February 11, 2019

First REIT (FREIT) has had a stellar 2019 thus far, registering 18.2% in total returns on a YTD basis, outstripping that of the FTSE Straits Times REIT Index (+9.0%). This represents a partial recovery of the steep losses in late-2018, as the counter still remains down by 10.0% on a TTM basis.

Based on Siloam’s 2017 Annual Report, rent expenses due to PT Lippo Karawaci Tbk (LK) amounted to 111,862m Rp. Assuming a generous Jan’17 SGDIDR conversion rate of 9,263.04, this amount comes up to ~S$12.1m. However, First REIT received ~S$91.5m of rental income from LK in 2017. This stark contrast was not an issue previously as LK had ~21.25% stake in FREIT (or 28.25%, accounting for LK’s stake in the REIT manager). With the partial sale of its stake late last year, LK now retains a smaller 10.6% stake in FREIT. S&P Global has recently downgraded LK from B- to CCC+ with negative outlook, and has mentioned that they could lower the rating by one notch or more if LK does not raise IDR1tr in 3 months, alongside other conditions. This IDR1tr can be potentially satisfied by the sale of LK’s remaining stake in FREIT, in our view. In such a scenario, it would not be unreasonable for LK to cease the above arrangement at the earliest opportunity, thus potentially requiring FREIT and Siloam to find some way to bridge the rental gap. Still, we understand that the first three Indonesian hospitals coming up for expiry in 2021 are doing well operationally, and the amount of ‘subsidy’ from LK could therefore be less than that received by the other Indonesian hospitals in FREIT’s portfolio.

With the recent rally, the forward yield spread of FREIT against ParkwayLife REIT has dropped to 1.85 S.D. above the 7-year mean. This is similar to the spread last seen during the ‘taper tantrum’ in 2013, but the prospects are now arguably more disconcerting, with LK contributing a significant portion of First REIT’s rental income (~82.42% in FY17). Thus, we remain concerned on valuation grounds, as a mean reversion of the yield spread is unlikely in the near-term, given the unchartered waters.  We downgrade FREIT tactically from Hold to SELL on valuation grounds with an unchanged FV of S$0.97

First REIT closed at: S$1.09