$589.2m China mall buys to spur short-term pain for CapitaLand Retail China Trust

Debt costs could pare its DPU by 7%.

CapitaLand Retail China Trust’s (CRCT) acquisition of three malls in China from CapitaLand’s subsidiary and associated companies for $589.2m (RMB2.96b) is expected to provide some short-term pain for the firm’s earnings, according to a report by OCBC Investment Research (OIR).

CapitaLand revealed that it would divest its interests in three companies that hold three malls in China, which include CapitaMall Xuefu and CapitaMall Aidemengdun in Harbin and CapitaMall Yuhuating in Changsha. The sale, which is expected to be completed in Q3 2019, would reportedly generate proceeds of about $239.9m and a net gain of about $37.6m for CapitaLand.

Whilst the malls, which enjoy an average occupancy of 99%, are projected to increase CRCT's portfolio gross floor area (GFA) by 30.7%, CRCT’s financing plan remains a concern in the short-term, according to OIR analyst Deborah Ong.

CRCT noted that it intended to finance the proposed acquisition via a combination of debt and equity, and has stated that its objective is to achieve accretion. The financing plan details will be decided at a later date, the firm said.

As at 31 March 2019, CRCT’s gearing was 35.5%, Ong noted. “Assuming CRCT geared up to 38%, this would translate into a debt headroom of $301m. Taking into account the debt held by the three holding companies that needs to be repaid by CRCT, CRCT effectively has $217.2m of debt headroom to use for the outlay,” she added.

According to Ong, in order for CRCT to raise the remainder of $288.2m needed for the transaction, a rights issue, as opposed to a private placement, may be required.

“If we then assume a 2.9% cost of debt and a 15% discount to $1.56 (the share price on 10 June) for the rights issue price, this would translate to a FY 2018 DPU dilution of 7%,” she noted, based on a 35% leakage from the firm's net property income (NPI). 

“We believe that it will be difficult for the transaction to be “DPU accretive” unless CRCT’s consensus dividend yield compresses significantly on the back of further unit price rally. The transaction may, however, be “DPU yield accretive” against the theoretical ex-rights price (TERP) in the event of a rights issue,” Ong highlighted. “An upside risk to our thesis is the divestment of one of CRCT’s assets to help fund this acquisition.”

She added that the transaction will strengthen CRCT’s portfolio by expanding its geographical reach to two more provincial capital cities, improving tenant diversification and increasing its portfolio size which can in turn lower financing costs.

A separate report by DBS Equity Research noted that CRCT is raising its visability amongst investors as it bulks up in China. DBS analysts Derek Tan and Mervin Song noted how similar to CRCT's Rock Square acquisition in 2017/2018, CRCT's latest move could be transformative for the REIT.

"If successful, it is set to drive an 18.8% increase in portfolio value to approximately $3.8b (RMB18.7b) and a 22.8% jump in NPI to $189.48b (RMB959.3b)," they highlighted. "This would significantly widen the assets under management (AUM) gap between CRCT and SGX-listed China-centric REIT peers, which are largely below the $2b mark. As this plays out, it could significantly enhance the REIT’s proposition to investors over time."