PhillipCapital has initiated coverage on OUE LJ3 -1.64% REIT, calling it a &ldquo 50% discounted investment-grade REIT&rdquo with upside potential from asset enhancements.

 

In a June 24 note, research head Paul Chew and analyst Liu Miaomiao note that OUE REIT has &ldquo the largest discount&rdquo to net asset value (NAV) among S-REITs rated &ldquo investment grade&rdquo , at 0.43x P/NAV. OUE REIT also boasts an &ldquo attractive&rdquo yield of 7.8%, they add. 

 

Starting OUE REIT at &ldquo buy&rdquo with a 33-cent target price, 27% above its last close price of 26 cents, Chew and Liu say the NAV discount is &ldquo not warranted&rdquo . &ldquo Around 92% of the portfolio is in Singapore with resilient occupancy rates and rental growth.&rdquo

 

OUE REIT is one of Singapore' s largest diversified REITs, say the analysts, with assets totalling $6.3 billion as of December 2023. Its assets are OUE Bayfront, One Raffles Place, OUE Downtown Office, Mandarin Gallery, Hilton Singapore Orchard, Crowne Plaza Changi Airport and Lippo Plaza in downtown Shanghai. 

 

Upside potential from AEI and repositioning

 

Chew and Liu see upside potential from asset enhancement initiatives (AEI) and repositioning, with downside protected by the master lease. 

 

Hilton had its full contribution in FY2023 after repositioning from Mandarin Orchard, focusing more on business travellers with a target on US customers, thereby increasing revenue per available room (RevPAR) by 27% after rebranding. 

 

&ldquo We forecast RevPAR to grow by 11% for Hilton in FY2024, given the continued recovery of visitor arrivals and limited new supply,&rdquo they note. &ldquo Meanwhile, Crowne Plaza also completed its AEI in October 2023. The master lease agreement ensures a minimum rent of $67.5 million, supporting a group yield of about 6%.&rdquo

 

Hilton is leased to OUE Limited under a master lease agreement with an initial term of 15 years starting from July 2013, and an option to renew for an additional 15 years. Crowne Plaza is also leased to OUE Airport Hotel Pte. Ltd. under a master lease agreement until May 2028, with an option to renew for two consecutive five-year terms. 

 

The master lease agreements consist of both a fixed rent component and a variable rent component. Variable rent for Hilton comprises a sum of 33.0% of gross operating revenue (GOR) and 27.5% of gross operating profit (GOP), subject to a minimum rent of $45.0 million. 

 

For Crowne Plaza, variable rent comprises the sum of 4% of hotel F& B revenues, 33% of hotel rooms and other revenues not related to F& B, 30% of hotel GOP and 80% of gross rental income from leased space, subject to a minimum rent of $22.5 million. 

 

OUE REIT has been enjoying downside protection since Covid-19, and the variable component just surpassed the minimum level in 2023, reaching $91.6 million. Thus, Chew and Liu &ldquo believe the two hotels will continue performing going forward&rdquo .

 

High rental reversion 

 

Chew and Liu expect high rental reversion to sustain in FY2024. OUE REIT managed to secure high rental reversions of 12.0% for office and 13.7% for retail in FY2023. This momentum is expected to continue in FY2024 at 10%, say the analysts.

 

&ldquo We believe the new office supply will not place significant rental pressure, as asking rents are higher than the office properties owned by OUE REIT. While rental reversion for Lippo Shanghai may still be negative, given its small revenue exposure of 7.7%, we believe the effect on the overall portfolio will be marginal.&rdquo

 

Attractive, investment-grade dividend yield

 

OUE REIT obtained an &ldquo investment grade&rdquo rating by S& P in 2023. Compared to the nine other S-REITs with investment ratings, OUE REIT has a relatively healthy gearing of 38.8%, the largest discount of 0.43x P/NAV, and an attractive yield of 7.8%, say Chew and Liu.

 

Early in June, the manager of OUE REIT announced it had priced $250 million of green notes under its $2 billion multicurrency debt issuance programme. Chew and Liu note that this green bond issuance is at a &ldquo more favourable&rdquo rate of 4.1%, lower than the current all-in cost of debt, which was 4.5% in 1Q2024. &ldquo We do expect another year of interest rate headwinds, causing DPU to decline further in FY2024 with a recovery in FY2025.&rdquo

 

OUE REIT follows a distribution policy of at least 90% of its taxable income. Since its listing in 2012, it has been distributing above 92%. In FY2023, the payout ratio was 93.5%. The REIT has consistently paid out quarterly dividends. 

 

Chew and Liu expect a DPU of 2.0 cents for FY2024 and 2.9 cents for FY2025, translating into yields of 7.8% and 11.4% respectively.

The corporate exercise is likely to boost the company&rsquo s NAV per share and may leave it with a narrower public float

 

INVESTORS reacted positively this past week to OUE&rsquo s announcement of an off-market, equal-access buyback of up to 10 per cent of its outstanding shares.

 

The corporate exercise may not result in a lasting re-rating of the real estate and healthcare group&rsquo s depressed share price, though.

 

Over the longer term, the smaller number of shares in issue may just reduce their trading liquidity and shrink the company&rsquo s investor following.

 

On May 20, OUE unveiled plans to repurchase more than 84 million shares at S$1.25 apiece &ndash a 20 per cent premium to the stock&rsquo s average closing price over the five trading days preceding the date of the announcement.

 

The offer will provide all shareholders of OUE with the option, but not the obligation, to sell up to 10 per cent of their shares for more than their recent market price.

 

The shareholders may tender shares in excess of 10 per cent of their holdings, if other shareholders do not accept their full entitlements.

 

All shares purchased under the offer will be cancelled immediately.

 

OUE said the share buyback &ndash which could cost as much as S$105.1 million &ndash is to commemorate its 60th anniversary, in addition to the special dividend of S$0.02 per share that was paid last week.

 

Including the special dividend, OUE declared total dividends for 2023 of S$0.04 per share &ndash or more than S$33.6 million, based on its 840.4 million outstanding shares.

 

OUE said the share buyback would also enhance shareholder value, as the reduced number of shares in issue would boost its earnings per share and its net asset value (NAV) per share.

 

The market seemed to accept this narrative last week. The company&rsquo s share price surged the day after the share buyback plan was announced, and continued climbing over the rest of the week.

 

OUE closed Friday (May 24) at S$1.17, up nearly 10.4 per cent for the week.

 

Higher NAV per share

In hindsight, OUE provided a strong hint that an off-market share buyback at a significant premium to market price might have been coming when it gave notice of its annual general meeting (AGM) last month.

 

The AGM notice said the company would seek shareholder approval for a mandate to purchase up to 10 per cent of its shares. This new mandate was similar to the one approved by shareholders at the previous AGM, except for the maximum prices OUE is allowed to pay for off-market purchases of its shares.

 

Under the new mandate, OUE is not allowed to pay more than 120 per cent of the average closing price over the preceding five trading days in the case of off-market purchases, and 105 per cent in the case of market purchases.

 

The previous mandate capped the maximum price for both market and off-market purchases at 105 per cent of the closing price over the preceding five trading days.

 

The new share purchase mandate was approved at OUE&rsquo s AGM held on Apr 26, paving the way for the company to announce its off-market, equal-access buyback offer at S$1.25 per share last week.

 

What financial impact would the buyback have on OUE? The company&rsquo s announcement last week did not provide detailed information, but its letter to shareholders last month about the new share purchase mandate offers some clues.

 

The company said in the letter that the new mandate would allow an off-market purchase of up to 84.2 million shares at a maximum price of S$1.284 per share, based on the number of shares in issue and their market price at the time.

 

This would have lifted the company&rsquo s NAV per share as at Dec 31 from S$4.32 to S$4.66, and pushed its gearing ratio up from 0.46 to 0.49.

 

It seems likely to me that the off-market, equal-access buyback at S$1.25 per share OUE has now proposed will have a similar financial impact.

 

Fewer shares in public hands

This column has in the past expressed ambivalence about share buybacks &ndash because companies generally do not explain how they determine that their shares offer good value.

 

It seems clear, however, that OUE is currently being undervalued by the market. Even after their recent bounce, the company&rsquo s shares are trading at a discount to NAV of nearly 73 per cent.

 

OUE has also divested more than S$1 billion worth of assets over the past four years, its top executives noted during the recent AGM. This helped reduce its gearing ratio from 0.58 as at end-2019 to 0.46 as at end-2023.

 

OUE&rsquo s off-market, equal-access buyback may not permanently improve investor appetite for its shares, though. Many other companies with significant exposure to real estate assets trade at big discounts to book value, too.

 

Moreover, OUE does not have a big public float. Stephen Riady, the company&rsquo s chairman and group CEO, has a deemed interest in 618.9 million &ndash or about 73.6 per cent &ndash of OUE&rsquo s outstanding shares.

 

Assuming all OUE&rsquo s shareholders utilise their full entitlements under the buyback offer, the roughly 221.5 million shares currently in the hands of the public would shrink by 10 per cent &ndash that is, 22.2 million shares.

 

On the other hand, if OUE&rsquo s controlling shareholders choose to hold on to their shares, and the company&rsquo s minority shareholders tender shares in excess of 10 per cent of their holdings, the number of shares in public hands could shrink by as much as 84 million shares.

 

By my calculations, this would result in OUE&rsquo s public float shrinking from the current 26.4 per cent to just 16.4 per cent.

 

This could weaken OUE&rsquo s investor following, weigh on the market valuation of its shares, and ultimately leave the company&rsquo s minority shareholders vulnerable to a lowball offer.

 

When I asked OUE last week whether the various entities linked to Riady would be taking up their entitlements, the company said it was not in a position to comment on behalf of its shareholders.

 

&ldquo Every shareholder has an equitable opportunity to realise a portion of their investment at an attractive premium over recent market prices,&rdquo it added.

 

&ldquo We currently have a public float of approximately 25 to 26 per cent and we do not expect any issue meeting the free float requirements under the listing rules.&rdquo