How rising risk-free rates are making Fortune REIT sweat

Unit price dropped 15% since May.

According to OCBC Investment Research, Fortune REIT (FRT) has been affected by rising risk-free rates leading a correction in its prices. The good news is that the spiking rates will not have much impact on cost of debt of FRT, which has otherwise has been posting strong operational performance and pursuing continued growth through asset enhancement inititiatives.

Here's more from OCBC:

Affected by rising risk-free rates. The prospect of an early tapering of US Federal Reserve’s quantitative easing program has driven up bond yields and, as a result, high-yield counters such as Fortune REIT (FRT) have seen a correction in their prices. FRT’s unit price has fallen 15.1% since the peak of HK$8.43 on 15th May this year (but still up 12.4% YTD). We note that rising risk-free rates will not have much impact on cost of debt for FRT given that interest cost for ~76% of FRT's debt exposure has been hedged to fixed rates with effective interest cost at 2.76%. FRT has no refinancing needs till 2015 and has a weighted term to maturity of 2.7 years. FRT's gearing continues to remain low at 23%.

Strong operational performance. To recap, Fortune REIT reported excellent results for 1Q13. Revenue and net property income climbed 16.3% YoY and 17.6% YoY to HK$301.4m and HK$217.9m respectively. Occupancy rose to 98.6%, the highest level in over two years, with good portfolio-wide operational statistics and a fast recovery after AEI. Average passing rents grew by 10.0% YoY to a new high of HK$32.9 sq ft. Due to a strong leasing market, rental reversions were at 19.5%, higher than the mid-teen percentages that management had guided.

Continued growth through AEIs. The HK$100m AEI for Fortune City One, completed in 4Q12, has repositioned the mall as a one-stop shopping, dining and leisure centre. The HK$15m AEI at Jubilee Square is expected to be completed in 2Q13 with an ROI of over 25%. Two smaller AEIs at FCO's wet market (HK$18m; 2Q13 start) and Ma On Shan Plaza (HK$17m; 3Q13 start) should be completed by end 2013. The next large scale project is Phase 3 AEI for Belvedere Square (HK$80m; 4Q13-end 2014).

Decrease FV to HK$7.51. Accounting for the higher HK 10-year government risk-free rate (which climbed from 0.8% at the beginning of May to 2.0% currently), we raise our cost of equity assumption to 7.5% from 6.6%. We also raise our LT nominal growth rate for dividends from 1.75% to 2.0%. Our FV falls to HK$7.51 from HK$8.64. We maintain a BUY rating on FRT.