Should you buy Frasers Property’s 3.95% perps callable in October 2022?

FY21 Financial Results

During the fiscal year ended 30 September 2021 (“FY21”), FPL reported SGD 3,763.8m in revenue which represents a 4.6% year-on-year (“YoY”) increase from SGD 3,597.0m in FY20. Profit before interest, fair value change, taxation and exceptional items (“PBIT”) for FY21 was SGD 1,424.7m, up 14.4% from a year ago. Results were however boosted by higher contributions from I&L properties due to the recognition of gains from the reclassification of some I&L properties that were held for sale. If we exclude the one-time gain on the reclassification, PBIT for FY21 would be SGD 1,069m which is a 14.2% decrease YoY.

From Table 1, we see that PBIT largely fell for most business segments except for Australia and Hospitality. The fall in PBIT for Singapore, Thailand & Vietnam and Others were due to reduced level of residential settlements and lower profit recognition from residential developments. As mentioned above, PBIT for the Industrial segment has been boosted by the one-time gain from the reclassification of I&L properties while Australia saw a gain of 58.7% due to higher level of residential settlements.

Table 1: FPL’s FY21 PBIT by business segment (in SGD m)

Growth of industrial assets

Within the last 5 years, FPL has been making a large effort to shift towards I&L and commercial and business parks exposure in its properties. As seen from Figure 2, in FY16, I&L, commercial and business parks made up 37% (SGD 7.5b) of its total property assets and grew at 19% CAGR (compound annual growth rate) to 52% (SGD 17.8b) in FY21.

Figure 2: Total property assets

In FY21, FPL completed 8 assets (6 in Australia and 2 in Europe) totalling SGD 406m in Gross Development Value (“GDV”). Looking ahead, FPL is currently developing 11 projects totalling to SGD 751m in GDV (9 in Australia and 2 in Europe) and they are expected to be completed in FY22 and FY23.  

The shift to industrial assets is due to the strong demand for these spaces underpinned by the growth in e-commerce. Rental growth is expected to pick up due to strong demand and limited supply for logistics and industrial spaces.

Strong earnings visibility and pipeline

FPL has a strong pipeline of development projects and this provides earnings visibility and revenue recognition from the completion of these projects. As of 30 September 2021, FPL has 30 development projects expected to be completed in FY22.

Additionally, FPL has SGD 1.8b of unrecognised revenue which will provide earnings and cashflow visibility going forward. Table 4 in the appendix lists all the development projects in FPL’s pipeline to be completed in 2022.

Figure 3: Total unrecognised revenue

Additionally, 68% of FPL’s FY21 PBIT was recurring income which provides stable and consistent cashflows to the company. As mentioned previously, a portfolio of industrial properties was reclassified from properties held for sale to investment properties. This was part of the group’s strategic initiative to grow its industrial and logistics asset base. FPL has no intention to sell these properties but instead hold them for capital appreciation. These assets are being leased to third parties for rental income.

Liquidity and credit profile

FPL has SGD 3.78b of cash and bank deposits as of FY21. Additionally it has more than SGD 3b of unused credit lines for their funding needs. Total borrowings was SGD 17.3b of which SGD 4.85b are short term borrowings. FPL may use its unused credit lines to refinance its short term borrowings. The balance of the gross proceeds from their 2021 rights issue was SGD 900.1m, which will provide liquidity to pay down its short term debts.

FPL has taken steps to reduce their gearing as seen from Figure 4, net debt to equity fell from 105.0% in 4Q20 to 73.7% in 4Q21. The management said that the company is comfortable with net gearing at a range between 80% and 100%. 

Figure 4: FPL’s net debt to equity

Table 2: Estimated credit ratios of comparable property developers

From Table 2, FPL has a high gearing ratio when compared to other comparable property developers. This could be due to the large amount of development in its pipeline. Interest coverage ratio is adequate at 4.0x, signifying earnings will be able to cover its financing costs.

Relative Valuation

At first glance, the FPLSP 3.950% Perpetual Corp (SGD) looks very attractive at its yield to next call (“YTC”) of 7.70% with about 10 months to its call date on 5 October 2022. If FPL does not call the notes, the 3.950% perps will reset at the prevailing SGD 5Y SOR + 2.245%.

With the US Federal Reserve looking to start hiking rates in 2022, this may push the 5Y SOR up, causing the reset rate to be more than its current coupon rate, increasing the likelihood that its financing cost will be more than its current coupon rate if the notes are not redeemed on its call date on 5 October 2022. As at 6 January 2022, the 5Y SOR was 1.6% and at current prices, the reset reference rate is at 3.845%, just 10 basis points below its current coupon rate of 3.95%.

Additionally, FPL may use its cash and banking lines to refinance short term debt to repay existing short term debt.

Another point to note is that the group had previously called back perps whose reset rates are lower than their coupon rate. Frasers Hospitality Trust called the FHREIT 4.450% Perpetual Corp (SGD) on their call date on 12 May 2021. The 4.450% perps could have reset at 3.475% (5Y SOR on 12 May 2021 was 1.025%). However, the issue size for the 4.450% perps was much lower at SGD 100m as compared to SGD 350m for the 3.95% perps. 

Figure 5: Relative valuation among other real estate perpetual notes

The FPLSP 4.380% Perpetual Corp (SGD) has a YTC of 4.27% (callable on 17 Jan 2023) and will reset on 17 January 2028. It will reset at the SGD 10Y SOR + initial spread of 2.180% + step-Up margin of 100bps. The FPLSP 4.38% Perpetual Corp (SGD) and FPLSP 4.980% Perpetual Corp (SGD)  have yields-to-worst (“YTW”) of 4.27% and 4.20% respectively, although we cannot rule out price fluctuations due to higher interest rates.

In terms of fixed rate notes, most of FPL issues are of longer maturities as seen from Table 3. Investors who invest in these bonds should be aware of interest rate risks and should be prepared to hold them until maturity.

Table 3: FPL fixed rate notes

Conclusion

We think that the 3.950% perps provide the highest yield along the FPLSP curve as the perps have a short call date of approximately 10 months to the next call date. The FPLSP 3.950% Perpetual Corp (SGD) is attractively priced as the issuer has a strong credit profile with about SGD 3b in cash and about SGD 3b in unused credit lines. At the 5Y SOR last price, the 5Y SOR was 1.6%, making it likely that the reset rate will be higher than the current coupon of 3.95%, if the notes are not called in October 2022. Investors who do not mind holding bonds until maturity may consider the fixed rate notes but should be aware of rising interest rate risks.  

Appendix

Table 4: FPL’s pipeline of development projects to be completed in FY22

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in FPLSP 4.980% Perpetual Corp (SGD) and the analyst who produced this report holds a NIL position in the abovementioned securities.