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Broker's take: OCBC downgrades First Reit to 'sell' on concerns of valuation and sponsor

OCBC Investment Research has downgraded First Reit from "hold" to "sell" as valuations are still not compelling, and concerns over the Reit's (real estate investment trust) main revenue contributor and sponsor remain.

Analyst Joseph Ng notes that the counter may have partially recovered some of its steep losses in late-2018 - it registered 18.2 per cent in total returns on a year-to-date basis in 2019 so far - but remains down by 10 per cent on a trailing 12 months (TTM) basis.

He maintains his estimates and fair value of S$0.97 for now. As at 11.50am, First Reit was trading 1.75 per cent lower at S$1.12. 

Last November, First Reit sank by 16 per cent in three days to its lowest since Aug 24, 2012, amid concerns over the Reit's main revenue contributor and sponsor, Lippo Karawaci. Fitch Ratings had downgraded Lippo Karawaci's rating from B to CCC+ over concerns about its liquidity risks as a result of uncertainty over its asset sales.

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Now, Mr Ng believes Lippo Karawaci could be looking to divest its remaining 10.6 per cent stake in First Reit for liquidity reasons, so as to meet one of S&P Global's conditions to stave off a further credit rating downgrade.

"Lippo Karawaci's loss of ownership over First Reit would have certain ramifications for the Reit, especially in terms of visibility over longer-term rental income," he said.

For example, among First Reit's portfolio, OCBC believes that Indonesian private hospital group Siloam paid Lippo Karawaci about S$12.1 million in rent expenses in 2017. On the other hand, First Reit received around S$91.5 million of rental income from Lippo Karawaci.

Taken together, Mr Ng thinks it would not be unreasonable for Lippo Karawaci to "cease the above arrangement at the earliest opportunity", thereby potentially requiring First Reit and Siloam to find some way to bridge the gap.

With Lippo Karawaci contributing a significant portion of First Reit’s rental income - about 82.42 per cent in FY2017 - the counter's prospects are now thus, "arguably more disconcerting", Mr Ng said.