CRCT to acquire three malls from CapitaLand, aims to deliver DPU accretion of up to 1.7%

An easy way to remember Aidemengdun is to think of the Canadian city of Edmonton, with which Harbin is twinned, suggests Tan Tze Wooi, CEO of CRCT’s manager. Aidemengdun is the Mandarin transliteration of Edmonton, he adds. Edmonton Road (Ãidéméngdùn Lù) is a major arterial road that connects two ring roads and the Harbin Taiping International Airport.

For unitholders concerned that their real estate investment trust (REIT) is acquiring malls in far-off places that they rarely visit, Tan gives the assurance that the acquisitions are accretive to distributions per unit (DPUs), and not just to net property income yield and distribution yield. “Based on the funding plan we are going to settle on, there will be accretion to unitholders, and at the NPI level, and we are confident of putting in place a financing plan to deliver accretion,” he says.

Funding plan to deliver DPU accretion

Tan says he is comfortable with a gearing of 38% compared with CRCT’s gearing of 35.5% as at March 31. That provides CRCT with a debt headroom of around $339 million and the remaining amount of about $249 million needs to be raised via an equity issue. With units outstanding of 998.52 million as at March 31, CRCT’s equity raising would be within 20% of its market capitalisation (based on its general mandate), which could be achieved through a placement and preferential equity offering, providing an accretion of up to 1.7% to DPU. Based on FY2018’s DPU of 10.22 cents, pro forma DPU, including the acquisition, could rise to as high as 10.4 cents.

After the acquisition, CRCT’s portfolio will comprise 14 shopping malls, up from the current 11. CRCT’s portfolio size will grow 18.6% to $3.8 billion, while NPI will enjoy an uplift of 22.8% to RMB959.3 million on a pro forma basis.

Based on the announcement issued on June 11, CRCT has stated that the ­average NPI yield of the three properties is 6%, which is a 30-basis-point accretion to the current CRCT portfolio NPI yield of 5.7%. The valuation for the three malls is $589.2 million. In addition, unitholders will have to pay fees of $5.9 million to the manager in CRCT units, and $10.5 million in other expenses.

According to CRCT’s press release, the addition of these three assets will increase the contribution of multi-tenanted malls to CRCT’s portfolio gross revenue by 1.8% to 93.5%, while the maximum gross revenue contribution by the top two properties within CRCT’s portfolio will decrease from 44.9% to 36% on a pro forma basis.

The three new malls have enjoyed rental reversions of 5% to 6%. Together, their average occupancy rate is 99%, compared with 97.4% for CRCT’s portfolio. Among the new malls, Xuefu commands the highest valuation of RMB16,732 psm, followed by Yuhuating at RMB12,017 psm and Aidemengdun at RMB10,808 psm.

Xuefu is the “dominant” mall, according to Tan. “It has gone through a few cycles in terms of creativity and cross-fertilisation of ideas,” he says. Aidemengdun and Yuhuating are typical suburban community malls that also cater for necessity shopping. Yuhuating has asset enhancement initiative potential, Tan adds.

Rejuvenating the portfolio

There is a need for CRCT to grow to a larger size, with Tan gunning for $5 billion in assets. “We will grow [around] 20% with this deal size, and for the next cycle of acquisition, we would be looking at close to a further 20% growth, and we hope to achieve $5 billion in assets soon. This is so that we can compete better in cost of capital. We are always working hard to see how we can strengthen the REIT and rejuvenate the portfolio,” he explains.

Analysts also like the implications that come with a larger CRCT. “The enlarged market cap will also improve liquidity and, over time, should enhance the visibility of CRCT as an attractive proxy to Singapore Exchange-listed, China-focused REITs among investors,” DBS Group Research says.

In 1QFY2019, CRCT announced a portfolio reconstitution strategy, which involves acquiring properties with upside potential in terms of rent, occupancy and retail offerings, and divesting properties that are master-leased or older and have limited upside. In January 2018, CRCT completed the acquisition of Rock Square in Guangzhou through a 51:49 joint venture with CapitaLand. The acquisition diversified CRCT’s rental income and footprint into a third Tier-1 city after Beijing and Shanghai. Since the acquisition of Rock Square, CRCT has achieved more than 20% rental reversions over four consecutive quarters.

In January this year, CRCT entered into a cooperative framework agreement with unrelated third parties for a bundle deal to acquire a property in Yuquan district, Hohhot, Inner Mongolia, at an agreed property value of RMB808.3 million ($159.6 million) and to transfer CapitaMall Saihan in Hohhot to a party related to the vendor of the new mall at an agreed property value of RMB460 million. The swap will be completed in 2HFY2020. By exchanging ­CapitaMall Saihan for the new Yuquan mall, CRCT is effectively recycling capital to obtain a more strategically located property that is newly built and enjoys direct connectivity to the upcoming metro line. Hohhot is the provincial capital of Inner Mongolia.

Yuquan has stronger growth potential, as it is double in size and has a longer remainder lease tenure of an additional eight years compared with CapitaMall Saihan. Plans are underway to transform Yuquan into a one-stop shopping destination with new retail concepts catering for Hohhot’s rising middle class.

“We want our malls to be a solid magnet for the catchment populations within a radius of three to five km. And even though lifestyles evolve over time, we want our offerings to grow in tandem with our customers’ tastes,” Tan says. “Urbanisation will continue; that is why you have new catchment areas and people will want to go somewhere to socialise. That is why we have to keep injecting freshness, and our trade mix requires constant tweaking. For instance, we’ve lowered our exposure to department stores and fashion, and we’ve injected F&B outlets, and are focusing on beauty and healthcare services and education. All the malls are in catchment areas near transport nodes served by public services and are near amenities. So, they [get] habitual repeat customers, and this is the kind of stickiness from customers we are building.”

CapitaLand stands to benefit

CRCT’s largest shareholder is CapitaLand, whose 38.04% stake includes CapitaLand Mall Trust’s 12.29% stake in CRCT. The sale of the three malls to CRCT by CapitaLand will generate around $239.9 million in proceeds and a net gain of $37.6 million for CapitaLand. In support of CRCT, CapitaLand has indicated that it intends to take up its pro-rata entitlement should equity fundraising be included as part of the funding for CRCT to acquire the three malls.

“This [acquisition] allows CapitaLand to continue participating in the assets’ longer-term growth potential (which is captured under its enlarged AUM [assets under management]) through its stake in CRCT, while delivering on its double-digit ROE [return on equity] targets over the medium term,” DBS says in an update.

Separately, OCBC Investment Research has downgraded CRCT to a “sell”, as it believes that the acquisition could be dilutive to DPU, based on its calculations. Other analysts have somewhat different calculations in terms of debt headroom, hence, the resultant equity portion for the acquisition and accretion to DPU.

UBS says CRCT is likely to fund the purchase with a 50:50 debt-to-equity mix to keep gearing below the 38% target. “This implies a potential equity issuance of around $300 million, 20% of its market capitalisation. We estimate DPU accretion to be marginal (less than 1%), given a high equity portion,” UBS says.

DBS has the highest estimate for accretion: “A 50%:50% debt/equity funding mix, which we assume to meet target gearing of around 38%, is projected to boost [forecast] FY2020 DPU by 2% to 3%.”

JP Morgan has retained its “overweight” rating on CRCT and also expects accretion to DPU. “Assuming: (1) 55% loan-to-value, (2) FY2019 NPI growth of 5%, (3) 4% equity issuance discount, and (4) 3% cost of debt (in Singapore dollars), we calculate initial DPU accretion of 0.5%.” However, JP Morgan expects continued NPI growth (2016 to 2018 NPI compound annual growth rate of 5.5% to 10.6%) to support better DPU accretion in the medium to long term.

CRCT was listed in 2006 at $1.13 a unit, with an asset size of $688.9 million. Since listing, CRCT unitholders would have recouped their initial investment through DPU. While CRCT has not had a rights issue, it had a preferential equity offering to part-pay for Grand Canyon Mall, which was acquired in 2013. While China is a concern in the short term, it delivered 6.4% GDP growth in 1Q2019 and, increasingly, its growth has shifted from being investment-led to relying on consumption.

In the short term, investors on the sidelines may be interested in taking a punt on CRCT when its units weaken ahead of the pricing of the placement and preferential equity offering. Market observers expect unitholders to subscribe to the preferential offering. Besides JP Morgan’s “overweight” recommendation, UBS and DBS have “buy” calls.

As at June 13, CRCT’s unit price was $1.49 — having fallen nine cents since the announcement of the transaction — translating into a yield of 6.9%, based on its ­annualised 1QFY2019 DPU.

China is still an attractive market

(June 17): The elephant in the room for any transaction involving Chinese assets is the trade war that the Trump administration is waging, and its impact on the renminbi.

Interestingly, in early May, to counter the impact of the trade war on Asean countries, the Japanese press said Asean finance leaders had agreed to add the renminbi and Japanese yen to their multilateral currency swap arrangement “to ramp up their firepower to deal with potential financial crises”.

For May, China’s foreign currency and gold reserves rose US$6.1 billion ($8.3 billion) m-o-m to US$3.101 trillion. The increase came as China raised its gold reserves by 1.88% to US$79.8 billion last month, according to central bank data released on June 10. That represented a rise in gold holdings for the sixth straight month to 61.61 million ounces.

These moves by Asean and the raising of gold reserves could lead to less volatility in the exchange rate for the renminbi and Asean currencies, including the Singapore dollar. At any rate, Singapore’s nominal effective exchange rate (NEER) depends on a basket of currencies of its main trading partners, which also mitigates some of the Trump-infused volatility.

“The movement of the exchange rate for the renminbi and Singapore dollar is based on their trade-weighted policies,” notes Tan Tze Wooi, CEO of CapitaLand Retail China Trust’s manager. “Over the last 10 years, the volatility [in the exchange rate] has been hovering within a tight band.”

In sum, there is less volatility in the exchange rate for the Singapore dollar and renminbi than that for the closely watched greenback and renminbi.

In a recent report, JP Morgan suggested that one of the risks it is watching out for with reference to CRCT is renminbi weakness. “Renminbi weakness is a risk due to the net asset value [NAV] impact of the asset-liability mismatch between Chinese assets and Singapore dollar funding,” JP Morgan says. “The renminbi weakened 3.6% against the Singapore dollar in 2018, with JPM’s economists expecting a reversal in 2019.”

In order to have tax transparency, real estate investment trusts distribute at least 90% of their cash flow, and thus, do not have retained earnings. This makes the NAV of REITs such as CRCT vulnerable to downward revaluations in the event the renminbi weakens against the Singapore dollar.

“We’ve taken on onshore debt and that helps natural hedging,” Tan says. Distributions are protected to an extent by the REIT’s hedging policy. “Overall, we continue to hedge 50% of distributable income. Last year, as we approached the fourth quarter, there were signs that the renminbi could weaken, and we hedged up to 80% of our distributable income; we look at this on a continual basis,” Tan says.

Tan’s strategy is to enter cities with strong fundamentals and economic outlook. The Harbin-Changchun city cluster development plan in China’s 13th Five Year Plan is viewed as one of the main measures to optimise urbanisation. The other clusters are Shanghai in the Yangtze River Delta, and Chongqing and Chengdu in the Chengdu-Chongqing city cluster. CRCT has a presence in all three city clusters.

Following from the US-China trade war, discretionary spending is likely to be more affected rather than necessity spending and children’s education. “Immediately, the sentiment may affect discretionary spending, where you can see a sharper correction,” Tan says. “We are focused on tapping rising disposable income and family-oriented lifestyle spending.”

The other threat to shopping malls is e-commerce. “Fundamentally, we don’t think e-commerce occupies 100% of your time and wallet share,” Tan notes. He reckons e-ecommerce accounts for 20% of spending.

Tan’s focus is to ensure that his malls are community ones where Chinese families choose to spend their time, so that the trade war remains a distant problem.