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My Analysis of Frasers Logistics & Industrial Trust’s Purchase of 21 Logistic Properties in Germany and Netherlands

SGX Listed Frasers Logistics & Industrial Trust (FLT | quote: BUOU) over the past week proposed an acquisition of 21 properties in Germany and Netherlands.

This acquisition requires some massive financing.

I wanted to take a break from writing about this and since my friend B at Forever Financial Freedom wrote a piece about it.

However, Dividend Knight asks in another article of mine whether the S$0.0183 dividends per unit is the post rights dividends per unit that we will be getting.

So I thought I will share some quick thoughts.

I will not be sharing some general overview, and would leave the qualitative thoughts to the end.

The Financing of the Acquisition

In the last quarter, FLT could have distributed a dividend per unit of $0.018 (FLT pays semi annually). On my Dividend Stock Tracker, it lists the dividend yield at 6.7% if the quarterly dividend per unit is $0.0175.  So on my dividend tracker I am not listing the optimistic dividend yield.

The whole purchase consideration is about $325 mil Euros. This works out to be S$515 mil.

So I wonder, why would the gearing go up from 30% to 36%? Couldn’t FLT finance partially by debt?

The above shows some of the forecast changes to the debt, assets, and equity as a result of the acquisition. The actual assets increase is A$945 mil.

According to Goola from the Edge, the management said that FLT is buying over the holding companies which owns the properties.

There are debt in the holding company. And the debt is amortizing. The debt likely amounts to A$463 mil.

Given this, FLT can’t really increase their debt further, unless they increase their equity substantially.

From FLT’s circular, how the financing eventually will turn out is still up in the air.

Since this acquisition is from parent Frasers Property Limited, and Frasers Property Limited owns a large part of FLT, this became an Interested Party Transaction (IPT), that requires an extra general meeting (EGM).

However, from the illustration provided, the target from FLT management is to issue 500 mil placement and non renounce-able rights at $1.

Non-renounce-able means that if you don’t wish to subscribe to the additional rights, to increase your capital, you cannot list the rights on the SGX stock market to be traded. You either subscribe or do not.

Unlike my old China Merchant Pacific non-reounceable rights issue, the Sponsors and substantial shareholders likely will not buy up those non-renounceable rights that we do not subscribe.

As a caveat, my old flame China Merchant Pacific did a non renounceable rights issue to purchase some roads, then the share price, due to overall stock market direction, went below the rights price.

So if the rights is more expensive than the current share price, why would you subscribe to the rights.

For the rights issue to work, the big boys need to somewhat engineer and support the share price. However, there are those problematic situation that nothing could be done.

In the circular, FLT provide a sensitivity analysis of what issue price would make the acquisition accretive, all else being equal.

From the table as long as the issue price is above $0.94 cents it is accretive. Currently the share price is at $1.05 and there are every possibility that the accretive nature might be reduced.

From the circular, the presentation slides, and analyst reports, everyone says this deal will be dividend per unit accretive.

Accretive means that, after all this dilution due to the expanded stock equity base, we will end up with a higher DPU. Which is a good thing. The estimated improvement is 1.7%

Thus, if the last DPU is $0.018, the forecast DPU would be $0.0183.

Annualized at $1.05, the DPU of $0.0732 will give a good dividend of 6.97%.

I always have a spreadsheet that lets me make sense of these acquisition. Since a lot of the figures are forecast, they are not definite. What we know is the current debt, assets and equity, and the forecast future debt, assets and equity.

We know the target is to issue 500 mil shares at S$1 (AUD is currently parity with SGD) and the debt  is 463 mil.

We can work out the new net property income yield , less the interest cost is 3.98%.

How come its this low?

While the circular did state that the NPI yield on the portfolio of property is 5.5%, that is an unleveraged yield. If you factor in that almost 50% of the portfolio is finance by debt, and you need to pay interest, the overall yield is totally different.

Negative Australia Dollars Movement and Negative Reversion of Rents

To answer Dividend Knight’s question, all else being equal, the dividend per unit should work out higher.

I cannot believe so many parties to be wrong on that.

However, if you ask me what is the realistic situation, it gets a little uncertain.

Being a REIT who has assets overseas, you got to deal with the currency fluctuations. This might or might not work in your favor.

And the AUD have been weakening against a lot of other currencies, including the SGD. Currently it is lower than SGD.

If you look at the graph above, we are back to the AUD/SGD situation during FLT’s IPO.

FLT typically hedges their AUD/SGD position for 6 months.

Personally, I don’t believe in hedging unless for operation and working level predictability. If the trend is upwards, or downwards, sooner or later, when you re-hedged, you will need to peg to the new rate.

That is, if you are buying and holding, not speculating. If you are speculating on REITs, then it does matter.

Given this, the S$0.018 DPU is based on a favorable AUD situation, whether the currency is hedged at AUD 1.05.

The DPU could be lower than this forecast put out in the circular.

Another factor is that, for FLT there are lease expiry.

For the past few quarters, those expiring leases are renewed with negative rental revision.

This is not new.

In my FLT IPO article 2 years ago, I provided each properties passing rent versus the market rent.

About 24 out of 54 properties have market rent 15% on average below the passing rent.

Basically, due to the 2-3% annual escalation, their passing rent out ran the market rent (due to the reality low inflation environment). As a landlord you won’t have it any other way.

These 2 are the overhangs that are reducing the DPU.

The potential positive cash flow wise is that the expiry might be low, and that for the rest there are built in 2-3% rental escalation.

How will it turn out? I am not sure. So much moving parts. I am lazy.

The Rational of the Acquisition

In July 2017, Frasers Property completed the acquisition of Netherlands based Geneba Properties for 315 mil Euros. Geneba is a European commercial real estate investment company headquartered in Amsterdam that manages German and Netherlands logistics and industrial properties.

In Feb 2018, Frasers Properties bought 22 assets mainly owned and managed by Alpha Industrial Holding.

Alpha Industrial Holding team is then merged with Geneba.

This became Frasers Property Europe.

Even before going to the EGM, I can anticipate the questions would be rather unpleasant.

In Australia, the Net Property Income Yield has compressed, but it should still be around 6%.

In contrast, the Net Property Income Yield or Market Cap Rate of this portfolio averages 5.5%.

JLL provides market data of the prevailing prime yields of the Germany and Netherlands logistic asset market. It looks like its acrretive versus the market cap rate.

Out of GIY, NIY and NPI, I compare using NPI more as it factors in not the acquisition cost. I am doing a like for like comparison since the market prime yields likely do not include acquisition costs.

The management provides further justification that this is accretive, by comparing the portfolio cap rate (NPI yield) against European REITs. It seems FLT’s acquisition properties’ CAP rate is near the median. The larger REITs have a lower NPI yield than the smaller ones.

Interestingly, Singapore listed Cromwell REIT have an outstanding high NPI yield.

When interest rate is rising, investors would wonder why the heck do the management go to a place to acquire assets that is lower in CAP rate.

In property asset valuation, we tend to compare the property asset’s return versus that of the risk free rate.  This tend to be the 10 year government bond rate.

From Investing.com , we can see the prevailing 10 year government bond yield.

The spread between FLT’s Germany portfolio NPI Yield to 10 year government bond is 5.4% – 0.56% = 4.84%

The spread between FLT’s Netherlands portfolio NPI Yield to 10 year government bond is 5.6% – 0.7% = 4.90%

In contrast, the spread between potential Australia Prime Cap Rate to 10 year government bond is 6% – 2.76% = 3.24%

Singapore properties spread between market cap rate and 10 year Singapore government bonds is lesser than 4%.

In terms of valuation wise, the low bond yields makes the assets attractive in Germany and Netherlands. As FLT investors, we just need to make sure the capital financing make the acquisitions accretive.

Germany and Netherlands are among the top logistics counties in Europe and globally. They are ranked highly by World Bank logistics performance index as prosperous countries with higher property values.

Profile of the REIT Changes

While we know this acquisition does look accretive, given the uncertainty over currency (now with 2 different currencies), negative rent revision and organic rental escalation, this acquisition might not eventually end up accretive.

Firstly, it increases the AUM. Based on market capitalization, the REIT is also larger and therefore it should gain prominence and get better support by institutional investors.

In the Edge, the CEO Robert Wallace said that majority of the investors are Singapore and Hong Kong investors.

An increase in AUM, means the manager automatically boost their fees. The base fee comprises of 0.4% of deposited  property while performance fee is 5% of DPU.

This acquisition does lengthen the WALE of the REIT from 6.8 years to 7.1 years. It diversifies the currency risk a bit.

Looking at the above, this looks like a laddered bond where each year a small percentage of tenants have lease expired for renewal.

This prevents a sudden drop in DPU due to a particularly bad year.

The major tenant composition are gradually reduced. Experienced investors like this, but this is a double edge sword. If your tenant is so strong, sticking with them might make things more stable.

There are some other characteristics:

  1. CIMB is assuming that the NPI Margin is as high as 90%
  2. Some of the properties are on Triple Net Leases
  3. Cost of debt might not necessary rise according to the CEO. Interest rates in Europe is still low and the debt in Europe is amortizing. Compared to bullet loan in this region, if they were to refinance, they might save more cash flow
  4. 89% will have rental escalation linked to CPI or fixed escalation. From what I read the escalation can be low at 1%
  5. FLT will leveraged on FPE to manage. FPE’s management looks strong and experienced. According to the Edge article, it reads like a strong lineage from Prologis. Jorg Schroder, chief investment officer of FPE, is the former managing director of Alpha Industrial and the person who introduced Prologis to Germany. Patrick Frank, FPE’s director of asset management, was formerly director of acquisition at Prologis Germany. Jeroen In Den Kleef, analyst, acquisition at Geneba was also a former Prologis employee. Wulf Meinel, CEO of Geneba was formerly managing director of The Carlyle Group

FPL didn’t gain much directly out of this. What I think happened.

FPL bought this 2 portfolio only last year and start of the year.

Usually, the sponsor will have some time to let the value of the properties appreciate, let CAP rate narrow, then sell it into the REIT to earn some unrealized gains.

The purchase to current acquisition period is very short.

I think it is likely that Frasers Property Limited came across this huge portfolio of assets and such a portfolio available on the market don’t happened a lot.

So FPL purchase these 2 portfolio with debts.

For FLT to purchase, they will need some time to get the funding, especially when they cannot leverage up. It is only now that they can organize a right issue and placement to get this done.

One question shareholders can ask the management during the EGM is that the shareholders have been asking the management are they venturing overseas.

Time and time again we were told that they are staying in Australia as there are opportunities and competency there.

So what has changed?

How much to set aside for Rights Issue?

We won’t know about this. The CEO said in the Edge that last time, the acquisition was with placement and shareholders was not too happy they cannot participate.

So this time they decide to make it a rights issue.

I suppose my best guess is 2/3 of the 500 units will be done by placement. I have a feeling it will be a 10 for 100 units rights issue.

This is just a guess. Depends much on sentiments.

I shared more about stuff on REITs like this in my section on REIT where I go deep into the weeds of investing in REIT. It is FREE and available:

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Unker BJ

Friday 4th of May 2018

FPL needs money for they have bigger fish to fry?

Kyith

Friday 4th of May 2018

Hi Unker BJ, they need to deleverage. Their leverage is pretty high

Alan

Thursday 3rd of May 2018

Actually , I think that an acquisition of this size seems suspicious

1) Why issue equity which is a expensive form of financing to fund such an overly large acquisition. Could they not grow organically or make strategic acquisitions over time. Noted that sales of such "rare" properties seem valuable. But could their parent company hold the assets and divest the slowly into the REIT. Capitaland Retail (unlisted) held the assets for CRCT when their properties achieved a certain form of stability in the form of NPI yield.

2) As you said why the rush and why the sudden need for diversification of portfolio when they were a Australia focused REIT.

Aik Keong Koh

Wednesday 2nd of May 2018

Great write up!! I've been reading their mailer regarding the acquisition and got questions that I'm too busy to find answers to. This acquisition isn't as clear cut as some of my previous REIT holdings, this seems like a lot of arrangements between sponsor and REIT management team. Anyway, now this REIT seems like there is going to hold two forex risks between AUD and EURO. I do hope our strengthening of the SGD won't affect them much.

Kyith

Thursday 3rd of May 2018

Hi Aik Keong,i think the strengthening or rather, weakening of the AUD is going to be negative, how negative I won't know. the question to ask is the speed at which they did all this acquisition. the timing and whether the shareholders are being fleeced.

Dividend Knight

Tuesday 1st of May 2018

Thanks for the explanation! ^^ Looks like a reasonable deal as long as there are no crazy movements in the Euro/SGD exchange rate.

Kyith

Thursday 3rd of May 2018

The deal is ok just that whether what you get in the end if you add on might be different

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