“Why go to a shopping mall when you can shop online, right?”
Analysts and market commentators in Singapore and around the world have been painting a doom-and-gloom picture for retail Real Estate Investment Trusts (REITs) over the last couple of years ever since e-commerce became popular, citing declining shopper traffic and tenant sales.
However, we think that malls are here to stay. Think about it – when was the last time you stepped into a mall? My guess is probably sometime this week.
The point is, we still like to visit stores like Uniqlo at the mall, and secondary school kids will continue to enjoy hanging out at its movie theatres while patronizing McDonalds afterward!
Of course, those concerns aren’t unwarranted.
Investors would be wise to buy into REITs which are financially stable, backed by a cash-rich sponsor, and whose management is working to constantly innovate its outfits to attract footfall.
Two of the biggest and most well-known retail REITs – CapitaLand Mall Trust, CMT (SGX:C38U) and Frasers Centrepoint Trust, FCT (SGX:J69U) – come to mind. Both recently released their first quarter results for 2019.
In this article, I’ll evaluate both of them in terms of growth potential, management and valuation to see which one gives a better deal for investors in 2019.
1. How Has Management Fared?
Let’s start by looking at some basic numbers.
In the first quarter results for 2019, the Distribution Per Unit (DPU) and Distribution Yield for the two REITs were as follows:
Although 4.8% and 5.0% distribution yields are unimpressive to a dividend or income investor, these are high-quality, highly stable REITs that are very unlikely to lose value over the long term.
Nonetheless, they have been increasing their yields over the last few years – which should attract some investors. It is worthwhile to note that the dividend yield growth for FCT is more consistent as compared to that of CMT.
The success of any REIT is not only what properties are within the portfolio – but also how the managers ensure sustainability of rental income. For retail REITs, good property managers must be able to consistently attract high rates of shopper traffic while increasing rental rates – all while keeping tenants and shoppers happy.
This is done through a variety of factors – some of which we will assess and compare here.
Firstly, good management needs to consistently increase rental rates while maintaining high occupancy rates of its malls, since the tenants are what drives the revenue of the retail REITs.
Looking at FY2018 results, we see that CMT increased rental rates by 0.7% on average, and has a total portfolio occupancy rate of 99.2%, maintained since FY2017. FCT, on the other hand, had an average rental reversion of 3.2%, and increased occupancy rate to 94.7% from 2017’s 92.0%.
Secondly, both malls have embarked on AEIs – or Asset-Enhancement Initiatives.
This is just a fancy way of saying they have done “renovation” on their malls. The goal is to, as CMT’s 2018 Annual Report puts it, “drive visitor traffic, elevate shopping experiences and create value for our retailers”.
We see this right away in FCT FY18 report – an 11.5% jump in shopper traffic in Northpoint City, for instance. This was mainly due to the AEI completion of North Wing. In fact, if you stay in the North like I do, you can physically see the difference without even relying on the numbers!
Finally, many people like to look at the gearing ratio for REITs as we do not want our REIT managers to over-leverage their positions. However, in Singapore, REITs are capped at a gearing limit of 45% – so I would not worry too much about how much debt they take on.
The important thing I would want to look out for is whether our managers have sufficient funds to repay their debts without fail. Thus, I would check out the Interest Coverage Ratio.
This ratio indicates how much earnings they have to cover their debts.
As you can see, both retail REIT managements have done a good job of maintaining high annual earnings relative to annual debt repayments. For instance, in the first quarter of 2019, FCT had 8.8 times amount of earnings to cover their debts, while CMT had 7.7 times. As a guideline by Investopedia, we want to target interest coverage to be 3 times or more
2. Any Growth Potential?
The two REITs understand very well that the retail landscape is changing – that is why they have embarked on AEIs and are in the midst of rethinking the consumer experience in a shopping mall.
Let’s look at some of the key changes CMT and FCT are making to ensure that they maintain their dominant market position and keep growing.
For FCT, their growth is driven through 3 routes: AEIs, acquisitions and active lease management. Nothing too fancy. They understand that their target market is the heartlanders and households – who make up the mass market. As such, anchor tenants like Cold Storage, Kopitiam, NTUC, and Uniqlo make up most of the Net Leasable Area (NLA) and Gross Rental Income (GRI).
Much of the growth for FCT comes in the form of continuously optimizing their tenant mix to meet mass market consumer needs. However, FCT is also poised to grow from upcoming acquisitions of Waterway Point and Northpoint City South Wing from its sponsor, Frasers Property Limited. (Update on 16 May 2019: FCT is issuing rights to acquire Waterway Point – citing it as a DPU-accretive acquisition)
For CMT, things look a little different. Its managers are making some bold moves – to keep relevance to consumer tastes and demands. Its goal is to differentiate itself through unique experiences. Its Annual Report talks much about “innovation”, “omnichannel” presence, and wanting to provide more lifestyle experiences and experiential-based platforms using technology.
For instance, CMT designed a “phygital” (physical plus digital) retail space at Plaza Singapura called “NomadX” – which features “plug and play” concept stores like a Taobao outlet. The newly refurbished Funan mall is another great example which incorporates automated technology and experiential concepts into their traditional malls.
As we can see, CMT and FCT are doing things very differently to grow. However, we see that CMT more growth runway in revenue and profits by taking advantage of the “phygital” trend and locking in customer and tenant loyalty through programs like StarPay (launched in 2018), CapitaVouchers, CapitaStar and CapitaCard.
3. So… Which Is Cheaper?
One of the simplest ways to evaluate whether a REIT is undervalued is to use Price-to-NAV. A Price-to-NAV less than 1 means that we are essentially buying the REIT for less than the per-share value of its property portfolio. Supporters of Dr Wealth would be very familiar with this method of investing.
Below, I plotted the Price-to-NAV chart of CMT and FCT using data from Shareinvestor.com.
As you can see, both the REITs are above Price-to-NAV of 1. Unfortunately, this doesn’t necessarily mean they are overvalued. Because both retail REITs are very stable and backed by strong sponsors, they usually market at a premium. However, we see that FCT is only at 1.14, while CMT is at 1.17 in 1Q2019. This means that FCT is relatively slightly cheaper than CMT.
Yet another way we can look at it is through their Price-to-AFFO. Adjusted Funds From Operations (AFFO) is an indication of the true residual cash flows left for the company after deducting ALL expenses and capital expenditures. This is akin to Free Cash Flow if we are valuing stocks.
In the above chart, we see that Price-to-AFFO for CMT is also consistently higher than FCT, indicating that FCT is relatively cheaper within the same peer group. This is in line with our first measure, Price-to-NAV, which gave us the same conclusion.
Moreover, Price-to-AFFO for CMT has been increasing quite a bit since 2014, from around 25 times to its current 33.12 in 1Q2019, suggesting that more people have a vested interest in the stock in the last few years, as the REIT’s price growth was much faster while AFFO did not grow at the same rate.
Although CMT and FCT are two very similar retail REITs with strong financial positions and competent management, we see some key differences that might lead an investor to prefer one REIT over the other.
CMT is dominant in more centrally-located areas, whereas FCT has its strengths in the suburban areas. Investors who want potentially higher growth in capital and DPU can look to CMT, but also have to bear in mind that fluctuations in DPU can be more frequent and unpredictable. On the flipside, investors who prefer DPU stability and don’t mind slower growth might lean toward FCT. Moreover, as I have shown using P/NAV and P/AFFO, it seems like FCT is relatively cheaper than CMT.
Ultimately, investors should ask themselves what do they value most in a REIT – each “good deal” will be different for each investor.
Let us know down in the comments which REIT would YOU pick, and why!
*Disclaimer: The author owns stocks of both CMT and FCT. The information in this article is not financial advice. It is general in nature and not specific to you. You are responsible for your own investment research and investment decisions.