taking pro-active steps to shore up its cash balance. Investors need to keep a keen eye on Lippo Karawaci's cash flow after these fund raising efforts are able to continue to support the group.
We have earlier written a detailed account and views on the entire sale of First REIT and Bowsprit Capital from Lippo Karawaci to OUE Ltd. As a result of this sale, First REIT would now have 2 parents who both own Healthcare assets which First REIT would have the rights of first refusal.
Couple with the previous dilutive rights issue of OUE Commercial Trust upon acquiring OUE Downtown, this has brought about another concern of investors that OUE being the second parent of First REIT could potentially pressure First REIT into acquiring poor quality assets at high prices.
As at this moment there is no past track record to assess this risk, it remains a point for investors to note and observe going forward. The structure of the first asset injection from OUE would be critical to observe as that would give us a hint on the new relationship between OUE and First REIT.
Should First REIT experience an unfavourable asset injection, investors should express their strong objection by voting down the acquisition.
Our Verdict: Medium Risk
Could First REIT be considering an equity fund raising such as rights issues or private placements? This is a likely risk going forward as First REIT has not made a single acquisition in 2018. Could it be due to cash constraints? Or perhaps not able to secure a suitable price for the assets from the sponsor?
A clue would be the cash balance of $10.5mil on its balance sheet based on its latest financial results. Its past acquisitions has been in the range of between $30mil to $40mil. For First REIT to maintain its gearing of 35%, it would need anywhere from $20mil to $26mil of cash for each acquisition. Money it does not have.
Notice also that First REIT’s trade receivables have increased significantly from 31-Dec-2017 since indicates some amount of strain of its tenants servicing rental obligations to First REIT.
It could potentially choose to push up its gearing to the 36% to 38% range to make an acquisition. But choosing so would mean adding a larger debt burden on top of the existing perpetual securities that is already has.
We think that this could be on the cards in the foreseeable future. Investors in First REIT should consider stashing aside some funds and should not be caught off guard if a rights issue is called. We see that it’s a matter of time before some form of equity fund raising would be needed to re-arm First REIT’s balance sheet. Hopefully this would be done when the share price must higher than it is now.
Our Verdict: High Possibility, but not Immediately
First REIT has a triple net lease structure in place and received its rental in SGD from Siloam Hospital. This was a structure that was put in place right from the IPO stage and has stayed on ever since. Going forward, the first lease expiry will be coming up in Aug-2021 followed by Dec-2021.
This lease structure as been one of the most attractive features of First REIT. By receiving the rental in SGD, the forex risk is being transferred from First REIT shareholders to Siloam Hospitals.
However, come 2021 investors need to watch the renewal negotiations very closely. Perhaps learning from the current experience, Lippo Karawaci may choose to renegotiate the rental structure transferring the forex risk back to First REIT shareholders. These leases are significant and account for about 22.0% of the leases by gross floor area (GFA). Any such changes will likely set the precedence for future tenancy restructuring.
At this point of time, it would be almost impossible to predict the outcome of the future rental renewal and restructuring. But it remains a risk that investors need to take note of regardless.
Our Verdict: Observed this risk with unpredictable probability
In a statement dated 05-Nov-2018, Lippo Karawaci publicly stated its intention to “divest our remaining stake in First REIT” <https://www.lippokarawaci.co.id/press-release/read/lpkr-asset-divestment-strengthens-balance-sheet-and-solidifies-position-as-indonesias-leading-property-development-platform-regrets-fitch-decision-to-downgrade> indicating that there will be another sale of units. But to whom and at how much? This statement further throws uncertainty for investors in First REIT.
While it is impossible to know for sure, from the structure of the previous transaction, it would be reasonable to speculate that the further sale is likely to be to an interested party – either to other entities within the greater Lippo Group or entities affiliated to the OUE Group. An interested party sale would bring some level of certainty or clarity to shareholders with regards to the new parent’s long term strategy for the REIT.
Our Verdict: Medium Risk
With regards to risk going forward, we see a number of risk going forward for investors in First REIT. We have documented 5 of those risk with our personal view on the likelihood of occurrence.
Should investors continue to stay invested in First REIT amidst this entire Lippo Karawaci saga? The answer is possibly a rather individual one as each and every investor would have a different risk profile and appetite.
For a more wholistic perspective of First REIT, do also review our related articles below:
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