Frasers Logistics and Commercial Trust: Update for Europe Energy Crisis

One tenth of my net worth is in Frasers Logistics and Commercial Trust - one third of their properties are in Europe - and Europe is fucked.  I need to see how they will be affected by both inflation and a recession.

Quick overview of FCLT:

• 105 properties: mostly industrial, logistics or business parks.  3 or 4 are office buildings.  2/3rds are freehold.
• Half the property in Australia, 23% in Germany, 20% in the UK.
• 30% leverage
• Like all SGX REITs, they payout all their cashflows as dividends and never pay down debt.  So they need to borrow or issue new shares every time they acquire.

FCLT is unique in that they provide a list of tenants for most of their properties in their Annual Report (pp57-69).  I go through the list to guess how they will be affected.  All numbers are from 2021.

Germany and The Netherlands

Energy Crisis

I'm most worried about these countries (28% of properties by asset value).  German industry will suffer permanently as they convert from cheap Russian piped gas to expensive shipped LNG.  Energy or gas intensive industries will have to shut down.  Heavy industry could move out, and the country may need a new economic model.

I try to categorise their tenants: I think anyone who is a heavy manufacturer, equipment manufacturer, or in the chemical industry is risky:

I estimate that 36% of their German/Dutch revenue is at risk.  These guys probably have to cut production if there are energy shortages, in the next 1 or 2 years, and then after that adapt to a permanently higher energy price. Don't know how that affects their businesses or rental payments.

Inflation

Soaring energy costs will cause inflation (probably with rapid depreciation of the Euro/Pound).  How well is FCLT protected from this?   "The majority of the REIT's European logistics and industrial leases benefit from CPI linked inflation" (p42).

The UK

The UK only had one industrial building, with small revenue.  Lounge Underwear is a tenant:

(This work is so boring I had to include that photo).

Business parks should nopt be affected by the energy crisis, as they don't manufacture things.  

Commercial (non-industrial) leases in the UK are "usually marked-to-market on lease renewals".  So no inflation protection.

Australia

I think Australian industry will have a recession - the first in 27 years, but not an energy crisis.  Since so little is manufactured there anyway, industry won't be affected.  Not worried about the recession, since its a normal part of business.

Ceva Logistics (2% of Total Gross Revenue) and WeWork (0.7%) look weak.  The rest I can't tell.

FCLT's "logistics and industrial leases generally have fixed annual increments averaging 3.1%", while "commercial leases in Australia generally have fixed increments averaging 3.3%."

Conclusion

I estimate:

• 36% of their German/Dutch revenue is at risk from the energy crisis, or 8.1% of total gross revenue.
• Add another 2.7% revenue at risk from risky companies (Ceva Logistics and WeWork)
• There may be some more recession casualties.  Lets just guess 5%.

Even if *all* 16% of this revenue was lost, the company would survive without raising capital.  Dividends would drop by 27%.  This is a worst case scenario, its not a realistic one.

The bigger risk for a Singapore investor is that SGD will rise against the AUD, EUR and Pound.  Especially for or the latter two, governments will print to help sooth over their energy problems.

Update on Frasers Logistics and Industrial Trust

I looked at FLT 10 months ago, but it never reached my buy price.  With REITs starting to fall, I look again.

July 2019 Acquisition

They acquired another 12 properties.  9 in Germany, 3 in Oz.  Its a significant acquisition, adding 21% to FLT's existing assets.

The numbers look good.  All freehold.  8.6 years WALE.  Slightly DPU accretive.  Better lease expiry profile (p4).

But the one of the tenants may not be so reliable.  Hermes Gmbh is now a top ten tenant, leasing two buildings.  Its a large logistics company that claims to handle 1 in 3 B2C packages in Germany.  Couldn't find any financial info.  But they are owned by Otto Group, which has 177m in profits, zero cashflow from operations vs 172bn in debt (pp 104-106).

Grading the new tenants as reliable, unknown or dodgy (weighted by property price): 37% would be reliable, 44% unknown, and 18% dodgy (just Hermes Gmbh).

FCOT Merger

Just evaluate this as another acquisition.  Its actually 2 acquisitions: the FCOT merger, and an acquisition of (the remaining) Farbourough Business Park. 

Gearing will be 37.4% after the 2 acquisitions.  A bit high.

FCOTs properties are quite big compared to FLTs:

Lets look at the larger ones individually.

China Central Square

This is a is a Grade B office building in the Singapore CBD, with a small retail component.  90.8% occupied (93.9% for the office tower).  WALE is slightly short at 3.7 years (p4).

For grade B offices in general, you need to wait for Grade A rents to rise, after which there is a lagging spillover effect onto Grade B    (1) (2).  The company expects Singapore office rents to be capped in the next 6-12 months (p35).

WeWork is a tenant.

Alexandra Technopark

A technology park building in Singapore outlying area.  WALE 3.5 years.  97% occupied.

FCOT noted (p36) that Singapore Business parks have a 12% vacancy rate , so not expecting positive rent revisions.

Farnborough Park

A business park.  Wale of 6.6 years, 99% occupied.  Long WALE.

The others

Both buildings where WeWork is a tenant have above average vacancy rates (7% for China Square, 18% for Perth).  May not be easy to replace them if they go bust.

Conclusion

The buildings don't seem so good as FLTs existing portfolio.  The Singapore buildings have short WALEs, and don't seem to have potential for rent increases.  The Australia buildings look OK, hopefully Perth is at the low point in the cycle.

How would I value this?

First, I expect the AUD to remain at a low level of SGD 90c.  The Australian Government shows no sign of wanting to raise rates, due to housing prices.

So if the merger fails, I expect DPU of SGD 6.8c.  At a 6% yield, I would pay SGD 1.13.

If the merger goes ahead, they project DPU of 7.38c:

But this is proforma (going back in time, as if the acquisition had been done earlier).  I adjust for a my lower AUD exchange rate, to get 7.14c.  I also deduct WeWork's contribution to get around 7c per share.  So at a 6% yield, I would pay SGD 1.16.

Frasers Logistics and Industrial Trust (FLT)

The Properties

FLIT has 60 industrial properties.  By value:

• 2/3rds are in Australia.   2/3rds of those are in Sydney & Melbourne.  Minimal exposure to Perth (1 property, or about 7% of the Australian properties' value).
• 1/3 are in Germany and the Netherlands

The Australian buildings seem to be mostly small, generic light industrial buildings, with a few large warehouses (5-6 buildings).

The European buildings are large Logistics or Industrial buildings.

None of the buildings seem highly specialised.

70% of the properties by value are freehold, and another 21% have a lease of over 80 years.

The Australian Property Cycle

Varies by city and within parts of a city.

• A 2019 Moodys Report expects Western Sydney Industrial property prices to rise, due to online shopping and new infrastructure.
• A Centuria Industrial REIT (ASX:CIP) presentation shows available space declined up to Oct 2018.

To know about the cycles, you really have to be an expert on the land supply in different parts of the cities.  And predicting future demand is just guesswork.

Tenant Quality

Generally good.

FLIT lists all their tenants (how many REITs do this?).  I categorised each tenant, trying to guess their ability to pay rent in a recession:

• Reliable: Is either part of an oligopoly (eg: Coles, Woolworths), government (eg: Australian Post), or listed (showing profits for the last 2 years and reasonable debt).  In essence, no way that they would not pay rent.
• Unknown: Private companies (eg: BAM Wine Logistics, Caprice, Broetje Automation).  Even though some of them sound interesting, there's no way of knowing how profitable they are.  Most companies in the world are going to be here.
• Dodgy: Currently loss making.  So when times go bad, we can expect the company to go under.

Each category, by gross revenue (Sept 2018):

Overall, this is a pretty high level of 'reliable' companies.  If you pick a random street or industrial park to walk through, you are not going to see such a high proportion of 'reliable' companies.

The two dodgy companies are CEVA Logistics: a merger of two loss making companies which is still loss making, and Constellium: an aluminium product manufacturer with borderline profits/losses and large debt.

CEVA is a worry: they are one of FLIT's top 10 clients.  They are renting a massive warehouse in the middle of nowhere - this may be difficult to lease out again, and buildings like this are valued by their lease (...no lease, no value).

But overall, tenant quality seems quite high.

Management Quality

Sponsor Holdings: Frasers Property, holds 20% of the trust.  I haven't looked at enough REITs to see how this compares.

Management Fees (p146): 0.4% of property value as base fee, plus 5% of distributable income.
Seems reasonable.  Would be better if the fee was based on DPU.

Most management fees are paid in units: at least 85% in 2018 (note 5) and 91% in 1H19 (p10).

Trust expenses were very high in 2017, but lower in 2018 (p158).  They were 8.6% and 1% of distributable income, respectively.  I found no explanation on what these expenses were.

Pipeline: ROFR for 17 Australian properties and 29 European properties.

Past Acquisitions have been OK:

• In July 2017, 7 Australian properties were acquired.  A small number of units were issued, plus debt (pp 53-54).
• In May 2018, there was a large surprise acquisition of 21 European properties.  Funded by issuing 484m new units (an increase of 31%), mostly by private placement with some preferential offering.  Borrowings doubled, and leverage increased from 29% to 35%.  Accretive to those who subscribed.
• In November 2018, a single European property was acquired.

The numbers

Gearing Ratio is now at 35.1%.   No perpetual bonds.

Debt Expiry: They have a large chunk of debt due in 2021:

They did mention their intention to refinance the (grey) European debt (currently at 2% interest) with a lower rate later.  But I think they should space out their debt a bit more.

79% of their loans are fixed rate (p5), or protected by swaps for the lifetime of the loan.

Unencumbered buildings: (In Sept 2018 AR, footnote 10) The secured bank loans are secured over investment properties with a total carrying amount of A$969,554,000 (2017: A$Nil).  So out of AUD 3bn worth of property, 2bn is unencumbered.

They have always had 100% dividend payout ratio.

Valuation

Other Risks:

• Kyith Ng highlighted that many of their Australian rents were above market rate during hte IPO (June 2016).  I am factoring in a AUD 3-4m income to be lost because of this.
• AUD has dropped a lot recently, I am factoring in a rate of 1 SGD to 0.9 AUD.  Same as the global financial crisis.  Assume no change in EUR/SGD exchange rate.

For a target 6% yield, I would value the stock at SGD 1.10.