Sunday, February 01, 2009

All that Glitters may not be Gold

The trailing yields of the REITs, shipping trusts and several infrastructure stocks trading on SGX are at all time highs. It is not unusual to find REITs trading in the 10-20% dividend yield range. Like their American listed counterparts, the three shipping trusts listed in Singapore are purportedly yielding more than 30%.

To the yield starved investor, these should be like honey attracting the bees. But the key here is that those sky high yields are derived based on historical dividend payouts figures. If historical payouts are sustainable, then the Babcock and Brown Global Investments must surely be the best thing since sliced bread because the current market price implies a yield of over 120%. Simply too good to be true!

The simple fact is focusing purely on the trailing yields of many such vehicles are misleading.

In today's turbulent market conditions, many vehicles need to preserve cash. Macquarie International Infrastructure Trust has also come out in Nov 08 to say that cash will be diverted to paying down corporate level debt. Following the revelation, its unit price has dipped by about 30%. A scrip dividend schedule was also introduced last year to conserve cash.

For the three shipping trusts, FSL Trust has announced on Jan 20th that it has to reduce its distribution payout ratio to as little as 75% of cash flow. That's a hefty 25% reduction from their usual 100% payout. This comes on the heel of an earlier announcement that its bankers are upping the interest on their debt due to extraordinary circumstances. Pacific Shipping Trust has also cut its payout ratio from 100% to 90% last year.

Clearly, future payouts of some of these vehicles are not sustainable and are subject to future cuts. Putting financing risk aside, business risk are also abound. The income stream from shipping trusts come from long leases inked with shippers. Spot freight rates have dropped and to our knowledge, two liners have gone bust last year. So, what's keeping liners from renegotiating leases with the shipping trusts?

As for REITs, based on the need to have a prudent capital structure, there is no doubt that many may have to reduce their payouts or may face refinancing stresses in future. Many saw the refinancing by smallish Cambridge Industrial Trust as a thumbs up for the ENTIRE sector. Please don't kid yourself. Note that the quantum involved for Cambridge was small. Do also count the number of banks involved for the S$390 mil and take note that the resulting interest cost of 6.6% was not the most attractive ever, thereby leading to a DPU cut. When the refinancing of a larger lump sum say involving S$750 mil and above comes about arising from an expiring CMBS facility, an entirely different story could play out.

REITs with no roll over access would have to do a cheap rights issue, thereby crushing its DPU. It is no secret that investment bankers have approached the S-REITs with respect to doing rights issuances. Saizen and A-REIT have been the first to bite the bullet with new equity issuances. Will more S-REITs follow? The debt maturity profile of some suggest that the likelihood is high.

There's an irony towards doing rights. As a corporate, you want the market price to be high in order to raise more equity. However, if the market gets a whiff that a rights could be on the cards, a mad selloff usually ensues. So, a corporate which really needs the cash usually ends up engaging in a more dilutive exercise to the detriment of the remaining holders. Further pussy footing may even cause the company to go belly up if it gets caught in a vicious downward spiral making a rights issue impossible. General Growth Properties in the US and several Aussie REITs appear to be victims in this respect.

So, it can be upsetting for an investor examining the DPU figure - either the numerator (dividend) drops due to higher interest expense, lower income or the denominator (number of units) increases following a rights exercise!

REITs may need to conserve cash to stay afloat. Bloomberg has estimated that an estimated 70 % of the American REITs are likely to pay out its dividends in scrip instead of cash this year. For example, New York based Vornado Realty Trust, America's third largest REIT, has announced that it would pay up to 60% of its next quarter dividend with scrip.

The regulators of S-REITs stipulate a minimum payout in order for these structures to enjoy a tax break and also to give holders certainty of income. But stubbornly maintaining the rule in these volatile times could well hasten the demise of these vehicles.

These are extraordinary times which calls for extraordinary measures. The rules on gearing have been re-looked to avoid technical breaches. The fact that REITs themselves are lobbying to allow for a cut in the payout ratio (to only 50%) suggests that the management thinks preserving cash is the way to go in this uncertain environment. Should the high payouts continue at the expense of the vehicles' future viability as a going concern? We argue that a cut in the REITs payout ratio should be allowed in today's circumstances until credit conditions normalise. So the stipulated payout ratio should be suspended if management deems fit.

We have applied our judgment and obviously have complied a list of "stay aways". But we do not profess to be superior beings and so cannot be here to tell you which of these business models or trusts are at high risk. After all, we may be dead wrong ourselves. Furthermore, it is also unfair to tar all these vehicles with the same brush. So examine the business model to satisfy yourself of its viability. But if you have not done your homework and are simply lured in by the astronomical historical yield, we advice you to stay away. Merely keeping your fingers crossed in hope of sustainable future payouts may not pan out well and will instead lead to another annus horribilis for your portfolio.

Hence, we wish to take this chance to remind you that: all that glitters may not be gold. During their course of duty, medical professionals are sometimes confounded with the need to make tough calls: - Do you severe the limb to preserve the life (ie, keep the business going by cutting DPU) or let the rot fester in at the risk of one's life later (ie, maintain DPU but face refinancing and counterparty issues down the road at the risk of destroying the entire entity)? As an investor without management influence, you may wish to hang on like a deer in the spotlight to see if the DPU gets crushed or take action now and bail out before the dividend payouts get axed and see your capital impaired.

The choice of individuals differ. But the choice is in your hand.