Frasers Commercial Trust (FCOT) is a Singapore-listed REIT that owns office buildings and business parks located in Singapore, Australia, and the UK. After FCOT posted its Q2 2018 results on 20 April, its share price fell from $1.48 to a low of $1.35 on 21 May – a drop of 8.9% over a matter of weeks.
In this article, I’ll share the cause of FCOT’s fall in share price and whether it’s still able to deliver sustainable distributions to unitholders in the near future.
Here are five things to know about Frasers Commercial Trust before you invest:
1. Four consecutive quarters of falling revenue
FCOT recorded its fourth consecutive drop in quarterly revenues when it posted revenues of S$33.0 million for Q2 2018 — an 18% drop quarter-on-quarter from S$40.2 million in Q2 2017.
Source: Frasers Commercial Trust quarterly reports
Despite the falling revenue, FCOT has managed to maintain its distributable income at S$19-20 million a quarter over the past year. How has it been able to do so? Distributable income can be paid from two sources: operating income and capital returns.
In tandem with its falling revenue, FCOT’s operating income fell 13.9%, from S$18.2 million in Q2 2017 to S$15.7 million in Q2 2018. However, this fall was offset by higher capital returns from the sale of hotel development rights at China Square Central and a return of capital from subsidiaries in Australia and the UK. As a result, FCOT has maintained its distribution per unit (DPU) at 2.4 cents over the last four quarters.
Source: Frasers Commercial Trust quarterly reports
2. What caused the drop in revenue?
There are three main reasons:
- Alexandra Technopark. The property is FCOT’s largest revenue contributor. However, key tenant Hewlett-Packard Enterprise Singapore (HPE) opted not to renew its lease after its expiration on 30 September 2017. Another key tenant, Hewlett-Packard Singapore (HPS), only chose to extend its leases at Alexandra Technopark for another two to 13 months after its initial expiry on 30 November 2017. These lease expirations resulted in the massive drop in revenue over the last six months.
- China Square Central. The property has seen a gradual fall in revenue since 2015. But the revenue drop accelerated in 2018 when the retail podium was shut for an asset enhancement initiative (AEI).
- Weakening Australian dollar. FCOT has three properties in Australia — Caroline Chisholm Centre, Central Park, and 357 Collin Streets – that accounted for 45.7% of total revenues in 2017. Hence, FCOT’s revenue is subjected to any foreign exchange volatility. Since 2013, the Australian has weakened against the Singapore dollar by 21.7% — from AUD1.00/SGD1.29 in 2013 to AUD1.00/SGD1.01 in 2018. As a result, this caused a drop in revenues in Singapore dollar terms for FCOT’s Australian properties.
3. Can FCOT sustain/grow its DPU?
Let’s start with the positives:
- FCOT completed the acquisition of 50% of Farnborough Business Park for S$157.4 million in January 2018. The property is a 46.5-hectare freehold business park comprising 14 commercial buildings in Thames Valley, London. It is a defensive asset with a long weighted average lease term (WALE) of 8.3 years and diversified base of 36 tenants. Based on pro forma results, FBP will contribute an additional S$7.2 million in distributable income and partially offset the fall in revenue from Alexandra Technopark and China Square Central.
- As at 31 March 2018, FCOT has a committed portfolio WALE of 4.0 years. Sixty-six percent of its portfolio leases will only start to expire from FY2020 onwards and thus, provide a level of income stability for FCOT.
Source: Frasers Commercial Trust Q2 2018 results
- FCOT has embarked on a S$45 million AEI to revamp and rebrand Alexandra Technopark as a contemporary business campus. As at 31 March 2018, the building has a committed occupancy rate of 70.4%. Moving forward, the completion of the AEI, scheduled for mid-2018, would help management with its efforts to secure new tenants and generate additional revenue for the REIT.
- In July 2018, FCOT entered an agreement to sell 55 Market Street for S$216.8 million. The amount is a 44.5% premium on itsvaluation and almost three times FCOT’s original purchase price of $72.5 million in 2006. This translates to an exit yield of just 1.7% (i.e. the buyer is earning 1.7% returns per annum based on the sale price and the income the property generates.) In other words, based on current market valuations, FCOT secured an exceptionally high price for the sale of 55 Market Street. Investors seemed to appreciate news of the sale and FCOT’s share price rebounded slightly to $1.43 (as at 18 July 2018). With the sale, FCOT can now recycle some of the divestment proceeds in higher-yielding assets that generate a better return for unitholders.
Now to move to some of the negatives:
- FCOT has embarked on a S$38 million AEI for the retail podium at China Square Central. The renovation will increase the net lettable area from 64,000 square feet to 75,000 square feet. As the retail podium is closed, FCOT will not be earning any revenue from it over the next 12 months. The AEI is expected to complete in mid-2019.
- Central Park recorded its lowest committed occupancy rate of 68.3% in Q2 2018. The 47-storey premium grade office building accounted for 17.1% of FCOT’s total revenue in 2017 and a further drop in occupancy rate would negatively impact FCOT results moving forward.
4. Solid balance sheet
As at 31 March 2018, FCOT has gross borrowings of S$799.2 million and a gearing ratio of 35.3%. Its average borrowing rate is 2.99% per annum.
Eighty-two percent of its debt is at fixed interest rates and its weighted average term to debt maturity is 2.2 years. FCOT has Baa2 rating by Moody’s in its credit opinion on 19 March 2018.
There are two main methods to value a REIT:
- P/B ratio. In Q2 2018, FCOT reported S$1.51 in net asset value per share. Therefore, its P/B ratio is 0.95 based on its FCOT’s share price of S$1.43 (as at 18 July 2018). Even though its share price is trading below its net asset value, its current P/B ratio is still higher than FCOT’s five-year average of 0.86.
- Dividend yield. Based on a trailing twelve months DPU of 9.61 cents and share price of S$1.43, FCOT’s distribution yield is 6.7%. This is marginally lower than its five-year average of 6.78%.
The fifth perspective
In short, I found FCOT to be a mixed bag. Its strength lies in having a strong and committed sponsor, a solid balance sheet, and long-term leases that add income stability.
Its shortcoming lies in a reduction in occupancy rates for Alexandra Technopark, China Square Central, and Central Park. However, the management intends to turn things around with AEIs on Alexandra Technopark and China Square Central. Thus, FCOT’s financial results are highly dependent on the performance of these properties once their AEIs have been completed. At the same time, the sale of 55 Market Street fetched an exceptionally good price, which the management can redeploy in higher-yielding assets.
At the moment, FCOT doesn’t look particularly undervalued with its P/B ratio above and its distribution yield slightly below their respective five-year averages. Due to some level of uncertainty surrounding FCOT right now, I would prefer to have a higher margin of safety before considering the REIT.
Ian, Good review.
I did my own analysis about 3 years ago and decided to invest in some other REITs. Although FCOT’s numbers didn’t look all that bad at the time I decided to avoid office and retail REITs in favour of industrial REITs with longer WALE (weighted average lease expiry).
My thinking was simple. It’s relatively easier to close/move a shop or office than it is to move a factory. In addition to business disruption there’s an oversupply of office and retail space in Singapore, and the latter is increasingly threatened by e-commerce.
However, FCOTs WALE and debt profile are actually quite good. Their overseas exposure might be a good reason to look at them again.
Thanks for the comment. Yes, industrial REITs tend to have higher WALEs than retail REITs.
With regards to e-commerce, it reminds me of Mapletree Logistics Trust as it is a REIT that has its sights on logistics/warehouse properties in China related to its booming e-commerce sector.
FCOT is a mixed bag, as mentioned. It has qualities but not exactly superb (for now). All in all, more comparison and homework is needed before making an investment decision.
All the best,