$Sasseur Reit(CRPU.SI), A Misunderstood REIT
Sasseur REIT (SR) is the only Outlet Malls REIT listed in Asia. Since its IPO in March 2018, the share price have fallen about 10%. This is despite that Outlet Malls have the highest growth rate in retail sales in China. This REIT’s business and structure is new to Singapore and is not easy to understand. Fortunately I got to attend a presentation by Sasseur REIT’s Head of Investor Relations, Mr Chen Zhen this week to understand more about the REIT. The presentation was arranged by Philips Capital.
Although it’s normal for a Head of Investor Relations to make a pitch for the company, I find his points logical and one can confirm it with information from the prospectus and the Web. From my research on SR, I find that there are a number of concerns about the REIT which is why it’s being avoided even though I think that this REIT’s yield can potentially be one with the best growth in Singapore. I will go through some of these concerns followed by what I don’t like and like about SR.
Competition from e-commerce. This is the biggest concern as online sales are threatening the growth of traditional shopping malls. However Outlet Malls are different, they are selling off season Branded Goods at a discount with prices that are as low as online retailers. The risk of getting counterfeit goods from online purchases also deters shoppers. Most importantly people who buy branded goods love the shopping experience provided by the Malls. They like to feel and try on the products. They also like to be seen carrying the shopping bags of branded products. This is substantiated by independent market research which shows that retail sales growth for Outlet Malls in China are higher than Online Platforms.
Malls are located in Tier-2 cities. Actually this is an advantage. Growth is faster in Tier-2 cities and there is little or no competition. The Sponsor has the first mover advantage in these cities. Retailers use Outlet Malls to clear their excess inventory so there is limited supply of these products. Furthermore the retailer would not like to have many Outlet stores as these may cannibalize the sales of their regular outlets. Therefore it’s difficult for competitors to open another Outlet Mall in the same city where the Sponsor has established themselves. This is an Economic Moat of this REIT.
Financial Engineering? One concern is the complicated 10 year Entrusted Management Agreements (EMA) with the Sponsor which is acts like a Master Lease. The EMA Rental Income consist of:
Fixed Component which is expected to contribute not more than 70% of EMA Resultant Rent for 2018 with a 3% step up annually over 10 years.
Variable Component which will be pegged to 4 to 5.5% of total sales of each malls.
Performance Sharing which is 40% of the remaining revenue after deducting the above and the EM Base Fee for Mall Operation and Maintenance.
The reason for this complicated rental system was explained by Mr Chen. The Sponsor does not collect rent from the Outlet Mall tenants. Instead it collects a percentage (10 to 16%) of the tenant sales as rent. However as most people are not familiar with the malls, to propose a rent structure based wholly on percentage of sales would not be acceptable by SGX or investors. The EMA allows stability in the DPU from the fixed portion and a chance to enjoy any upside from the variable portion and performance sharing. The flipside side is that the upside would not be as great when the sales soars.
An advantageous feature of the EMA for investors is that the rental income for 2018 and 2019 is guaranteed (like income support). If there is a shortfall in the forecasted rental income, there will be top up by the Sponsor to meet the shortfall. This minimum rental guarantee will continue until there are two consecutive years with no top up.
Counterparty Risk. Possible mismanagement or fraud by the Sponsor. The Sponsor has 29 years of history and has been successfully managing outlet malls with CAGR sales growth of 40% from 2009. The sponsor has reputable strategic investors, namely L Catterton, the Private Equity arm of LVMH and Ping Ann Real Estate, a subsidiary of the Ping An Insurance Conglomerate. These companies would surely have done due diligence on the Sponsor.
High EM Base fee paid to the sponsor. The EM Base fee for property operating expenses may go up to 30% of gross revenue before there is Performance Sharing. This may seem high but if you look at Capital Retail China Trust, the total property expenses comes up to 35% of gross revenue. One reason is due to high property related taxes in China. Furthermore Outlet Malls operators have high manpower expenses compared with Retail Malls which I will explain next.
Poor rental collection from tenants. This does not apply to Outlet Malls as all sales are paid to the Mall operator first including the cash. Everyday the tenants will drop the day’s collection into a safe deposit box. The Sponsor’s staff will tally the takings with the receipts everyday which is why it’s manpower intensive. The advantage is great cashflow for the sponsor as they will return to the tenant the balance of the sales proceeds a month or a month and a half later.
Overestimate of Sales Growth by Sponsor. The first quarterly results after the IPO was released one month ago and sales from all four mall exceeded the management forecast. Total tenant sales at all four malls totalled $193.3 million which exceeded the forecast by 8.8% and up a whopping 40.6% YoY. This have shown that the forecast figures are actually conservative. There were also concerns that the Kunming Outlets Mall which opened in Dec 2016 was sold to the REIT too soon as it’s performance was unproven. The Kunming Outlet exceeded sales forecast by 21.3% and increased by 142% YoY.
Short WALE by Gross Revenue of 1.3 years. This is a strategy of the Sponsor as they collect rent based on sales. So if the tenant sales fails to meet expectations even after promotional efforts by the Sponsor, it’s better to change the tenant.
Short remaining Land Lease of around 30 years. This is valid concern and it’s similar to our industrial REITs. To me 30 years is still a long time and if the cash flow generated grows, the valuations on the properties will follow.
Now for the negatives.
High Borrowing Cost. The Average Financial Cost is 5.4% which leads to a low Interest Coverage Ratio of 2.1 times. This is rather low compared with ICR of above 4 times for most REITs..
Foreign Currency Risk. The REITs income is in RMB and distributions in SGD would be affected by the exchange rate. With the current trade war with US, the RMB has fallen slightly and may drop more when the trade war escalates. About 25% of the loans are in SGD and a drop in RMB will increase the debt burden of the REIT. I am glad that the REIT management didn’t decide to take a larger portion of debts in SGD even though the borrowing cost is lower in SGD.
What I like about Sasseur REIT
Alignment of interest with Sponsor. The sponsor holds 57.5% of the REIT which is very high for a sponsor and ensures that interest are aligned with minority shareholders. The REIT management fees are also aligned with shareholders as the base fee is 10% of distribution income and performance fee is 25% of the increase in DPU. This is in sharp contrast with many REITs where the fees are based on assets under management which is totally not to shareholders interest.
There are also many cornerstone investors like Charles and Keith and e-commerce players like JD.com and Secoo. This confirms that e-commerce platforms thinks positively of Outlet Malls. L Catterton has also taken a direct stake in SR.
The macroeconomic indicators like a growing middle class population and increase in consumption expenditure are both positive in the long term.
Lastly is the high yield, which is above 8.5% based on the Q2 results and the last closing price of 72 cents. Mr Chen has shared that historically the 2nd quarter results are the weakest in the year due to two reasons. It’s when they sell Summer wear which is lighter and therefore cheaper and there are less sales promotions compared with other quarters.
I also like that the management team which are all Singaporeans are actively promoting the REIT. According to a NextInsight report, the CEO is leading a group of analyst and investors on a 3 day visit to the malls in Nanjing, Hefei and Chongqing. That's why he was not at the presentation. This means that Nanjing Mall which is one of the pipeline properties which the Sponsor has a ROFR will likely be the next acquisition target for the REIT after IPO. Hopefully the analysts will come out with positive reports.
Although more time is needed to monitor the performance, I think it’s worth taking a nibble.
Vested 25k shares. Please DYODD.