Thursday 22 February 2024

US Office Commercial REITs- PRIME Pulls Positive Surprise With Its Young Property Age.

The full year results for the 3 US Office REITs are out. Downward valuations, as expected were reported with varying magnitudes.

Below are their current financial health:


To me what came as a surprise is the CAPEX needs of KORE's property portfolio. KORE spends more CAPEX than the rest. This is due to KORE's portfolio being the oldest among the 3. While KORE claims the higher CAPEX is needed to retain tenants, the main (probable) reason is due to the need to refurbish its old buildings to match tenants needs.

As a result of the higher CAPEX needs as compared to PRIME US, KORE has decided to suspend dividends. PRIME US REIT on the other hand, due to its smaller CAPEX by virtue of having newer buildings, has slashed it to 10% payout ratio with a plan to delever wtih US$100 million. 

On the point on CAPEX, its interesting to note KORE puts in nearly twice the CAPEX expenses but still obtains the same ratio of "NPI to property revenue" or "Revenue to Valuation" as compared to PRIME. This clearly shows the main reason why KORE needs to pay so much for its CAPEX is because its properties are old and there is a need to spend more to maintain. This showed Keppel Capital had tried to fool public investors by IPO'ing older assets in a way to get rid of the looming cash needs then. Keppel seems to have pulled a fast one over Singapore investors.

PRIME- All eyes will be on debt Maturing on Jul 2024

PRIME carries a significant risk where a 600 million debt facility is due July 2024. This is a make or break segment, if it succeds, PRIME will have a very strong chance of an upside and rebound. A failure to renew and there will be a massive haircut to building valuation during the firesale. PRIME management has to present to the syndicate of bankers that its properties are of good balance sheet, the manager is committed to the REIT future and preferably the sale of 01 building should be done before this. 

ManuLife US REIT Has to Execute Well

MUST did a year-end valuation. With the revaluation, the expected sales from Tranche 1 assets are still within range of the announced sales proceed in their December circular for Tranche 1 sale.

However the resultant leverage places MUST very close to 50% (estimation is 49.7%). The sale to Diablo to me will be difficult because it is of a Class B asset (least desired) and it has not undergone refurbishment since its completion in the 1980s. Hence, there may not be many interested buyers. If the US Commercial office issue persists until 2025, MUST might need to sell off 01 additional building in Tranche 2 because the next revaluation in end 2024 would put it above 50% leverage again.

Sale of Buildings

In all likelihood, both PRIME and MUST could be selling buildings at the trough of the business cycle to delever to safety. It is a neccessary move but one that is forced due to the breach of leverage. 

Sunday 18 February 2024

Lesson from my US REIT Investing: Understanding CAPEX Requriments and Age Profile of Buildings

Investing in the US Office space taught me a lesson. Its not about the US real estate cycle but the need to understand the CAPEX requirement of the REITs and the building age profile. For these US office REITs, capital expenditure has to be spent to ensure the property is refreshed As a building ages, more capital expenditure is needed. And CAPEX is a cash expenditure.

It got me wondering why does Keppel Pacific Oak (KORE) require so much CAPEX as compared to Manulife US and PRIME US REITs. A further delve into the IPO prospectus reveals an area investors often not looked at.

KORE Building Age

 MUST Building Age

PRIME US Building Age

Different REIT, Different Age

If one looks at the age of the different buildings each REIT owns, one can notice KORE has a significant number of properties built in the early 80s, putting it as the oldest profile. This is followed by MUST and then PRIME US. For older buildings there is a need for more CAPEX to ensure its relevancy and for things to not fall into a state of disrepair. In fact, corresponding to the age profile, we can see the CAPEX spent by the 3 REITs follows closely to their age profile.

PRIME spends the least and that could be because its buildings are newer. 

How It Affects Us Investors?

For us investors, we have to know CAPEX is not added under the distributable income metrics. This means while the US REITs can give 100% of their income as dividends, they are adding more to their debt for the cash needs of CAPEX. In KORE's case, because its buildings are older, it has to increase its CAPEX, not just to attract tenants but to ensure their buildings do not go down. And the expense effects of CAPEX takes a delayed period of time and not one-off

Distributable Income is not a fair metric for us investors to guage. What we in fact need is to gauge the CAPEX requirements of each US Office REIT to know the sustainable dividend we can get. As shown in my previous article on KORE results, KORE's actual cash generation ability is only about 4.5 US cents and not 5.0 US cents due to the need for CAPEX.

Alibaba Quarterly Earnings: Matured Company and Reveal of Management Thinking in Buybacks

Alibaba latest quarterly results revealed how its largest 2 performing segment- local E commerce and cloud, have evolved into a mature state business. Revenue is growing in single digits which shows the difficulty of the company growing further. 

Cainaio is the only positive with a large growing in revenue and further steps to profitability.

My Thoughts

Alibaba China e commerce have cloud are still churning through with margin improvements being made. This has helped the company to report flattish profits. However, what is terrible was its digital commerce group, in particular South East Asia.

South East Asia is turning to be a financial black hole because Tiktokshop and Shopee are present and desperately fighting for market share. In my view, South East Asia is too small a market of 3 e commerce players to be earning billions. Previously Tokopedia, Shopee and Lazada were fighting. Only Shopee was profitable churning at an estimated profit level of US$1.2 billion per year (based on the 2 quarters it was profitable), while Lazada and Tokopedia were loss making and slowly making themselves to go to breakeven.

However, the surrender of Go-to and entry of Tiktokshop makes it worse. All are now engaged in a cut throat pricing war with Tiktok being supplemented by the tens of billions it earns from douyin and the brainwashing advertisement empire it has built. Douyin is immensely profitable and rivals Alibaba's e commerce profitability. Alibaba's Lazada has sought to efficienise by closing its highest loss making market of Vietnam. However, I feel this is too small. Lazada should layoff its entire Malaysia and Singapore staff to reap cost savings. As evident by the latest quarter, the losses are widening. Lazada is a black hole which seems to never break even; pherhaps Alibaba should learn to cut losses and close down more unprofitable operations or sell off to either Shopee or Tiktok. In my view, it will be a more accretivie move.

A full closure of Lazada could help Alibaba as a group improve its margins by 8%.This to me could be a good move for Alibaba investors. I am supportive of Lazada closing down more markets for the benefit of the parent company.

Management Talk- Too Slow a Buyback Pace

The transcript during Alibaba's analyst call was interesting. While Alibaba had announced a larger share buyback program, the US stock analyst were quick to pick up that the increase in buyback amount corresponded to a longer duration. Doing simple maths, Alibaba was not increasing the intensity of its buyback per quarter; there was no change. An analyst voiced this as a question.

CFO Toby Xu's reply shed a few insights. I quote verbatim: 

"And we can use it if we need it. You know, we can increase the leverage, you know, also to sort of get sufficient cash for us to do the share buyback. So, as I said in my script, you know, we're targeting to reduce -- to have a net reduction of share count at least 3% every year in the next three fiscal years." & 

"And if -- so combined with the buyback, accretion, and the dividend yield, you're looking at, you know, about 4.4%, 4.5%, which is actually quite close to the 10-year Treasury yield. So, if you buy Alibaba stock, it's like you've bought a 10-year Treasury bond "

What I intrepret is we can expect earnings of the company to grow by about 5.3% due to declining no of shares (3.3%) and Alibaba's ability to improve its margins (2%). We should not expect much in revenue growth because most of Alibaba's key business has plateaued. In addition the company will continue to give about US$1 to US$2 in dividends, the company is not going to give more dividends. Alibaba will only continue to reduce the amount of shares by 3.3% per year.

The End of Alibaba as A Growth Stock

With a maturing state of itself and the cloud business being unable to grow further because the communist party favours Huawei as its cloud vendor and flag bearer and not Alibaba, it is very hard to peg Alibaba as a growth stock.

It is now a matured value play. However, on an operations front, Alibaba is improving and the share buybacks increases earnings organically. Moving forth, I anticipate Alibaba to improve earnings by 5% per year. It is not that impressive but good enough. 

I expect this year Alibaba will clock full year earnings of S$7 per ADR. This translates to a P/E  of 10.5 times. However, with given knowledge that Alibaba will be improving its earnings albeit gradually by 5%, Alibaba is a hold for now; however, I truly do not think bulls who are shouting for Alibaba US$300 will see it be a reality. Because a 40+ price earnings with 5% earnings growth does not justify valuations. If i were to value, a company who can grow its earnings by 5% deserves to be awarded a 20 times price earnings max, this means a fair price for Alibaba is US$140.

However, the closure of Lazada could be a positive move which adds US$20 to share prices and a one-off earnings boost of 8% (equivalent to 4 years of cost cutting)

Thursday 15 February 2024

Keppel Pacific Oak (KORE) Suspension of Dividend- A Too Cautious Move

In the latest financial result, KORE announced the surprise of suspension in dividends. The REIT elaborated it had considered other avenues such as fund raising and sale of building, but they were not beneficial to Unitholders. While the REIT is rational, I feel the REIT is being too cautious with its cashflow.

Debt Profile

KORE has US$78 mil of debt due in 4Q2024. With a cash generation ability of US$77 mil, expected CAPEX of US$30mil and cash balance of $43.7 mil, KORE is too cautious with expectations it is unable to refinance its tranche due in 4Q2024. With its cash flow and cash balance, KORE can repay in full without going to the bank.

KORE Cashflow is US$77 Mil per year

Effects of Full Repayment

Assuming a full repayment of US$70 mil at end 2024, KORE leverage will fall to 38.2% (barring further valuation fall). This I feel shows KORE is too cautious. It could have paid out a bit of dividend and maintain leverage at 41.0%, refinance 50% of the debt due in end 2024, it will still be below the 45% leverage ratio it fears of breaching.

Net Property Income (NPI) has remained stable

KORE NPI has increased slightly and I forsee for 2024, it will remain stable with slight uptick. With a cash generation ability of US$77 million (before interest expense), the REIT will be stronger. I am biased because I own KORE but what I have described is based on empirical reporting of its financials. KORE has only about 27.5% of leases due until end 2025, hence I feel the risk of its financials deteriorating is rather low.

KORE is Going to be Low Levered 

If KORE keeps saving aside US$45 million per year; in 2.5 years, the REIT will set aside US$135 million. It has US$601.9 million of debt. This means in 2.5 years; it will be able to repay 22% of its debt without refinancing. Assuming property and asset base valuation of US$1,350 million with little revaluation and debt position of US$466 million, KORE will be 34.5% levered at end 2025. This makes it one of the lowest levered REIT in the SGX REIT space.

What I Feel Will Happen

Again my biased view, I feel KORE will resume dividends from the start of 2025. The chief reason is that its leverage will be far from 45%. KORE is being very cautious to stop dividends until end 2025. Based on its current trajectory, KORE has provisioned for a further 20% drop in real estate commercial value. If Manulife US REIT CEO and PRIME CEO views are considered with both saying we are at the bottom of the cycle, KORE is being too cautious.

Amount of Reinstated Dividends

This is where I feel KORE must be careful. Based on its cashflow, it is apparent KORE is only able to distribute about US$40 million in dividend to unitholders. It must set aside CAPEX to ensure its buildings are in good conditions. Even if finance expenses are lower due to dropping interest rates, US$50 million should be the maximum sustainable level. This translates to about US$4.5 cents in dividends per year.

With the above overview, I feel KORE is a 9-10% dividend yielder if it executes well. From the above empirical observation of its financials, there is a low probability KORE needs equity fund raising or sale of building. With good execution and barring a sudden deterioration of market valuations, KORE should be able to return 4.5 US cents annually to unitholders post 2025 or even in 2024. A fair value of 45 US cents value is where KORE should be.

KORE is too cautious in how it is controlling its cash. It could continue to pay a small amount of dividend. With what it is doing, it will generate US$40 million in cash annually which it is keeping for rainy days. KORE is too pessimistic, and I hope when the storm clears, KORE does not use the spare cash to lever up by buying new buildings. It is a dumb move to buy new buildings at low cap rates due to an upturn.