Analysts have downgraded Manulife US REIT (MUST) after the REIT’s portfolio valuation fell by 14.6% to US$1.63 billion ($2.16 billion) as at June 30, down from the valuation of US$1.91 billion as at Dec 31, 2022.
The decline was much greater than expected, says William (Tripp) Gantt, CEO of MUST in a call to media and analysts on July 18.
The valuation drop caused the REIT’s aggregate leverage to spike to 57% as at June 30, with the erosion of capital values “more severe than anticipated”, says UOB Kay Hian analyst Jonathan Koh.
“The discount rate used in [MUST’s] valuation increased by 50 to 125 basis points (bps), while terminal cap rate increased by 25 - 100 bps. Overall, cap rate for its portfolio expanded 75 bps from 6.25% to 7.00%,” Koh writes.
In its statement, the REIT noted that about 60% of the decline came from five properties, namely Figueroa (-US$37 million or -17.5%), Michelson (-US$36 million or - 12.3%), Exchange (-US$32 million or -11%), Penn (-US$32 million or -20.5%) and Phipps (-US$31.9 million or -15.2%).
At the same call, the REIT manager cautioned that US office valuations remain under pressure and could continue to decline in 2023.
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As such, Koh has downgraded MUST to “sell” while slashing his target price to 16.5 US cents from 47 US cents previously.
He has also estimated that the fair value of MUST’s investment properties may drop by 21% to US$1.37 billion as at end-2023, a steeper decline from his previous estimate of 15%. This is assuming that the cap rate for MUST’s portfolio expands by 100 bps (from his previous estimate of 50 bps) to 6.8% (from 6.3% before).
“Thus, we expect aggregate leverage to increase and hit 55.2% at end-2023 (previously 51.5%),” Koh writes.
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In addition, Koh has cut his distribution per unit (DPU) forecast for FY2024 by 17% due to a 1,400:1,000 rights issue (from 969:1,000 rights issue) with an issue price of 10 US cents (from 12 US cents) to raise US$260 million (US$215 million) and reduce aggregate leverage to 39.3% as at end-FY2024.
“MUST is likely to need an infusion of equity capital. We hypothetically assumed an equity fund-raising exercise to make our valuation for MUST more comparable to that of other US office REITs. There is execution risk associated with launching a rights issue. Nevertheless, a rights issue has the virtue of not diluting minority unitholders’ interest,” says the analyst.
His new target price is based on a fully diluted FY2024 P/NAV of 0.5x adjusted for rights entitlements.
'Too little too late' for MUST: DBS
DBS Group Research analysts Rachel Tan and Derek Tan have taken an equally negative outlook on MUST as they downgraded their call to "fully valued" from "buy". Like UOB Kay Hian's Koh, the analysts have slashed their target price down to 10 US cents from 24 US cents previously.
"We have, in our past reports, envisioned a roadmap which highlights a more urgent response from the sponsor (through asset sales and/or equity injection) towards MUST, to prevent an incidence of any further breach of the financial covenants, but found the timing to be lacking," the analysts write.
"With a spiralling debt crisis and a near-term 'dividend stopper', we believe that equity shareholders will not be compensated if they wait out a recovery. As such, we see weakness in the stock price in the interim," they add.
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In addition, the analysts have raised their discount rate assumptions to a weighted average cost of capital (WACC) of 8.6% (versus 6.8% previously) with a revised TP of 10 US cents.
"Based on a revised book of 42 US cents per share, our target price implies a P/B of 0.2x," say the analysts.
The analysts have also forecasted a DPU decline of a compound annual growth rate (CAGR) of 15% from FY2022 to FY2024 due to the higher refinancing costs.
"Our estimates have yet to factor in the potential impact of a capital injection, which, we believe, is needed, given its strained financials (gearing of 57%, interest coverage ratio or ICR of 2.6x) with a breach of a covenant that the manager is seeking a waiver on. While the stock trades at a 20% yield, the potential delay in paying 1HFY2023 distributions will remain an overhang," they write.
RHB and CGS-CIMB keep 'buy' and 'add' calls as they still see upside
RHB Bank Singapore analyst Vijay Natarajan has kept “buy” on MUST while reducing his target price on MUST to 25 US cents from 40 US cents previously.
The decline of MUST’s portfolio valuation was more than double of what Natarajan anticipated, and this is on top of a 11% decline announced at the end of 2022, the analyst notes.
Following the revaluation, MUST’s NAV is expected to be around 40 US cents.
In its call, MUST’s manager revealed that it is actively discussing with its sponsor and lenders to “remedy the situation”, to which Natarajan believes that it is “high time” for the REIT’s sponsor, Manulife, to show “more active and immediate support”.
“Manulife, with its strong financial position could help offer support in the form of the completion of the proposed acquisition of The Phipps from the REIT, preferably at an average of year end (December 2022) and latest valuation as well as potentially buying back few more assets from the REIT, and working with the lenders in resolving and offering continued financial support to the REIT,” he writes.
He adds that if needed, Manulife should “provide a shareholder loan or act as a lender of the last resort”.
In its statement, MUST’s manager guided that it is considering seeking a disposition mandate from unitholders that would help in providing more flexibility to dispose certain assets as long as the disposition meets certain conditions.
“This, in our view, is reasonable as the current buyers’ market conditions need a speedy execution process,” says Natarajan.
In addition to his lowered target price, the analyst has lowered his DPU estimates for FY2024 and FY2025 by 5% and 3% respectively by adjusting his occupancy assumptions and raising his cost of equity (COE) assumptions by 5 percentage points amid “increased uncertainty”.
His “buy” call comes as he sees “some upside potential, even in an orderly liquidation scenario” as the REIT is still trading at a 60% discount to book even after the revaluation.
MUST’s environmental, social and governance (ESG) score of 3.2 out of 4.0 is two notches above RHB’s country median score. As such, a 4% ESG premium has been applied to MUST’s TP.
CGS-CIMB Research analysts Lock Mun Yee and Natalie Ong have also kept their "add" call with a lowered target price of 41 US cents down from 55 US cents previously. Even after their revised target price, Lock and Ong remain the most upbeat on MUST's prospects.
In their report, the analysts see that MUST's unit price has already priced in much of the challenges that the REIT is currently facing with "value starting to emerge at the current level".
That said, the analysts see that its unit price performance may be hampered by the near-term overhang from the financial covenant breach and potential temporary halt in MUST's DPU payout for the 1HFY2023. The opacity of MUST's longer-term strategic direction could also dampen any prospects of an upside to its unit price for the moment.
Like their peers, Lock and Ong have cut their DPU estimates from FY2023 to FY2025 by 11.4% to 16.2% after factoring in the income vacuum from the early termination of MUST's fifth tenant, The Children's Place, as well as the divestment of the Tanasbourne property.
As at 12.26pm, units in MUST are trading 5.2 US cents lower or 30.77% down at 11.7 US cents.
