Shareholders of CapitaLand Investment (CLI) must be breathing sighs of relief at the performance of the stock and CLI’s results for FY2021 ended December 2021. Excluding the 15 cents dividend, CLI’s share price is up some 11.5% year to date. Since the listing of CLI at $2.95 on Sept 20 last year, its share price is up 31.5%.
Geographically, CLI’s earnings are a lot more diversified than the old CapitaLand. For instance, in FY2021, 36% of ebitda was from developed markets excluding Singapore, 33% from Singapore, 28% from China, and 3% from emerging markets.
The old CapitaLand was heavy on residential development, retail malls and integrated developments, with many of these in China. CapitaLand’s previous management was focused on a high exposure to China. The target was Singapore and China contributing 80% to assets and earnings.
In FY2019, before the pandemic, China contributed 43.4% to ebitda, more than any other country including Singapore, which accounted for 38.5% of ebitda. Developed markets comprised 14.6%, and other Asia markets 3.4%. Hence, ebitda from China and Singapore, which was more than 80% of ebitda, is now down to 61%. Following the restructuring where the development business — in particular residential development — was privatised, CLI’s earnings are more balanced geographically.
In addition, Chinese developers are trading at significant discounts — in large part because of bond defaults by around 101 developers, or 1% of Chinese developers, based on Bloomberg data.
Missteps along the way
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That CLI has managed to outperform the Straits Times Index and other real estate-based companies, including developers, is a credit to the foresight of its current management team. It was not always like this.
In 2014, CapitaLand divested Australand which was focused on logistics and industrial properties in Australia — the so-called new economy assets of today. CapitaLand then doubled down on retail malls and integrated properties, in particular in China. Grandiose projects such as Raffles City Chongqing and its three Raffles City projects in Shenzhen, Chengdu and Ningbo tied up its balance sheet.
In 2019, CapitaLand acquired Ascendas-Singbridge (ASB), which returned new economy assets into the fold. These included logistics, data centres, IT and science parks, and gave the company a toehold in Australia and other developed markets, as well as exposure to these new asset classes in India and China.
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As a result, the focus in China has shifted. Retail malls and integrated projects are balance-sheet-heavy. They also take a longer time to develop and stabilise. ASB brought with it IT and science parks in China, and innovation hubs which are more relevant to China’s dual circulation and common prosperity themes.
There was an overlap on the lodging front after the ASB merger, which resulted in Ascott Residence Trust (ART) merging with Ascendas Hospitality Trust. Separately, in 2020, CapitaLand Mall Trust merged with CapitaLand Commercial Trust, forming CapitaLand Integrated Commercial Trust (CICT), Asia’s second largest REIT by assets and market capitalisation.
CLI finds its stride
With the burden of the development business and much of the balance-sheet-heavy Chinese business removed, CLI appears to have found its stride. While there is some noise in its FY2021 financials, the overall performance underscores the advantage of restructuring CapitaLand into a real estate investment manager (REIM).
In September last year, CapitaLand was split into CLI which is listed, with the unlisted development business placed in CapitaLand Development (CLD). CapitaLand’s shareholders were given one CLI share, 95 cents and some odd lots of CICT units for every CapitaLand share they owned.
In FY2021 (see Table 1 “CLI financial highlights”) despite an ongoing pandemic, CLI reversed an FY2020 loss of $559 million into a patmi of $1,349 million.
CLI’s operating patmi was $497 million, up 12.2% y-o-y. Operating patmi comprises profit from business operations excluding any gains or losses from divestments, revaluations and impairments. Operating patmi was underpinned by higher fee income from its fund management and lodging management businesses, and improved property performance from CLI’s investment properties portfolio.
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Cash patmi for FY2021 doubled to $1.113 billion compared to FY2020, on the back of improved operating performance and record asset recycling in 2021, which yielded a realised portfolio gain of $616 million. Cash patmi comprises operating patmi, divestment gains and realised revaluation gains. The all-round better performance yielded a return on equity (ROE) of 8.7%. CLI’s management is now looking at ROE rising to double digits.
The case for a REIM
REIMs and REITs have a higher number of income-producing assets. In general, REIMs generally adopt a more asset-light model, using less of their balance sheet in development and other types of properties. REIMs tend to lean on third-party capital to grow assets under management (AUM) and fee income. This enables them to achieve higher ROEs than developers for an equivalent amount of AUM. REIMs earn fees determined by outcome and pre-defined formula as well as performance fees when managed private funds exceed the target returns, thereby further boosting their ROEs.
Developers’ ROE are likely to be calculated over a larger capital base. This is especially so for developers that fund large-scale developments with long development and gestation periods on their own balance sheets. For instance, the ROE of City Developments in FY2021 was less than 2%, and the ROE of UOL Group was 3.1% in FY2021.
Singapore developers — whose cash flows are relatively resilient — trade at significant discounts to net asset value (NAV). CapitaLand also traded at a discount when it owned the development business. As a REIM , CLI started trading a shade above its FY2020 NAV of $2.83, and is now comfortably above its Dec 31, 2021 NAV of $3.12.
“The very nature of development means you convert land into an income-producing asset, so you take on risk and time to do that. Some investors do not have the appetite to take on the risk and the lower desire to take such risk is reflected in the share price which is lower than the natural value of the asset,” explains Jonathan Yap, CEO, fund management, CLI, in a recent interview.
The trading price of companies reflects investors’ assessment of the companies and the investors’ risk-return appetite. If the perceived higher risk of the development model is not desired by investors, which appears to be the case in more recent times, the share price of developers would be affected.
In addition, cash flow and earnings from development projects are lumpy, unlike REIMs where cash flow is a lot more stable.
“In contrast, current market trends show investors view REIMs more positively as we have a higher base of recurring fee income as well as a higher proportion of investments in income-producing or value-add properties and development properties with shorter gestation periods,” Yap explains.
That does not mean that CLI will not take on development projects. “Both our listed and private fund platforms can undertake development projects and will evaluate these projects based on their ability to meet the requirements of our investors subject to the respective fund mandate and extent of development limit,” Yap says.
As an example, CapitaLand India Logistics Fund II invests in the development of logistics assets in warehousing and manufacturing hubs in six major cities in India — Ahmedabad, Bangalore, Chennai, Mumbai, National Capital Region (NCR), and Pune — as well as in emerging markets such as Coimbatore, Guwahati, Jaipur, Kolkata and Lucknow.
Ascendas India Logistics Programme was launched in 2018 to develop six logistics and industrial projects in Bangalore, Chennai, NCR, and Pune. Two of the projects are operational.
Some fund managers, such as ARA Asset Management prior to its acquisition, take minimal or no stakes in funds and REITs they manage.
CLI has a different positioning. It will continue to take meaningful stakes in its private equity funds, and hold at least 20% in its listed REITs.
“We will take a position in development funds. For example in India, we have logistics development funds where our role is to act as a fund manager and we take stakes,” Yap says, to show that CLI has skin in the game, so to speak.
Elsewhere, CICT and CLD are partners in CapitaSpring. In Science Park, Ascendas REIT is partnering with CLD in a redevelopment project.
Geographical and sector focus
As Yap tells it, CLI has sharpened the focus of its REITs, as either asset classes focused on developed markets, or single-country-focused, emerging-market REITs. S-REITs with local, committed sponsors, and developed market assets usually trade at tighter yields than emerging-market-focused REITs. This reflects the tighter property yields in developed markets, the lower risk in terms of governance and regulation, and the lower interest rate regime in developed markets.
Emerging markets have higher risk-free rates than developed markets, and REITs’ trading yields take their pricing off risk-free rates.
“Trading yields reflect investors’ assessment of the risk-return profile of the REIT. If they like certain REITs, they will pay for it. For example at the start of Covid, the new economy REITs did well. Secondly, trading yield reflects the portfolio within the REIT. If you buy a REIT with developed market assets, the trading yield will be lower because the underlying yield of the assets is lower. Singapore assets trade at lower yields than emerging market assets. The trading yield reflects the ability of the manager, and investors’ assessment of the manager, which is why some [developed market REITs] trade at discounts,” Yap indicates.
“As a sponsor we do everything to support our REIT. Investors see that the sponsor gives the REIT the best support because they are an important part of the CLI model,” he adds.
In emerging markets, CLI is the sponsor to two REITs and a property trust — CapitaLand China Trust (CLCT), CapitaLand Malaysia Trust (CLMT) — which was formerly CapitaLand Malaysia Mall Trust — and Ascendas India Trust (AIT). These are single-country, emerging-markets-focused REITs.
CLCT, which formerly owned retail malls, has widened its mandate to include logistics, data centres, IT and science parks as these are assets supporting China’s next stage of development.
AIT, which focused mainly on business and IT parks, has widened its scope to include logistics properties and data centres. CLCT now has a portfolio of office, retail and integrated developments. Yap says the boundaries and requirements of asset classes have become increasingly complex. But, having a large and diversified portfolio of mainly commercial properties lowers concentration risk and enables CICT to undertake perhaps some redevelopment projects.
Interestingly, Link REIT — the only other REIT in Asia that compares with CICT’s size — has extended its mandate from just retail property in Hong Kong to logistics assets in China and office properties in Australia and UK, blurring asset classes even more than CICT.
“The way we look at our listed REITs is developed markets versus emerging markets. Ascendas REIT and CICT are only focused on developed markets. CICT focuses largely on Singapore. With the transaction in Australia, we are still going to be more than 90% focused on Singapore and at no time will Singapore be less than 80%. ART has a global mandate,” Yap elaborates. Because of its lower cost of capital in its home market, CICT’s manager has made it very clear that Singapore remains at these high levels of exposure.
Singapore’s second largest REIT, Ascendas REIT, which once owned a handful of properties in China, is now wholly developed market-focused. In fact, 81% of Ascendas REIT’s portfolio is predominantly in spaces catering to technology or life science-focused tenants, data centres and logistics.
For instance, in the US, Ascendas REIT is present in locations attractive to technology and life science tenants such as San Diego, Raleigh and Portland. “We can be broader in country coverage without losing our risk profile,” Yap says.
ART’s lodging portfolio — which had always focused on long-stay serviced residences globally and rental homes in Japan — has expanded to include purpose-built student accommodation (PBSA). Weighted average lease expiries in PBSA is around 12 months. ART is looking at including multi-family residences to its portfolio.
Bursa-listed CLMT in Malaysia has expanded its mandate to include non-retail assets. Some investors prefer the higher yields of emerging markets, whether China, India or Malaysia. “Because these REITs are single-country-focused, we try to give sectoral diversification to investors,” Yap says.
Analysts expect continued growth
Analysts are unanimous in their “buy” recommendations. In a report dated March 17, JP Morgan says CLI is likely to continue delivering double-digit growth in patmi, of 17% annually over the next two years. According to the 49-page report, the reason is structural.
“Rising allocation to real estate by global investors from 8.9% in 2013 to 10.9% of AUM in 2021 has been driven by the search for income amidst low bond yields and ageing demographics. Within APAC, CLI’s home market, investors remain under-allocated to real estate at 7.5% of AUM versus their 11.5% target,” JP Morgan says.
As part of this growth, CLI is likely to recycle $10.7 billion of assets on its balance sheet to its REITs and funds. CapitaLand’s management has guided that it could recycle $2 billion to $3 billion a year. Although CLI has a funds under management (FUM) target of $100 billion by 2024, JP Morgan expects CLI’s FUM to grow to $106 billion by 2023. This, coupled with growth in its lodging units, is likely to underpin a 17% per annum growth in core patmi over the next two years, JP Morgan estimates. Part of the patmi growth is likely to be from disposal gains.
“Furthermore, the announcement of share buybacks should signal to the market the undervalued status of CLI’s share price,” JP Morgan says. CLI has an ongoing share buyback programme which started with CapitaLand in July 2021, up to a maximum of 260 million shares. JP Morgan has a target of $4.40 for CLI using a sum-of-the-parts analysis.
All these factors — light balance sheet, FUM growth, fee income, capital recycling and relative income stability in the face of rising interest rates, inflation, war and the pandemic — are keeping investors invested and interested in CLI’s future.
