Prepare for a 14% valuation drop in PRIME US and a lower drop in Keppel Pacific Oak

Manulife US REIT has announced its year end valuation and it did not look pretty. For year 2023, Manulife US REIT reported a 22% drop in valuation, primarily due to increase in discount rate and cap rate assumption used.

How about PRIME US, Keppacoak REIT?

Cap Rate assumption, discount rate and higher leasing cost will definitely affect the 2 REITs. PRIME US REIT will be affected more due to its loss of tenants especially for One Washingtonian Centre. For PRIME US REIT, I am looking at a decline of valuation of 14% while for Keppacoak, it should be an approx decline of 10%.

Effects

Keppacoak REIT should remain safe, standing at 43-44% leverage ratio. But for PRIME US REIT, it is different.

PRIME US REIT Difficulty

I expect PRIME US to slightly breach the 50% leverage ratio and along with it a few convenants. In my view, PRIME US has to do a few things urgently to return to below 50% leverage:

Firstly, reduce the dividend payout ratio from 100% to 90%. This should help the REIT reduce its leverage by 0.3 percentage point per year. Secondly, PRIME should evaluate if it can sell 1 building to lower its leverage. Thirdly, equity raising should be on the card if the second step fails because PRIME needs to enter the negotiating table with lenders on a stronger financial footing. In my view, a 1 to 5 rights may happen to recap the REIT with about US$35 million with underwriting taken by the REIT manager.

What I Hope PRIME US REIT Manager will Do

Out of goodwill, PRIME US REIT manager should consider the witholding of its cash base fees and use it as proceeds to fund the probable right raising or if there is no rights, give a 1 year grace period interest free.

A sponsor led loan should not be decided because such a measure should only be considered out of desperation, unless the sponsor is willing to backstop with a loan that is SOFR + 2.0%; otherwise, it is a no-go/ investor unfriendly action for a loan rate that is higher than SOFR + 2.0%.

Has China Stocks Bottomed?

 Measures have been announced that China has decided to reduce its reserve ratio rate to boost liquidity of its monetary system

Is it Over?

Optimism has come in with a slight boost in share prices of Chinese companies. However, I would caveat against being too optimistic if it is a turnaround

Poor Government and Civil Service Messaging

One would remember back in Oct 2022 after President Xi's cabinet reshuffle investors were spooked due to the installing of his yes men; the president and cabinet shortly came out to reassure investors that business regulations will be lessened in an attempt to stabilise the market.

1 year on, the Chinese government and Civil service went on another wave of technology company reform and of course the worsening of the real estate market. We are now back to the lows of October 2022.

The Chinese Civil Service has been incoherent in the messaging it wishes to send to investors. The posturing is max with a calming message followed by a policy which further strangles companies. This puts investors on see-saw and have stayed away from the market. 

What is there for Now?

I do not know where it goes from here, but what I am pretty certain is that money is going to keep flowing out of the Chinese Capital markets, the poor messaging by the civil service which goes all the way up to the highest senior ministers is sending markets in jitter. The current turmoil caused by China is due to negative policies introducted to hurt business and the civil service trying to quell investor fears but its words are not matched by actions where policies occassionally crop up to hammer sentiments down.

Until the Chinese Civil service improves, I think the chinese capital market will continue to flounder. China continues to report positive GDP but I also caveat on believing the actual figures reported. Former President Richard Nixon has a quote of "Trust, but verify". This is entirely true for the current chinese communist regime while we can trust, our own verifications still shows how anti business China is. 

President Nixon faced the threat of communist powers during the cold war era, investors now face a similar communist threat in investing in China. It is indeed an era of cold war for China stocks which I do not think can be easily resolved until the communist become coherent and investor friendly in their policies.

China can keep injecting liquidity but the poor execution of its civil service and policies will continue to drive foreign capital out. If capital flight continues, it may signal the end of China as an economic no 2. The stock market will be stuck in a rut and has been down for 6 years. However, Japan has shown how a loss of confidence led to 2 decades of trough, China is not even halfway there

Invest Overseas For Higher Yield and its REITs

This is a strategy I am executing so I am putting my actions where my mouth is.

Dividend Yield of Local REITs

Singapore REITs are currently valued at 4-8% dividend yields. It is indeed one of the highest in investment recent times due to the hike in interest rates. However, on the SGX, there are a group of overseas REITs which presumably have a stronger balance sheet and are near double digit yields. Just look at Keppel Pacificoak US REIT, Utd Hampshire REIT US, Elite UK, Cromwell Europe REIT. In terms of dividend yield, they are at an expected forward yield of 12.5%, 11%, 9.5%, 9% respectively. 

Stronger Balance Sheet and Lower Tenancy Risk

While they are in the weak commercial and retail spaces, their occupancy rate has not been that adversely affected. In addition, their leverage ratio are now far from MAS's regulatory ratio (even Suntec REIT at 7% yield is closer to breaching MAS's regulatory limit).

Earn 3-5% more Per Year, while taking on Exchange Rate Risk 

These REITs carry the risk of currency exchange because they are in USD, UK Pounds or Euro. No doubt the Sing Dollar has been appreciating but if we look over the long term, the Sing dollar has been appreciating at about 1.5% annually to these currencies (USD is only about 1%).

With the dividend rate differential so high as compared to our local REITs, I do feel these 4 reits makes sense enabling me to earn above average dividends.

I have been accumulating Elite Commercial REIT and soon, my entire portfolio will become a high dividend REIT yielder with the exception of Alibaba. Even my holdings in Ping An Insurance is granting about 8% yield which is triple that of Great Eastern Life. Ping An is much larger than Great Eastern and one of the important companies to China.

E-commerce War in South East Asia: Explaining Lazada's Action and the Future.

By now, investors would be aware there is intense competition in South East Asia's e commerce scene. Bytedance's Tiktok has entered since early 2023 and been utilising its US$10+ billion annual profits from China to subsidise the large losses incurred in South East Asia, the aim is simple to be the one of the de facto 2 e-commerce players (given South East Asia population and lesser spending power, it seems this region can only support 2 profitable players)

Shopee (Sea Group's e commerce arm) demonstrated how profitable e commerce could be when it posted 2 quarters amounting to an annual US$1 billion of annual EBITDA gains (or about US$500 million in annual net profits). Lazada and Tokopedia being the no 2 in each of their country was starting to turn EBITDA positive and would have turned profitable in a few years time.

Bytedance seeing the potential returns came in to fight for the top spot. This has resulted in a 3 corner war where the top 3 (Shopee, Lazada, Tiktok shop) are now selling below cost in order to kill each other. It is a war of attrition. Consumers gain because lots of incentives are now dished out. Tokopedia gave up and sold itself to Tiktok.

Why E Commerce is lucrative

E commerce profits on (i) the traditional format of users looking for products and (ii) the peddling style where products look for users. While (i) contributes to some amount of profits, (ii) is where money is made; products looking for users tend to be inferior in the hierarchy of needs and of the highest margins. Additionally, a few products are OEM goods which is slapped on with a brand and superior marketing (peddling the product to users), the branded good commands a larger margin compared to its OEM peer. Singapore's PRISM is one such product line which relies on OEM products and then slapping its brand and asking for 40% more to a comparable products. Due to its superior marketting, naive consumers in this region would pay close to 40% more.

In recent times, both E commerce platforms and Short form social media like tik tok helps in the marketing aspect of such products, they earn a cut from (ii) where they peddle goods to its user base. Live-streaming is another example. The China e commerce space is rift with such advertising to the extent that Douyin, Bytedance's Tiktok in China and its army of influencers helps Bytedance command close to US$10+ billion in profits selling "unneccessary" products to the China base.

Both Lazada and Shopee used the same method albeit a less intrusive by offering the goods to be the first few searches when being searched by consumers or placed in the front of the app home page. This is akin to being on the first floor of the shopping mall or similar to how Google and Apple charges websites to be the first few search results when we search on browsers. 

The Current No 2: Tokopedia and Lazada

Tokopedia was no 2 in Indonesia and close to becoming cashflow positive. This proves to show how only the top 2 e commerce platforms can be profitable and lucrative in South East Asia. 

However Tiktok shop entered and Tokopedia started to make large losses again. This resulted in Toko shutting down, selling their marketting channels and infrastructure to Bytedance Tiktok shop. Bytedance is now using this and their cash hoard from China to burn to become the no 1 in South East Asia with the aim of securing US$1-$2 billion in annual profits.

Lazada is still loss making in South East Asia but the no 2 in other countries. However, the amount of losses they have raked up is about US$1 billion a year so far. As the penetration of e commerce improves and efficiencies, the original intent was to continue improving until positive EBITDA is achieved. However, that ended when Bytedance entered disrupting the natural evolution.

Differing Strategy

Bytedance's Tiktok is addictive, it attracts users to be hooked to its short form video. With the addiction and attraction of eyes, it moves to monetise by peddling products to its users. The purchase of Tokopedia helps it to build its infrastructure of shopping channels. Bytedance is doing quick time by overhiring staff in order to set up quickly. It has cash to do this because Bytedance has a warchest in the US billions to support loss making in the short term.

The mass hiring by Bytedance is only a temporary move; many of its workers will be made redundant once it moves to the maturity stage. However, now it requires all the manpower to fight with Sea Group to take the no 1 spot. The current no 2 spot will only make a very small amount.

Sea Group's Shopee has responded in kind by slashing prices to negative margins and hired influencers to market more goods on its shopee platform. In the process, the e commerce losses amount to a US$1.5 billion of negative equity. Shopee has a US$7.5 billion in cash warchest and a cash generating sister in Garena which earns US$400 million in cash. In all likelihood, Shopee has a runway of 4 years to fight while Byedance's tiktok loses billions in cash each year in South East Asia.

Explaining Lazada Strategy

Lazada do not want to paratake in the cash burning war. Instead it is opting for optimisation to minimse cash losses. Its e commerce strategy continues to focus on mainly the traditional format of allowing users to search for products with a little of (ii). It is currently selective choosing which South East Asia countries it wants to be the no 2 and focusing its resources there. For other countries, it is shutting down its operations.

Beyond what Singaporeans are complaining about the job cuts here by Lazada, Lazada has made redundant its entire operations and staff in Vietnam. This is because it is a distant second. The next in line for Lazada could be the laying off is its entire staff in Indonesia because of how weak its position is there, as the no 3. This shows the reality that Lazada had previously overhired staff in its early years to prepare for war with Shopee at each South East Asia country. When the dust settled, cost optimisation had to take place, optimisation is done to turn profitable.

Lazada is likely to only concentrate its battle in 3 South East Asia countries and let Shopee and Tiktok/Tokopedia fight it out in the whole region in a loss making battle. In short, Shopee and Tiktok are fighting a war of attrition to be no 1 while Lazada has decided for cost optimisation, take the No 2 spot in selected countries (for the time being). I caveat I am not sure if Lazada will mount a challenge again when only 1 is left.

Prepare for Mass Layoffs in Sea Group and Bytedance in the Future

The pay for IT staff, live streamers and influencers are lucrative now for these 2 companies. In times of war, the demand for talents and mercenaries are high. Both Bytedance and Sea Group need to expend large amount of IT manpower and marketting staff in order to take the No 1 market leader position. This means paying over the top for IT resources and influencers.

This is evident in Singapore. However, eventually one of them (Bytedance or Sea) will wave the white flag on the e commerce front. When it is raised, a large number of layoffs will occur becaue it will mean the ending of operations in countries. The National Trade Union of Singapore's FDAWU has to be aware of this and should not complain when the time comes because it is the eventuality, either Singapore introduces a legislative framework to backstop redundancy exercises or shut up when redundancy happens. Union leaders have to start reading more and be learned about realities.

Both Sea Group and Bytedance are now burning cash to duke it out, the loser will go bankrupt and layoff its staff. South East Asia will never be able to support 3 e-commerce giants due to its population size and spending power. Only 2 will remain and the unfortunate third will have to massively downsize including those working in Singapore. Lazada is showing its intent to settle for the no 2 spot and securing it. Bytedance and Sea Group will either be the No 1 or the bankruptee because of their high fixed cost in fighting the war. The e commerce war will likely last for 4 more years and if it exceeds that point, Sea Group would likely go bankrupt or just focus on being Garena only.

(What I think) 2024 Theme: Invest in Overseas REITs

Due to the interest rate differential between Singapore and the rest of the World, overseas REITs listed in the SGX are now valued at a much higher dividend yield than that of local REITs. To add to that, the Sing Dollar has appreciated to make the purchase of foreign assets palatable.

Stronger Balance Sheet Overseas REITs 

For many overseas REITs listed in the SGX, most are exposed to the commercial real estate which globally is experiencing a tenant recession/downsizing. However, 2 REITs (Keppacoak and Elite Commercial) are reporting strong tenancy that is above 90%. 

Elite Commercial REIT has just done a round of equity raising to strengthen its balance sheet. This has improved its financial standing when meeting creditors. Keppacoak, on its own, has a balance sheet that is lower leveraged and of a higher interest coverage than many Singapore local REITs. My view is that both REITs have a high percentage of survivial and are of the same level as the blue chip REITs.

In terms of dividend yield, Elite is yielding at 11% while Keppacoak is at 12.5%. These are of a much higher yield and worth the forex risk. Compare that against the local commercial REITs of 6-8% yield, that is a 5% yield differential to earn each year.

Sing Dollar Appreciation

The Sing Dollar has been appreciating against the USD and SGD. However, I feel the difference in yield for these less risky REITs are worth it. Granted the Sing Dollar may appreciate about 1% per year, but I am getting 5% more in dividends per year. This translates to the likelihood of a nett positive return.

Therefore, the theme for 2024 investment will be exchanging Sing Dollars into British Pounds or US dollars to buy these 2 REITs. What makes it even better is that the Sing Dollar has appreciated to an all time high which makes purchase of assets cheaper; same as how Singaporeans travelling to Malaysia and Japan have been shouting that food and items there are cheap. I would say even foreign investments are now cheap to the Singapore investors and it is time to use the strong Sing Dollar to buy.

Taking More Risk

There are riskier REITs such as PRIME US REIT which has a higher leverage close to MAS's regulatory limits. The yield of the REIT is at 20%, which is juicy. However, there is a high risk that the REIT will need to do an equity raising (similar to Elite Commercial) so as to be on a better financial standing when talking to lenders.