Do internal estimates of property values have a place in calculating RNAV?

Singapore

INVESTORS should not be too quick to dismiss a company's revalued net asset value (RNAV) even if it was calculated using internal estimates of asset values.

While greater disclosure of the details and basis of these estimates will certainly make them more meaningful for shareholders, such figures may still be worth a second look, depending on the rationale and assumptions behind them.

When City Developments Limited (CDL) reported its full-year results last month, it provided two numbers for its RNAV per share as at Dec 30, 2020: S$14.26 and S$16.88. These represent, respectively, 1.9 times and 2.2 times its share price of S$7.51 at Wednesday's close.

The S$16.88 figure included revaluation surpluses for the hotels of Millennium & Copthorne Hotels (M&C). Importantly, these were based on CDL's internal estimates and external valuations, though it did not reveal which hotels were valued externally, nor each property's valuation.

Some market observers thus questioned the relevance of the S$16.88 RNAV per share if specifics were not provided, especially considering the pandemic has made it more difficult to value properties in general.

CDL adopts the accounting policy of stating its investment properties and property, plant and equipment (PPE) at cost less accumulated depreciation and impairment losses. It considers the M&C hotels as operating assets and hence accounts them as PPE.

Under the cost method, an asset is recorded and retained in a company's books at the acquisition cost when it was purchased, regardless of its market value now.

Asset depreciation is also subtracted from the cost, resulting in a lower net asset value (NAV). This is a conservative accounting principle as it ensures the asset's true value is not overstated.

CDL's NAV per share stood at S$9.38 at the end of last year, down from S$11.60 in 2019, due to impairments made and the pandemic's impact. The group then factored in fair-value gains on investment properties, to derive RNAV per share of S$14.26.

Even then, that RNAV was based on the hotels being stated at cost. To give an indication of what they might be worth, CDL went on to include the hotels' revaluation surpluses, bringing RNAV per share to S$16.88.

The increase of S$2.62 per share, from S$14.26, quantifies the hotel portfolio's revaluation surpluses. It works out to S$2.38 billion based on CDL's 906.9 million total issued ordinary shares, equivalent to 43 per cent of the S$5.53 billion in PPE assets held on the group's balance sheet.

A CDL spokesperson told The Business Times (BT) that external valuers were used for 76 per cent of the hotel portfolio by value, and the valuation date factored in the pandemic's aftermath and the recovery trajectory.

Internal estimates were done for the other 24 per cent of the hotels. The spokesperson said these estimates were conservative, based on the last external valuation and also took into account the external valuer's assumptions in each region.

After the privatisation of M&C and amid "concern over valuations of the properties during Covid-19, particularly for the hospitality sector", the group thus commissioned a "substantial coverage of external valuations" on the hotel portfolio, the spokesperson said.

"CDL attempts to show its investors a more reflective fair value" of NAV, as it is an asset-based group and the assets at depreciated costs may not adequately reflect the company's true value, the spokesperson added.

Jefferies analyst Krishna Guha pointed out that CDL's Feb 26 financial statements already gave some indication of the parameters in the assessment of the hotels. However, there was no breakdown of the numbers by each property or country.

More disclosure is always better, but it may also be commercially detrimental given that CDL is considering repositioning the hotel portfolio, Mr Guha said.

RHB analyst Vijay Natarajan told BT that CDL's RNAV numbers were not arbitrary, and likely based on fundamental valuations done by external valuers. The S$16.88 figure is therefore still "meaningful for investors to get a sense of what CDL could get if they sell all their hotels", and can serve as "a good guidance", he said.

CDL has said it is reviewing the M&C portfolio with plans to unlock the hotels' "deep value", as travel curbs led to a slump in the business.

In a March 1 note, RHB estimated that the RNAV per share amounted to S$5.78 for M&C hotels and S$15.81 for the group. Jefferies on Feb 28 cut its estimates of group RNAV to S$11 per share. Both analysts issued "buy" calls on CDL's stock.

In the broader market, it has become challenging to estimate the risk premium, discount rate and future cash flows for property valuations, given the uncertainties and volatility resulting from the Covid-19 crisis. Assumptions used in valuations may well change rapidly and significantly.

"It's hard to tell how assets could shape up post-Covid. For hotels, is global travel going to return in 2022, 2023 or 2024?" Mr Natarajan said.

Mr Guha noted it could be difficult now to ascertain the pace and level of recovery, which will affect rents or occupancy. "Further, there may not be enough transactional data to benchmark against," he added.

Valuers are also facing largely stable cap rates, Mr Natarajan said. Unlike in previous financial crises when they expanded as assets were sold at a bargain, cap rates have generally been steady or even compressed over the past year.

This came amid a dearth of distressed sales, ultra-low interest rates, and investors' hunt for yield, he added.

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