Good Recurring Income from a Large SG Property Co: The Frasers Property Bonds

• We are comfortable with Frasers Property’s credit profile, which is supported by its well-diversified property portfolio, strong recurring income base, and good access to capital markets.
• FPL’s property portfolio is well-diversified across geographies and property segments, protecting it from adverse local economy and policy changes. Recurring income assets make up 80% of the group’s portfolio and smoothen out the earnings lumpiness that is inherent in its development business.
• Within the FPLSP curve, we like the FPLSP 5% perps and the FPLSP 3.95% perps, which are offering very generous yield pickup above the senior FPLSP bonds. The 5.13% yield to worst on the FPLSP 3.95% perps is close to the 5.21% dividend yield from FPL’s ordinary shares.
• The FPLSP senior SGD bonds provide decent value against the bonds of major Singapore property companies.

Since 1963: from Cold Storage to leading property conglomerate

Frasers Property Limited (“FPL”) is the second largest Singapore real estate company by total assets, with total assets of S$31.7 billion in June. To put that in context, the leading local developer, CapitaLand Limited, has total assets of S$62.5 billion, while City Developments Limited and UOL Group Limited trail behind FPL with S$20.3 billion and S$19.9 billion of total assets respectively.

FPL has a rich history dating back to 1963 when it was incorporated under the name Cold Storage (Malaysia) Limited. Over the years, FPL underwent several rounds of transformations. The firm divested its non-property assets in the early eighties, renamed itself as Centrepoint Properties Ltd (“CPL”) in 1988, and was listed on the Singapore Exchange (“SGX”) in the same year.

CPL then became a subsidiary of Fraser and Neave (“F&N”) in 1990. F&N subsequently privatized CPL in 2002 and rebranded it as Frasers Centrepoint Limited (“FCL”) in 2006. After the Thai conglomerate TCC Group won a bidding war for F&N in 2013, FCL was spun off as a separate listing on SGX in 2014. Finally, the company renamed itself as Frasers Property Limited earlier this year in February, to reinforce its identity as a single, global property brand.

Today, FPL’s businesses include property development, and investment in and management of retail, commercial, industrial, and hospitality properties and property trusts. The group organizes itself into four operating segments, namely Singapore strategic business unit (“SBU”), Australia SBU, Hospitality SBU, and International business unit.

FPL is also the sponsor of four Singapore-listed real estate investment trusts (“REIT”). Frasers Centrepoint Trust (“FCT”), Frasers Commercial Trust (“FCOT”), Frasers Logistics and Industrial Trust (“FLT”), and Frasers Hospitality Trust (“FHT”) serve as the platform for FPL’s retail, commercial, logistics and industrial, and hotel properties respectively.

The Sirivadhanabhakdi family of TCC Group, which also controls Thai Beverage Plc and F&N, is the majority shareholder with 87.2% stake held through related entities. Mr Charoen Sirivadhanabhakdi and his wife Khunying Wanna Sirivadhanabhakdi lead FPL’s board of directors as chairman and vice chairman respectively. Their youngest son, Mr Panote Sirivadhanabhakdi, heads the management team as group chief executive officer.

Three-pronged strategy

Since 2012, FPL has adopted a three-pronged strategy in building its business, which is to diversify its earnings geographically, strengthen its recurring income base, and improving capital productivity. The evolution of FPL’s property portfolio and earnings makeup over the years bear witness to the company’s progress in executing this strategy.

In its FY13 ended 30 Sep 13, just 37% of FPL’s profit before interest, fair value change, taxation, and exceptional items (“PBIT”) was from recurring income sources—the firm’s retail, hospitality, logistics and industrial, and office and business park assets. Today, recurring income makes up 67% of the company’s PBIT (see Figure 1). Meanwhile, development assets, which constituted more than 50% of FPL’s property portfolio in 2012, have shrunk to just 18% at the end of June.

Figure 1: FPL’s recurring income base has grown significantly since 2012

Similarly, FPL’s geographical diversification has improved markedly in recent years (see Figure 2). In FY13, FPL was still very much a local enterprise that was heavily reliant on the domestic economy, as its Singapore SBU contributed 87% of PBIT. Over the years, besides Singapore (35% in 9MFY18), the company has built its business in Australia (31%), Europe (15%), and China (10%) to become meaningful earnings contributors.

Figure 2: FPL’s PBIT breakdown by geography

FPL’s listed REITs are the major element to the third prong of its strategy—optimizing capital productivity. Together, the four REITs constitute around one-third of FPL’s consolidated total assets, and we estimate that they paid approximately S$109m of distributions to the parent in their last financial year. To put that in context, we estimate that FPL’s interest expense excluding those incurred at the REITs level was ~S$69m in FY17; the firm could cover its borrowing cost with just dividends from its REITs.

The REITs are also an important platform for FPL to recycle its capital, where the firm monetizes its stabilized investment properties to free up capital for growth and higher-risk opportunities. For instance, FPL injected S$1.7 billion worth of industrial properties into FLT when the latter was listed in 2016, and used most of the proceeds to pay off debt. The company can also partner its REITs in acquisitions, such as when it acquired Farnborough Business Park in January for GBP175m (S$315m) via a 50:50 joint venture (“JV”) with FCOT.

FPL’s business model provides it earnings resilience and stability. The company’s portfolio that is well-diversified across geographies and property segments protect it from adverse local economy and policy changes, such as the recent property cooling measures imposed by the Singapore government. Its robust recurring income base smoothens out the earnings lumpiness that is inherent in its development business.

Continued push into overseas markets

In FY18 (ending September) to-date, FPL has continued to grow its footprint in newer markets such as Europe, Thailand, and Vietnam. The group announced in February its acquisition of a portfolio of 22 logistics and light industrial properties located in Germany and Austria, together with the property manager, Alpha Industrial GmbH & Co KG, for EUR285.2m (~S$467.7m). The first phase of the transaction, comprising eleven of the properties and Alpha Industrial, was completed in July.

FPL also completed the buyout for the remaining minority shares in Geneba Properties NV, a real estate investment company which owns and manages a portfolio of 25 logistics, light industrial and other assets in the Netherlands and Germany. The company first took an 86.6% stake in Geneba in July 2017 for EUR314.8m (~S$504.9m).

Additional share purchases and a tender offer in April brought FPL’s deemed interest in TICON Industrial Connection Public Company Limited (“TICON”) to 89.46% from 40.95%. TICON, which is a logistics and industrial real estate developer listed in Thailand, has been reclassified from an associate to a subsidiary consequently. The consolidation of TICON added S$1.6 billion of investment properties to FPL’s balance sheet.

FPL also further expanded into the UK and Vietnam. In the UK, the group bought four business parks in November for GBP686m (~S$1.2 billion), and Farnborough Business Park in January for GBP175m (~S$315m) via a JV with FCOT. In Vietnam, FPL acquired 75% of Phu An Dien Real Estate Joint Stock Company (“PAD”) in July for VND799 billion (~S$47m). PAD will develop a residential-cum-commercial project in Ho Chi Minh City.

Lower development income and higher interest cost affected 9MFY18 profitability

FPL’s 9MFY18 results were decent albeit uninspiring. A lack of project completions in Australia, China, and the UK relative to FY17 weighed on revenue, while contributions from new recurring income sources offset the lumpiness of development income.

Revenue dropped 4.3% YoY to S$2.94 billion in the nine months ended June (9MFY17: S$3.08 billion), mainly due to the timing of project completions. Projects that contributed significant revenue contribution in 9MFY17 included Phase 3C1 of Baitang One in China, Vauxhall Sky Gardens in the UK, and Central Park and student accommodation in Australia. The completion of Parc Life Executive Condominium (“EC”) in Singapore and Phase 3B of Baitang One partially mitigated the fall in development income.

Results were mixed across FPL’s business segments. Its Singapore SBU saw revenue jumped 82% YoY to S$1.13 billion (9MFY17: S$620m), due to profit recognition from the completion of Parc Life EC in March, start of business at the south wing of Northpoint City, and progressive revenue recognition from North Park Residences and Seaside Residences. Meanwhile, revenue from the Australia and Europe & rest of Asia segments fell 33% and 37% to S$806m (9MFY17: S$1.20 billion) and S$411m (9MFY17: S$655m) respectively, mostly because of the timing of project completions as mentioned above.

A 49% YoY increase in profit from JVs and associates to S$123m (9MFY17: S$82m) helped boost PBIT to S$879m, up 1% from S$867m in 9MFY17. Net interest expense more than doubled (+146%) however to S$203m (9MFY17: S$83m), due to an increase in debt to fund acquisitions. As a result, FPL’s profit before fair value changes, tax and exceptional items fell 14% to S$676m (9MFY17: S$784m).

Operating cash flow swung to negative due to development expenditures

Cash flow from operating activities (“CFO”) swung to a negative S$178m in 9MFY18 from positive S$744m in the previous corresponding period, primarily due to a S$622m increase in properties held for sale and S$371m increase in trade and other receivables. The Jiak Kim Street site in Singapore (acquired in December) and development projects in Australia took up most of the development expenditures, which were partially offset by settlements of completed units in Australia and Parc Life EC. The increase in trade and other receivables comprise mostly of sales proceeds receivable from Parc Life EC and goods and services tax recoverable on the acquisition of the land parcel at Jiak Kim Street.

We are unconcerned over the negative CFO at this juncture, as we expect FPL’s strong recurring income base to anchor its earnings and cash flow moving forward. The group also has a good track record in this area, having generated positive CFO every year since its listing in 2014.

Leverage rose due to acquisitions, though credit profile remained well-supported by property portfolio and recurring income

FPL took on bank borrowings of S$2.28 billion and issued S$311m of debentures in 9MFY18 to fund its recent acquisitions. The consolidation of TICON added another S$662m of debentures to the group’s balance sheet. Therefore, total borrowings climbed to S$14.84 billion as at 30 Jun 18 (4QFY17: S$11.63 billion).

At the same time, cash outflow from operating activities led to a lower cash balance of S$2.14 billion at the end of June (4QFY17: S$2.41 billion). Net gearing (net debt/equity) consequently rose to 0.89x from 0.71x in the nine months ended June.

FPL also issued the S$300m FPLSP 4.380% Perpetual Corp (SGD) in January, taking its outstanding perps (including those of its REITs) to S$2.05 billion, or 14% of total equity. Treating these perps as debt, we find adjusted gearing at 1.21x (4QFY17: 0.96x), a significant level for many conservative investors.

We note that the offering circular for FPL’s debt program stipulates a covenant that prohibits the group’s consolidated net borrowings from exceeding consolidated tangible net worth by 1.5x. That clause should prevent net gearing from reaching elevated levels, so long as FPL does not grow over-reliant on perpetual securities as a funding source.

On the whole, we are comfortable with FPL’s credit profile, which is supported by its vast and well-diversified portfolio of properties including S$20.18 billion of investment properties, S$2.22 billion of property, plant and equipment (predominantly hotels), and S$4.08 billion of development properties. We estimate that FPL holds directly at least S$9.5 billion of non-development property assets, which could be recycled into the group’s REITs to improve its capital structure. The most recent example is the group’s injection of 21 industrial properties in Europe into FLT in May for EUR596.8m (~S$972.8m) including existing debt.

In addition, at 67% of its PBIT, FPL’s recurring income should sustain the company’s ability to service its debt. While FPL’s adjusted interest coverage ratio including distributions to perps (PBIT/net interest expense) was only 3.6x in 9MFY18 compared to 7.3x in the previous corresponding period, it was still a healthy number. Furthermore, FPL’s interest-servicing capacity is unlikely to deteriorate much beyond the current level, given its existing portfolio composition—~80% of the group’s total property assets are recurring income assets.

We like that FPL’s average cost of debt has stayed cheap at 3% (4QFY17: 3%) despite a significant increase in borrowings. Also, fixed rate debt as a percentage of total debt rose to 74.8% at the end of June (4QFY17: 67.4%), which should improve earnings stability and reduce exposure to the adverse scenario of interest rates spiking.

Good debt distribution profile with low refinancing risk

FPL’s debt maturity profile at the end of June looked well-staggered (see Figure 3), although we note that the company has to address S$4.35 billion of maturing debt including perps in the year ending June 2020. Its average debt maturity of 3 years as at 30 Jun 18 (4QFY17: 3.1 years) reflects the balanced debt distribution profile.

Figure 3: FPL’s debt maturities are optimally spaced out

Cash and cash equivalents of S$2.14 billion in 3QFY18 seemed insufficient against short-term borrowings of S$2.76 billion. However, FPL announced earlier this month that it has drawn down on a new S$1.2 billion five-year term loan to refinance existing loans relating to the development of Frasers Tower.

Furthermore, FPL has continued to enjoy good access to financing despite the sluggish Asian market environment this year. For example, besides the above-mentioned five-year term loan, FPL has issued THB11 billion (~S$457m) worth of debentures since September last year. We expect little difficulties for FPL in refinancing its remaining near-term maturities.

Business Outlook

Development pipeline supplements earnings visibility over the next 2-3 years

Besides recurring income, FPL’s development pipeline also supplements its earnings visibility and should be sufficient to drive development income over the next 2-3 years. The company’s unbilled sales stood at S$2.7 billion at the end of June, spread across Singapore (S$0.5 billion), China (S$0.3 billion), and Australia (S$1.9 billion). As most of the presold revenue is derived from Australia and China, where revenue recognition is tied to project completion and settlement, we expect earnings contribution from FPL’s development business to remain volatile while recurring income anchors PBIT.

The development pipeline in Singapore and China looks dry. FPL only has two projects currently under development in Singapore, being the fully-owned North Park Residences that is scheduled to be completed in 4QFY18, and the 40%-owned Seaside Residences that has a target completion date of 2QFY21. The group expects to launch the Jiak Kim Street project—its only land bank in Singapore—in 2H19, which should yield 500 units.

In China, FPL expects to complete Phase 4F of Gemdale Megacity (99.4% sold) and Phase 3C2 of Baitang One in 4QFY18 and 4QFY19 respectively. Meanwhile in Australia, the group has a strong residential development pipeline of 15,650 units with S$8.2 billion of gross development value. FPL plans to launch 1,850 of those units in the current financial year, with 1,250 units already released for sale during the nine months ended June.

Downturn in Australia’s housing market: severe price crash is unlikely

The ongoing downturn in Australia’s residential market is set to continue for some time, given the sector headwinds from rising mortgage rates, poor affordability, and rising unit supply. After Westpac Banking Corp raised its key home loan interest rate in late August, other big Australian banks— Australia and New Zealand Banking Group and Commonwealth Bank of Australia—also hiked their rates early this month. National Australia Bank was the only bank among the big four Australian banks that refrained from lifting its variable mortgage rate amid higher short-term funding costs this year.

The increasing mortgage costs are likely to weigh on buyer demand, which is already weak due to expensive house prices. According to the 14th Annual Demographia International Housing Affordability Survey, Australia is among the least affordable countries for housing, ranking third behind New Zealand and Hong Kong. The ratio of household disposable income to house prices, a benchmark for housing affordability, has climbed steadily over the years (see Figure 4) to levels that indicate severely unaffordable housing.

Figure 4: Home prices in Australia have climbed to sky-high levels

Meanwhile, a high volume of dwelling constructions in recent years has led to climbing vacancy rates in major cities in Australia. For instance, SQM Research figures show that 2.8% of residential dwellings were unoccupied in June—the highest vacancy rate in at least 13 years. The higher vacancy rates are expected to put further downward pressure on home prices and rents in the immediate future.

On the bright side, we expect the ongoing housing downturn in Australia to be a gradual correction rather than a severe crash. The country’s strong population growth should support demand for housing. The above-trend domestic economic growth and improving labor market conditions also bode well for owner-occupier demand, although wages growth has remained tepid.

Australia’s rising population (see Figure 5) has been an important factor behind housing demand, and the Urban Development Institute of Australia expects population growth to remain strong and people on student visas to drive net overseas migration. In 2017, the nation as a whole added 1.58% of total estimated residents to 24.9m.

Figure 5: Solid population growth in Australia

In addition, the current pull-back in home prices will improve affordability for owner-occupiers. According to a report in August by Australian Housing and Urban Research Institute, some 2.1m households—which make up more than a quarter of all Australian households—are private renters. The falling prices will bring home ownership within the reach of a greater number of these renters, thus providing a demand floor under the residential property market.

Recommendation

To sum up, we are Neutral on FPL’s credit outlook and satisfied with its financial health. Although net adjusted gearing including perps looks significant, the group’s credit profile is supported by its well-diversified property portfolio, strong recurring income base, and good access to capital markets.

Within the FPLSP curve, we like the FPLSP 5.000% Perpetual Corp (SGD) and the FPLSP 3.950% Perpetual Corp (SGD), which are offering very generous yield pickup above the senior FPLSP bonds. The FPLSP 5% perp and FPLSP 3.95% perp are indicating at ask yield to worst (“YTW”) of 4.14% (Z-spread: 208bps) and 5.13% (Z-spread: 277bps) respectively. The latter is especially attractive and close to the dividend yield of 5.21% from FPL’s ordinary shares (based on dividends paid for FY17 and share price of S$1.65).

Between the two FPLSP perps mentioned above, the FPLSP 5% perp carries lower extension risk due to its significantly wider reset spread (3.015%). We prefer the FPLSP 3.95% perp (reset spread: 2.245%) over the FPLSP 4.380% Perpetual Corp (SGD) due to its nearer coupon reset date and better valuation. The FPLSP 4.38% is first callable in January 2023, but its coupon reset will only take place in January 2028.

Among the straight bonds, we think the USD-denominated FPLSP 2.500% 21Jul2021 Corp (USD) is most attractive. The FPLSP 2.5% ‘21s (USD) are indicating at YTW (ask) of 4.80%, which translates to around 3.96% for a SGD investor on a post-swap basis.

The other FPLSP senior SGD bonds provide decent value against the bonds of major Singapore property companies. As a reference, the senior FPLSP bonds are yielding sizeable spreads above similar-tenor bonds of CapitaLand Limited and City Developments Limited. We think the generous yield pickup from the FPLSP senior bonds are good compensation for FPL’s more aggressive balance sheet, which is partially mitigated by the higher mix of recurring income assets in its property portfolio.

Figure 6: Relative valuation

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) has a principal position in FPLSP 3.650% 22May2022 Corp (SGD) - Retail. The analyst who produced this report owns shares in Fraser and Neave, Limited, and City Developments Limited.