SINGAPORE (Aug 26): During a results briefing -earlier this year, Pua Seck Guan, CEO of Perennial Real Estate Holdings (PREH), sidestepped questions on capital expenditure, debt, debt-to-equity levels, cash flow, earnings before interest and taxes (Ebit), earnings before interest, taxes, depreciation and amortisation (Ebitda), hedging policy, and sponsors and consortiums. He preferred, instead, to discuss China’s great potential for healthcare and eldercare operators.
PREH holds, through its own balance sheet, consortiums and joint ventures, stakes in properties in Singapore and China, and healthcare facilities in China. The Singapore properties are AXA Tower, -CHIJMES, 111 Somerset and Capitol Singapore. In China, PREH owns stakes in hospitals in Guangzhou and Chengdu, a medical centre in Chengdu, and an eldercare business through its 49.9% stake in Renshoutang, a private, integrated eldercare company. PREH paid the equivalent of $148 million in 2016 for its stake.
Overall, China real estate accounts for 60.7% of PREH’s total assets, and Singapore real estate 30.2% by effective stake, that is, based on PREH’s stake in each -asset.
For 2QFY2019, PREH’s revenue rose 52.4% y-o-y to $27.62 million. The main contributors were CHIJMES and Capitol in Singapore as well as Perennial Jihua Mall, Perennial Qingyang Mall and Perennial International Health and Medical Hub -(PIHMH) in China. The Singapore properties contributed $9.9 million, or 36% of total revenue, while the Chinese properties contributed $13 million, or 46.9% of revenue. The remaining 17.1% of revenue was from the group’s fee-based management business. Whenever PREH forms consortiums and joint ventures, it receives fees, just like any other general partner (GP) in private equity.
In 2QFY2019, despite the surge in revenue, net profit fell 83.6% y-o-y to $3.88 million as a result of higher administrative expenses, a jump in finance costs and the absence of revaluation gains. Its operating cash flow and, in particular, free cash flow have not been visible in the past four years.
Optimistic, opportunistic business model
In its annual report, PREH describes -itself as an integrated real estate and healthcare company. “We have access to diversified sources of funding (such as bonds and loans) in the markets in which we operate. Our sponsors have established relationships with local banks and knowledge of local regulations, which facilitate Perennial’s access to financing. Our sponsors also own an aggregate effective interest of 82.3%,” PREH says. The main sponsors are the company’s major shareholders: Kuok Khoon Hong (nephew of Robert Kuok), who owns 36.5% of the company; and Wilmar International, one of the largest plantation companies in the world, which owns 20% of PREH.
For properties in Singapore, the company’s modus operandi is to acquire assets that can be repositioned and redeveloped. To augment cash flow, the company adopts a strata-sale and long-term hold strategy to better manage fund flows. In the event that the company needs capital, it looks for partners to co-invest.
For instance, in 2017, PREH formed a consortium with Yanlord Land Group and Heng Yue Holdings to acquire a 33.7% stake in United Engineers. Yanlord holds a 49% stake in the consortium, while PREH holds 45%. The remaining 6% is held by Heng Yue Holdings.
Similarly, before it was listed through a reverse takeover of St James Holdings in October 2014, PREH had formed a consortium to redevelop Capitol Singapore. The project was delayed and PREH eventually took full control of Capitol Singapore last year.
During an analysts and media briefing earlier this month, Pua said he was looking to reposition Capitol Singapore and more income was expected to come in next year. At present, tenant mix is being tweaked and the full repositioning of the retail portion is expected to be completed in 3QFY2019. Once the income has stabilised, Pua is open to considering a co-investor in the development.
Elsewhere, 111 Somerset’s office units are being strata-sold at margins of 20% to 30% above PREH’s breakeven costs.
AXA Tower’s permitted gross floor area (GFA) could increase 46.5% from 1.05 million sq ft to 1.55 million sq ft, based on URA’s Draft Master Plan 2019. In 2015, PREH and a consortium acquired AXA Tower for $1.175 billion. Based on the cost of the asset enhancement initiative the consortium put in, Pua indicates that the breakeven for the company and its partners is $1,800 psf. He is still assessing plans for AXA Tower. If AXA Tower were to be developed into a mixed-use development with hotel and residential components, the cost could be as high as $2.5 billion, Pua indicates. In the meantime, the total committed occupancy rate for AXA Tower has risen from 92.3% as at March 31 to 96% as at June 30.
Pua is looking to ramp up business at PIHMH and for it to contribute more to the company’s income. PIHMH’s anchor tenant, Gleneagles Chengdu Hospital, is progressively completing its fitting-out works and is expected to commence operations in October. Other integrated projects under development are in Xi’an, near the city’s High Speed Rail, and near the Tianjin South HSR and Kunming South HSR as well as in Beijing Tongzhou.
Where does the cash (flow) come from?
The divestment of Chinatown Point, which resulted in a $17.2 million gain, helped to partly offset the Ebit drop of $34.9 million in 2QFY2019, from $41.9 million in 2QFY2018. This divestment is part of Perennial’s “capital recycling” strategy to improve the company’s balance sheet, and more divestments can be expected. The Chinatown Point divestment was done at a 9% premium to the book value of the property as at Dec 30, 2018.
Whatever the case, it appears that analysts are concerned about PREH’s growing debt pile and lower liquidity. Its trailing 12-month interest cover is 2.6 times, one of the lowest among the local real estate companies. Pua says the company intends to keep its net debt-to-equity ratio at a maximum of 1.
Chart 1 shows the historical breakdown of PREH’s net debt to equity, debt-weighted average term to expiry (in years) and weighted average interest rate for the debt the company has. Net debt to equity has risen from 0.41 times in 2QFY2015 to 0.76 times in 2QFY2019. This is not excessively high, but the trend is upwards. During the same period, the debt-weighted average term to expiry has fallen from 2.21 years to 1.83, indicating that PREH’s debt would need to be paid or refinanced within a shorter period of time. This trend, coupled with an increasing weighted average interest rate on PREH’s debt repayment, indicates higher credit risk and lower liquidity.
During the results briefing, Pua said the company’s preference was to recycle its Ebit from the Chinese properties back into developing new properties, in particular into the healthcare sector.
Some recent openings, such as Changzhou’s Jintan eldercare and retirement home, which opened at end-May, and Shanghai’s Renshoutang Wenjin nursing home in Hongqiao, which has commenced operations progressively since end-July, are likely to contribute to income.
Despite the optimism surrounding the opening of the new healthcare and eldercare facilities, China healthcare makes up only 3.7% PREH’s total assets. The committed pipeline of eldercare and senior housing should make up a larger portion in the future, while potentially contributing positive cash flow to the group as a whole.
Most developers do not hedge their investment properties in China because they adopt a natural hedge by using the local currency, or renminbi. PREH also does not hedge its investments in China, but funds the Chinese assets with Singapore dollar debt. Of the $2.9 billion of debt, including bonds and retail bonds as at Dec 13, 2018, less than 4% is in renminbi.
Pua says the company’s investments in China are for the long term, citing increasing domestic consumption and spending power and high margins and returns on investment for his outlook. He is optimistic that China will become a superpower over the long term.
Valuation conundrum
At its current price of 58 cents, PREH is trading at almost a third of its net asset value of $1.606 (as at June 30). NAV has fallen from $1.644 as at Dec 31. This is due to a combination of lower retained earnings and higher negative foreign currency translation reserves. Other reserves — which comprise fair value reserve, equity compensation reserve, reserve for own shares and statutory reserve — also fell.
Since its reverse takeover in 2014, shares in PREH have fallen 42.3%. PREH’s financial performance largely mirrors the capital loss, as financial metrics have been weak (see Chart 2). Of the past 18 financial quarters, PREH was able to register only three quarters in which net income and operating cash flow were positive.
PREH is likely to continue reporting negative free cash flow on an annual basis if it continues to plough back Ebit and cash into its business for expansion and growth. PREH’s real estate business in China is still largely at the development stage. Only when this segment commences operations and reports earnings will the company’s prospects crystallise. Negative cash flows and increasing debt and weighted average interest rates continue to weigh on the company’s share price. On the other hand, if PREH can report a net profit and stable cash flows consistently, it could be a turnaround story. Until then, PREH’s share price may continue trading at a significant discount to NAV (see Chart 3).
