Sunday, July 13, 2008

Cambridge Industrial Trust: Fundamental Analysis

I was attracted to CIT because of its near 10% yield. CIT holds many small, light-industrial properties in Singapore which it manages and rents out. Below is a simple analysis. Risks are in red.

A REIT's business model is pretty simple:
1) Get money
2) Use money to buy properties. Rent out properties, collect rent, pay the profits to shareholders
3) Go back to 1.

1) Financing:
Back in the days of rising share prices ('05 to '07), REITs could just raise money by issuing their highly valued shares, which they used to buy properties yielding more than the shares. This lead to profit growth which pushed their share price higher allowing more money to be raised, in a virtuous cycle.

Now, with falling stock prices and the sub-prime mess, REIT's may actually have to get their lifeblood (refinancing) from people who aren't too keen to give it. Witness the problems with Allco REIT's refinancing problems because of its large debt, ratings downgrade and potential refinancing problems (a vicious cycle).

How has CIT fared?

In Dec 07, S&P reaffirmed CITs BBB credit rating, while upgrading the outlook from stable to positive.

Their current funding position. They have $400m debt (from 1Q08 results) on their balance sheet which is from (paraphrased from their 07 Annual Report, Note 7 in finaicial stmnts):

  • Financing agreement on 8th Feb 07 to raise $400m, arranged by AMBN Ambro, with funding from 'Orchid Funding', which is passed thtough a chain of several special-purpose-vehicle entities (SPVs), to paper issued on the US Asset Backed Commercial Paper market. The funding is for 2 years (so renewable Feb 2009), and may be extended an additional 2 years with consent from ABN Ambro.
My comments:
  • Their funding comes from the US debt market, they were lucky to refinance just before sub-prime. This funding/luck lasts until Feb 2009 - a bit soon - need to see if ABM Ambro extebds funding for 2 more years first...
  • Why the chain of SPVs? Why not just issue the debt themselves? SPVs are notoriously un-transprent and one of their purposes is to hide debt, or conditions leading to potential debt, from the balance sheet. Maybe this is normal and there are legitimate reasons for this - I am not in the finance industry.

2) Buy properties and rent them out:
  • From their property and tenant list, they rent to SMEs, which would increase the risk of default.
  • The property market is highly cyclical, tied to the overall economy. See chart 5 on p2 of this report got a graph of industrial rental yields since the Asian crisis. In bad times, there is a glut of vacant properties, developers go bankrupt and stop building. When good times return, rents go up, followed by building prices, which spurs developers to develop property, leading to a repeat of the cycle.
  • My comments: My guess is that we are probably near the top of the property cycle. Others are projecting moderate growth for 2008.
  • Longer term contracts are more normal for industrial properties - This is a reason why the rentals for industrial properties are less volatile. Most of CITs tenants are locked in to 6-7 year rental contracts, reducing the cyclical risk.
  • One thing I'm always worried about low valued cyclical stocks is that the low valuation often reflects that earnings are about to dive off a cliff.
  • Growth Potential: Only way for CIT to grow is through acquisitions. Singapore REITs may borrow up to 60% of their properties' value if they are graded by Moodys or S&P, or 35% if not (Sect 9.2 of MAS regulations).
    At 31 Mar 08, CIT's property is worth 956m and total borrowings of 357m giving a gearing ratio of 37%.
3) Should I buy?
  • Good value, but not irresistible value due to potential cyclical and financing issues.
  • Edited 19th July 08: On 11th Jul, ML issued a report saying "S$337 million worth of debt due for renewal in 1Q09. Expects weighted average cost of debt to rise to 4.6% by 2010 from 2.9% currently". This would reduce their 1Q08 income from 12m to 8m, a reduction of 1/3.
  • Edited 19th July 08: However, the stock did not react to the news of the ML report badly...
  • The market in general (and REITS) are still going down. Can wait...
  • CIT Does not have controlling shareholder, may be target of acquisition.
My decision is: No buy. Firstly because the market is still going down. Secondly, would need to see at what rate they secure funding in 1Q09 first...

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