Mapletree Logistics Trust: 'Retention strategy'

Stable QoQ. Mapletree Logistics Trust posted S$52m in gross revenue (down 2.4% QoQ) and S$45.7m in net property income (down 1.2% QoQ). The revenue decline was primarily due to forex effects, which were hedged at the distributable income level. Total amount distributable to unitholders was consequently stable at S$28.7m (up 0.2% QoQ). MLT will pay out 1.48 S cents for the quarter. Results were better than expected due to our fairly bearish occupancy assumptions. Portfolio occupancy was sustained at 98.3%, versus 98.5% three months ago and 99.6% six months ago. Hong Kong and China, where a property was repossessed last quarter, continue to be the weakest markets.

Occupancy through retention. The manager said 65% of leases expiring in 2009, equivalent to 13% of total portfolio revenue, have already been renewed. It said the average reversion rate was flat due to "priority in retaining tenants" as securing new (higher) leases was too costly in terms of downtime and concessions including rent-free periods. In our view, this strategy is preserving performance today but perhaps at the expense of performance tomorrow. Around 100k sqm or 7% of portfolio revenue still needs to be renewed for 2009. The manager guided that despite some stabilization in the economic environment, in 2H09 "the environment remains challenging and occupancy and rental rates may be under pressure".

Exploring acquisitions. MLT is geared at 37.8% debt-to-assets and has S$107m of debt maturing in the next six months. It plans to refinance that debt using a combination of already secured borrowings, term loan refinancing and working capital lines. The manager was emphatic that it will not raise equity solely to reduce gearing. However, it did indicate its interest in third-party acquisitions, provided these buys are coupled with an equity issue to at least maintain current gearing levels. With MLT's current tenant retention focus, we think acquisitions will be needed, sooner rather than later, to power the next leg of DPU growth.

Still cautious. In line with the 'retention strategy' and some macro stability, we have increased our occupancy estimates to 96-97% over FY09-10 versus 90% previously. On the flip side, we have also worked in lower achieved rents. All in, we expect a weaker 2H09 over 1H09 as occupancy slips and any rent declines to flow through. We are still cautious on the industrial sector but like the quality and diversification of MLT's portfolio. Our new fair value estimate is S$0.52 (prev: S$0.45). Maintain HOLD.

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Mapletree Logistics Trust - External demand exposure to impact rents/occupancy

Our Singapore economics team sees weakness in external demand as the major threat to the economy. This, combined with a contraction of manufacturing output by 26.1% y-y in 1Q09, does not augur well for industrial demand, either for flatted factories or warehouses. According to the Ministry of Trade and Industry, Singapore lost 19,900 jobs in the manufacturing sector in 1Q09, with 1,700 transport and storage jobs lost in the same period. While recent data from the URA suggest that industrial supply is slipping, we expect vacancy in both the flatted factory and warehouse segments to broach 10% by yearend, impacting rents and asset value expectations. Indeed, in Mapletree’s recent 1Q09 results announcement, it was evident, in our view, that the REIT had opted to trade rent for tenure. While occupancy in the portfolio at end-1Q09 was 98.5% (down from 99.6% at end-FY08), renewals of expiring leases saw “flat” average reversion rates, a precursor to potential negative reversions. Approximately 166,700sm is subject to renewal in 2Q09-4Q09F, equivalent to 8% of the portfolio.

Since 2005, Mapletree Logistics Trust’s DPU yield has averaged 7.22%, equating to a 433bps spread over the average 10-year government bond of 2.89%. Currently, MLT’s FY10F yield is 8.6%, versus the current 10-year government bond of 2.60%. The historically low yield spread between MLT’s DPU yield and prevailing risk-free rate reflects, in our view, the market’s growth expectations for the REIT over the period driven by rental reversions and acquisitions — we note that during 2005-08, MLT saw average annual compound growth in its DPU of 19.2%. While we see MLT’s growth prospects as markedly different from those experienced in 2004-09 (we forecast its DPU will fall 30.6% over FY08-11F), there is inevitably a temptation to extrapolate past trends. Adopting the historical yield spread (433bps) and the current risk-free rate of 2.6% implies a yield of 6.93% (versus MLT’s current yield of 8.6%), equating to a unit price of S$0.74/unit. We believe our asset-based approach to valuing MLT incorporates the cashflow risks of both negative reversions and higher vacancy risk, and believe such “spread analysis” is both overly simple and simplistic.

We have revisited our earnings numbers and marginally raise our DPU forecasts for FY09-11F on the back of income expectations from recently completed/acquired properties. In addition to the marginally higher earnings, we have rolled forward our intrinsic net asset valuation to FY10F and determine an NAV of S$0.43/unit (previously S$0.37/unit). Valuations prompt us to cut our rating on MLT to REDUCE from Neutral.