CapitaLand Mall Trust - Merger to axe growing pains

• 4Q19/FY19 NPI and DPU in line with our forecast.
• Improved performance despite weak retail outlook – NPI +1.3% positive reversion of 0.8%, high occupancy of 99.3% maintained.
• Proposed merger with CapitaLand Commercial Trust heralds new phase of growth for CMT.
• Upgrade to ACCUMULATE with higher TP of S$2.70 (prev. $2.68).

The Positives

+ FY19 NPI grew 1.3% YoY on a comparable mall basis. Revaluation gains of S$17.6mn largely driven by better performance at malls – cap rates holding steady except for office component of Funan – cap rate compression of 10bps tied to tapering office supply.

+ Positive rental reversions of 0.8% for FY 19 amidst weak retail outlook and substantial supply. Rental reversions for FY19 were +0.8% over the initial signing rents (typically committed three years ago). Positive reversions ranging 0.4% to 3.5% were observed for all malls except RCS (-0.1%), CQ (-2.1%) and Bedok Mall (-6.5%).

+ Portfolio remained high at 99.3% as at 31 Dec 2019. Tenant retention was high at 83%.

The Negatives

– Falling tenant sales. Despite an improvement in shopper traffic (+1.4%), tenant sales for 1H19 fell by 1.3% (Figure 1). However, tenant sales psf/month for the top five trade categories that contributed >70% of gross turnover (GTO) income improved 1.0% in FY19. These were F&B (+2.9%), Supermarket (+1.2%), Beauty & Health (+0.9%), Fashion (-0.4%) and Department Stores (-5.3%).

What’s in the news?

Proposed merger of CapitaLand Mall Trust (CMT) with CapitaLand Commercial Trust (CCT)

CMT will acquire all the issued and paid-up units of CCT. The consideration for each CCT unit comprises 0.72 new units of CMT and S$0.259 in cash, resulting in an illustrative value of S$2.1238 per CCT share. The consideration implies a gross exchange ratio of 0.82x, based on the issue price of S$2.59 per CMT unit. The new entity, CapitaLand Integrated Commercial Trust (CICT) will be a proxy for Singapore commercial real estate, investing in retail, office or integrated development assets, with overseas developed market exposure capped at 20%.

The cash component will be paid using debt facilities. EGMs will be in May 2020 with targeted completion being June 2020.

What do we think?

We like it. We view the merger as a strategic and pre-emptive move that paves the way for accelerated growth. The proposed merger provides growth opportunities for CMT and risk diversification benefits for CCT that would have been challenging for them to achieve individually otherwise. To attain this magnitude of growth opportunity and risk diversification, both REITs must shed their old mandates – the proposed merger provides this opportunity. The merged entity will combine two champions in their respective asset classes, providing a solid foundation to unlock a myriad of scale-related advantages: Growth and Resilience.

 Key benefits of the merger are highlighted in Figure 3.

Outlook

Retail rents bottomed out and started climbing in 2H19. Despite substantial supply coming onto the market in 2019, rents and occupancy showed marginal improvement. Better differentiation, active tenant management and retention will help CMT malls retain their attractiveness as retail space providers. We like CMT for the following reasons:

Balanced revenue from portfolio of 15 downtown and suburban malls – CMT’s earnings are backed by necessity spending at suburban malls, while enjoying exposure to the more discretional and tourism spending at central malls. Maintained consistently high portfolio occupancy of c.99%.

Willing and able to undertake redevelopment projects to create and unlock value – Funan reopening ahead of schedule on 28 June 2019. The redevelopment project cost S$360mn resulted in a mixed-use asset comprising a retail, office and hospitality (not part of CMT’s portfolio) components. Funan realized S$391mn in revaluation gains upon achieving TOP status in June 2018 and a further S$24mn in 4Q19. The redevelopment of Funan helped to refresh, strengthen and futureproof their portfolio. CMT’s track record and expertise as a mall operator is evident from their consistently high portfolio occupancy of c.98% in the last 8 years.

Superior Mall Management: Turning E-commerce threats into online-to-offline (O2O) opportunity – Competition from E-commerce will continue to vie for the same retail pie but CMT has created opportunity amidst struggle. CMT has been very active and in trying to embrace E-commerce players with their Taobao retail concept store at Plaza Singapura (Nomadx) and Funan. Their centrally located malls (Raffles City, Funan, Bugis, Plaza Singapura etc.), in addition to their loyalty program to increase customer stickiness (CapitaStar) makes CapitaLand malls good flagship store locations for e-commerce players who are looking to have and/or build an offline (physical) presence, starting with one central store and expanding via the CMT   ecosystem.

Upgrade to ACCUMULATE with unchanged TP of S$2.68.

We upgrade CMT to ACCUMULATE. Our target price translates to a 4.9%/5.1% FY20e/FY21e distribution yield and an upside of 5.1%. Our TP does not include the effects of the merger. The merger will give CMT a new runway for growth and acquisition and allow the enlarged REIT to compete for or under take mixed-use redevelopments projects.