Link Real Estate Investment Trust (823) Earnings Call Transcript & Summary

Thank you for dialing in to this briefing regarding Link's acquisition of 2 retail properties in Singapore and the commencement of asset-light business. Today, we are glad to have our CEO, Mr. George Hongchoy, our CFO, Mr. Kok Siong Ng; our CCTO, Mr. Ronald Tham; and our COO International, Mr. Greg Chubb with us. [Operator Instructions] If you encounter any problem submitting questions via chat box, you may send us an e-mail to [email protected]. The questions will be convened to the management during the Q&A session. I'll now hand over the time to K.S. to take us through the presentation. K.S., please.

Thank you, Sylvia. Good morning to all. Last evening, we announced the acquisition of Jurong Point and Swing By at Thompson Plaza from Mercatus together with the commencement of our asset and property management business in Singapore. This will be our first investment into Singapore and represents our continued push towards pursuing diversification in our income sources and geographic presence. Strategically located in major heartlands, both assets are BCA Green Mark certified with great specifications. The total consideration of the portfolio is SGD 2.161 million -- billion. So $2.161 billion, representing a discount of about 6% to the appraised value. We anticipate completion by 31 March 2023. Link will acquire both Jurong Point and Swing By Thompson Plaza through Diamond Run Limited, which we fully own. This will allow us to acquire the sellers assets and property management capabilities through the transfer of approximately 140 employees from the seller's platform. In addition, we have entered into a 10-year agreement to provide asset and property management services to AMK Hub, which will remain under Mercatus ownership. Strategically, this transaction will increase our geographical diversification and position us as an APAC fund and asset manager. We will be the top 10 retail asset owner and 6 largest manager operator in Singapore, providing meaningful tenant relationships. We also leveraged the expertise of the experienced Mercatus team further to expand our Singapore presence in a disciplined manner. In line with our strategy to embrace growth through capital partnerships, we are actively targeting capital partners to take on a partial stake in this portfolio. Primarily, we are looking to create strategic partnerships with reputable like-minded investors. Bringing on capital partners allows us to manage our gearing level and optimize our capital structure. We have always liked Singapore for sound economic fundamentals. It is a transparent market with a strong rule of law and competent government. The stability of the SGD is conducive for long-term sustainable economic growth. GDP growth, inflation and employment numbers are all looking healthy. This acquisition represents a unique opportunity to acquire a sizable retail platform in Singapore, which we believe is in the best interest of unitholders. Both malls enjoyed excellent natural footfall from surrounding residential estates and stand to benefit from upcoming development projects. Occupancy rates have remained high despite COVID-19 with cash flow supported by tenants from nondiscretionary trades. Brands at suburban malls have been very resilient with supply tightly controlled. With Link's track record and experience of the MCL team, we are in a good position to unlock value through enhancing operating efficiencies and optimizing the tenant mix. We are entering the 10-year asset and property management services agreement for Ang Mo Kio Hub, which is called AMK Hub, which supplements Link's revenue with new fee income and boost our profitability. Both properties collectively serve population catchments amounting to almost 10% of Singapore's population. The upcoming developments and completions of the railway infrastructure are expected to facilitate traffic and movement within the region, which will drive further footfall for the assets. Furthermore, both malls enjoy limited competition in the primary trade areas. They have been successfully in -- differentiating themselves and remain popular for their focus on nondiscretionary trades and affordability. A key advantage of the properties is their proximity to key transportation infrastructure, particularly Jurong Point located at 1 of 11 integrated transport hubs. Swing By @ Thompson Plaza recently saw the completion of the Upper Thompson MRT station, which became operational last month. Apart from train and bus stations, both properties has various pedestrian amenities such as Link bridges for easy access residential estates nearby. The properties have robust asset fundamentals with a 99.8% occupancy rate despite pandemic restrictions. Approximately 60% of tenants are in nondiscretionary tricks, which tend to remain resilient 2 periods of economic volatility. The short way of approximately 2 years, with approximately 85% of gross rent expiring by 2025, enables a resetting of brands in this current inflationary environment. Suburban retail has been a very resilient asset class. From the chart on the top left of the slide, suburban rent grew by 2% since first Q 2022 or debt of prime retail actually declined by 12%. Suburban retail occupancy rates have similarly remained stable during pandemic. Outlook on customer spending is also positive. We are seeing a strong rebound post COVID with retail sales expected to grow at about 3.8% per annum for the next 10 years. In the Singapore market, opportunities to acquire suburban retail malls are rare with supply being tightly controlled by the URE. Forecast apply our new urban retail space annually from 2025 -- 2022 to 2025 is less than half of that of 2017 to 2021. This transaction, therefore, represents a unique opportunity to acquire a resilient asset class. Link is also well positioned to unlock value by employing our strong asset enhancement capabilities. We will use our expertise to drive operational efficiencies and tap into Link's as tenant pool in Hong Kong and Mainland China to introduce new traits and new tenants to the malls. We also stand to benefit from the deep expertise and local know-how of the MCL team. Our objective is to unlock value by improving the overall shopping experience and accept performance and we look forward to the results of the knowledge sharing between our teams. This transaction will also encompass the establishment of an asset and property management services agreement for AMK Hub, over the next 10 years, and this is expected to provide a new source of recurring asset-light income. The transaction is expected to be immediately accretive to Link. It provides an upfront indicative entry yield of about 4.9% with a positive spread over Link's existing borrowing cost. Transaction will be financed by a combination of internal cash resources and bank borrowings denominated in local currency, SGD. Post transaction, the pro forma gearing will be 27.1%. With this acquisition, Link's total portfolio value increases to HKD 246 billion, with Singapore contributing 4.9%. This asset brings us a big step forward in increasing our portfolio diversity, and we are excited to embark on our next chapter of growth with this investment in Singapore. Thank you, everyone.

Thank you K.S. for presentation. We are now open to QA from the floor.

[Operator Instructions] So the first question is regarding the funding. So what kind of loan are we using, fixed or floating? And what funding costs should that be if we funded in the SGD?

K.S.?

Currently, the plan is to look at a combination of fixed and float funding in SGD. The truth is whether we fix it or float today, the yield curve is pretty flat, whether it's a 3-month or a 3 year or 5 years. On average, if you look at a quick 50, 650 float, we will be looking at a benchmark rate funding cost of about 3.1 to 3.2 adding a margin of, say, about 100 bps, you should be looking at about 4.2% type of funding costs all in on the 50s, 650s float. I think the intention is not to be too excited to over fix it or leave it too much on flow, but keep options open in case rates starts to fluctuate. And of course, behind the cash flow there is lease expiry that will come, that will, of course, then reflect where the risks and inflations are.

I think one more point to add is that, obviously, Singapore monetary policy does not actually aligned with the U.S. compared to Hong Kong. That's one of the points for diversification.

The other question is on the strategy. So any further acquisition plans in ASEAN in the pipeline?

I guess, you know our reputation will continue to look at everything. So I will tell you when anything comes up. But we're quite focused on a few markets. So Singapore, Australia, Hong Kong, China -- Mainland China have been some of the areas that we have focused on maybe.

There is another question of disposal plan. So will there be any disposal to reduce the gearing?

We're working on a variety of possibilities. So our right sale to possibility of bringing in capital partners to recap, invest in some of our existing assets, et cetera. So -- and also with this project, as we said, we may end up completing this deal without investing 100%. So there's still a few, I guess, I think balls in the air that will need to finalize over the next few months, and we'll update you on as soon as we can.

There is a few specific questions. So could you clarify why next, [indiscernible] has been excluded from the package? And why they acquired 2 asset after -- of -- which offer better investment opportunities [indiscernible]?

You have to ask the seller, sorry. They've excluded it. But I guess we need to be -- want to -- to guess what was the reason is that our mix is only 50% owned by KHS and the other 50% is subject to -- they have the right of first review. So -- but anything more than that, we hope you asked the seller. They did exclude it during the process.

So there's another question, a similar question. So does that service agreement for AMK Hub container right of first offer for this asset in the future?

No, we are [indiscernible] of any of the assets. I mean, as George explained, excluded, but it is subject to [indiscernible]. So we'll see what happens for that. AMK will be managing these assets. So we know this asset really well. If and one day, it comes out in the market to be in a good position we'll go ahead, but nothing is promised.

So there's a question on the operation of the 2 assets that we acquired. So the occupancy of these 2 assets are particularly full. So how much is this portfolio under-rented?

Greg?

Good morning, everyone. So we will be taking time working with the existing Mercatus team to work through trade mix options, and it will be both a focus on driving sustainable income growth and improving the tenant mix in the assets. So I guess one thing that we would point to is the discount to the appraised value and some of that would point to the under-rented nature of the asset or assets, I should say. So we do see that there being significant opportunity to improve the tenant mix and the income attributes to the assets. And also noting the occupancy cost of the retailers in the portfolio is very pretty sustainable. Thank you.

If you look at the lease expiry profile, we try to highlight a lot of leases expiring over the next 2 years that our team the opportunity to really review the type of tenants that we want to have and the more especially into on point to be mix as necessary. I thought we'll change everyone. Let's start to point, and that's not how we do it, but with some disciplined asset management, we're confident of how -- what we have underwritten internally.

So there's another question on the fee income from AMK Hub. So how much fee income should we expect to gain from this management service?

K.S.?

The fee structure of the management asset and property -- asset and property management is actually industry comment. So it's about 2 plus 2, plus certain bps. I think all in, we were looking at about $6 million to $8 million of net fees back to us. Correct me, I'm wrong, Ronald?

Yes, that's about right. Yes.

So is this in line with market terms.

Yes. So pretty much, I think we have structured the AMK Hub contracts very close to market terms.

I think the other significant while we don't own the asset because we manage it basically in one go we have tenant relationship across 3 good sized property. I mean that's why it is important for us as we enter a new market to renew the tenants, especially the local ones. So fees is one thing, which I'm sure you all factor into the model, tenant relationship is as important to us. So having a relationship not just from 2, but 3 assets create a lot of synergy for us as well.

So will there be any asset enhancement of these 2 assets to enhance the profitability?

Greg?

So Thompson Plaza -- Swing by Thompson has seen a very successful asset enhancement program in recent times. So that asset is very well positioned. And Jurong Point being the largest suburban asset in Singapore provides with significant opportunity. It's got a very strong trade area, a very diverse demographic. So again, there is what I would term almost unlimited opportunity to enhance Jurong Point over time, whether it be around enhancing the tenant mix, improving connections. We know that there is extensions to the rail network around the Jurong Point. So we'll be looking to make connections there. But ultimately, it's a matter of continuing the very strong positioning in the market that Jurong Point is famous for. So we see there being significant opportunities to enhance the asset both at a smaller tenant level but also at a broader asset level.

K.S., can you clarify the $6 million to $8 million fee income, is it SGD?

SGD, SGD.

So this question is for K.S. as well. What's the comfortable gearing ratio?

I think we have signaled for a few seasons now that we are comfortable, it's up to about 30, mid-20s to 30s. I think today, after this deal or come March, we will be coming into about 27s with intentions to sell some stakes to capital partners as well as recycling of the Hong Kong portfolio. So I think you'll see us traversing between the mid-20s to high 20s, maybe touch 30. I think the intention is to continue to keep all the other debt metrics besides LTV, maturity profile, funding refinancing risk as well as interest coverage. I think -- so far, we are comfortable given the quality of the assets, the cash flow. So I think, yes, we will continue to signal to the high 20s at this point.

I think there's 2 important points to add. One is we have obviously have focused on growth on our balance sheet. So as you look at gearing, it's obviously the gearing at the balance sheet level. Over time, what we want to create is a business where our AUM is bigger than our GAV where we would have some of the assets even with consolidating some of the debt or some will just be equity accounted to lower the impact on our overall gearing. So that's something that with this particular project, we are successful in bringing in capital partner, you probably see that being achieved as a first step -- first order. Second is, I guess, in your projection, how high and how long interest rate will stay up. So that would have impact as we increase gearing. We're mindful of that, and we're looking at ways to lower that capital recycling, hopefully, within the next 6 to 12 months.

The question is about the capital partners. So these assets have been on market for some time, and we also announced our capital partnership program lot long ago. So how much interest is there from potential capital partners? Would the capital partnership should only be drawn on given Swing By is already a strong titled?

We're still discussing with several parties quite well down the line, but I guess until AC that we actually have signed the contract, sometimes a little difficult to -- for them to take it to their investment committees. And so we'll try to get this order signed up before the completion date. So a few moving parts, very difficult to give you an exact position today. But we're looking to bring those in. I guess this asset is core with a very small plus. So you can then assess roughly who those people are who will be coming with us.

George, would you mind talking about what kind of criteria to reduce to select our capital partners?

K.S.?

Okay. Yes. I think if you look at the portfolio, there's core, core plus and potentially an opportunity around redevelopment. So I think we have been looking at capital partners along those space. Specifically, if I would share would be some of these family offices clubbing together, there's also insurance and pension funds that we are talking to. And I think the criteria for us is, of course, hopefully, these capital partners besides bringing in the liquidity, they are also familiar with the asset class that could help us as part of our capital partners and not just overly passive. I think in this aspect in terms of the asset class and return profile, we are pretty much clear that sovereign insurance and pension funds are the best fee.

I think it's worth adding since K.S. mentioned those type of potential capital partners is that we will reach -- in most cases, while we might do a 10-year projection in our underwriting, we don't really have a 5, 7-year exit plan for most of our assets, although we review how long we want to hold them on a yearly basis. So we want to have capital partners who also behave like that rather than having to be forcing us to sell together with them because they need to get out after a few years. So like-minded in so many different ways that make the process a little bit longer. And then each side need to go through the internal investment process as well.

So as well onboarding 140 new employees as part of the acquisition, what financial impact does this have on the annualized G&A?

K.S.?

Yes. So the 140 headcount is actually inclusive of the operational headcount directly employed in the mall. So if you look at the total number, when we split up, there's probably 100 to 110 that are actively working in the 3 malls and [indiscernible] has a HQ staff of about 30 to 40, that is a required support cost of running any business offshore for us. So in terms of finance, HR, IT, investment, asset management support. So I think when we look at the whole full package, it's not going to be increase marginally more because the asset -- a lot of the cost will be actually put down through the NPI which we call it direct costs. So if you look at the 30, 40, there's going to be incremental G&A costs, which we will disclose further down the road. Separately, there will also be support from the seller on integrating the staff and some -- I guess, some assistance from that part.

I think the key for us is that this is a platform that allows us to use in the future in Singapore, especially because of the local knowledge of the tender market, retail market, they will report directly to Greg. But more importantly, as we have a larger footprint, it provides these individuals just at stores in Hong Kong and China to look at developing the career in other locations as well. So we can leverage on their skill set. So through this whole process, for example, while we were doing due diligence, we have our colleagues from Australia, Hong Kong going there to assess the profitability, the growth potential of these assets. Likewise, I'm sure we will learn from our new Singapore colleagues and see what they are doing better than the rest. And over time, lift up the whole standard of how we do things across the entire footprint.

So there are questions on the operations at the mall. What are the rental reversion for the last 2 years? And how would you guide the rental reversion going forward?

Greg?

Broadly, the reversions have been positive over the last few years. Also important to note that during the COVID period, occupancy and rental collections have been very, very strong. So we're starting from a very strong base. And Mercatus team has done a very, very strong job in managing the portfolio during the COVID period. So all I would suggest at this point in time is that we see positive reversion trends continuing, and we'll be doing all we can to enhance the mix and the income returns for the assets -- for the 2 assets that we will be directly owning. And for AMK, that will be managing on behalf of Mercatus. Thank you.

Some more questions on the same topic. So could you comment on the NPI margins? And what has been the impact of higher utility costs towards the NPI margin?

Greg?

K.S, you'd be able to talk to the margin, I think.

So I think if you look at the entry yield at 4.9%. I think clearly, it looks like a very sound deal. But I think in all fairness, most of us in doing the underwriting that do recognize that the Singapore utility cost is going to go up by at least double that amount. So I think NPI margin is going to look like something from 70 over to coming down slightly and then see whether rental reversion side, we can then pick it up. I think overall, we have considered the increased utility costs and potentially some of these wage inflation that we are seeing across Asia.

And also our experience in managing energy efficiency isn't just broader ESG, strength that we bring to the management of this portfolio is something we'll be focused on very, very strongly. We do appreciate the rising costs of energy, for example, not just in Singapore, but across the regions, and it's something that we're very, very focused on at a portfolio level. So we'll bring that same level of thinking to the Mercatus team as we look to enhance our margins across the portfolio.

When we first started the journey, looking at energy savings, we were trying to find benchmark -- external benchmark to measure our Hong Kong property against. I guess, now the assets in China, Hong Kong, Australia and Singapore, we do have internal benchmark to make sure that we will keep improving on energy usage. It is also important to have this set of assets to benchmark against each other because when we first started looking at this, we will look at some comparables all the way from the U.S., et cetera. And temperature difference, humidity difference, make a big impact on how much electricity we use, et cetera. And so I think Singapore is a good one for us to use against Hong Kong and China and vice versa.

So on a separate note but a related topic, could management clarify on the intent behind the recent CP insurance? Is it for financing this acquisition?

I'm not sure because the money has been collected, put in the bank, we pay down some loans outstanding. So as far as money is fundable, we optimize it as a treasury of day-to-day. And so clearly, the CP money has been used for bringing down our -- optimizing our gearing cost. So I think the CP, if I were to revisit was a window that we saw about a month ago that we thought the interest cost savings versus the equity option traded out, does make sense for unitholders. So we articulated that we were saving about 125, 150 bps per year, and we issued a CP on the 5 to 3. So let's say 4, so you'll be looking about saving about 5% interest cost over the potential life of the CP trade-out equity options, looking at about conversion price about 17.5%. I guess it looks good today with unit price having come back up. Dilution is actually only about 2%. So clearly, market has changed. China opened up. Everybody is looking a bit more optimistic, but the conversion at 60 over is still quite a distance of and I think the point of CP is also to tap that liquidity from the market and the strong gets to refinance, the weak, the window is closed. There's a competitive angle to this funding playing field that we are also positioning ourselves. I think when we look at this deal in terms of financing, we are looking at asset level financing at LTV about 50 to 60. Equity portion we can draw from the Hong Kong treasury or can draw down SGD or we can also tap new SGD loans if that's appetite. So I think as far as our concern, CP is not -- is not actually take on, I think at the end of the day, whether it's a CP or the asset, it's about Link's credit margin. And the credit margin today is still looking at about high double-digit not crossing into the 1% credit margin. So we remain our strong credit margin to fund our needs. I think that's the most important. It's hard to compare whether the CP is actually going to be used specifically for acquisition.

So if we have not received further questions, the following one will be the last question. So what's the impact on DPU for this deal?

K.S.?

I would not comment on the overall DPU because we are not supposed to. I think marginally, this deal would -- after factoring all the cost, clearly, there's the manpower absorption of 140, then there is the AMK fees that helped offset a little bit of the H2 cost. And then you saw the asset deal being priced out at 4.9% yield. We think our funding costs should come in near to about 4-ish -- low 4-ish and of course, if we manage to bring capital partner, there's another layer of AM and fund and FM fees. And so I think we put together, I would say we will be seeing an accretion in the plus/minus of 50 bps for this deal from the 4.9%, right? So 50 bps on the $2.1 billion to $2.2 billion asset size would be a good indicative of the marginal DPU.

Okay. Thanks, K.S. for not saying what you said and then you said it. So, I guess with traveling being easier, I'm not offering you exact dates, but certainly, if you have the chance, be in Singapore, look at these assets. And after completion, we'll be able to bring you there with our own colleagues. And whether we'll try and work out some time where we can hold you in Australia or Singapore or China, I think 2023 is definitely a time when we can do some asset tours which is something that we all missed for the last 2, 3 years. So we look forward to that, give us some time. I think we're not going to plan anything too early or things need to settle down a little bit after this relaxation. Just to touch while we have everyone on -- on the call here, just to say, we'll be opening in Hong Kong, where we are see very pleased that it's happening a little bit faster than some of us expected and the reversion in terms of percentage of leases, having positive reversion have increased significantly, there are still a few where we decided to give them some support, but that proportion is really skewed towards a positive reversion, which is pleasing to see. For China, it has been challenging. Obviously, even as -- all the reopening has happened but a lot of colleagues [indiscernible] some shoppers are not coming out yet. So I think it will be a very slow reopening. It's not a quick rebound as we have seen in the early 2020 when China reopened at that time. But again, after Chinese New Year, I think we'll expect the Chinese New Year trade will be good. And similar to Hong Kong, the percentage of leases that we are talking to tenants going to be more positive than negative. So it's all going in the right direction for us. And I think Australia is probably enjoying the sunshine and all that. So good to have a slightly more positive tone on this call than we have in the last 1 or 2 years.

Thank you, management. So this is the end of the call. Thank you very much for joining in today and wish you a prosperous and fruitful 2023. Thank you.

Happy New Year, everyone. Thank you.

Happy New Year. Thank you.