AA Reit is my largest holding and constitutes close to 18% of my SGX Income Portfolio, heavier than the likes of Ascendas Reit (SGX:A17U) and Mapletree Industrial Trust (SGX:ME8U).
I am happy and proud to own this Reit despite its relatively smaller market capitalisation and have blogged about it many times. See previous posts:
2. Aims Apac Reit in Quest of Recovery
3. Tried to add Aims Apac Reit but failed
4. #10 in 10 Best Reits in Singapore
AA Reit owns and invests in a diversified portfolio of 28 income-producing industrial, logistics and business park real estate, of which 26 are located in Singapore and 2 in Australia - Boardriders APAC HQ located in Gold Coast, Queensland and a 49% interest in Optus Centre, a business park in Macquarie Park, New South Wales.
Let me provide 10 reasons why I have strong conviction for this investment.
1. Stability
The share price of AA Reit is less volatile than 75% of SG stocks over the past 6 months, typically moving +- 3% a week. It is relatively less volatile (3%) over the past year. Excluding the one-off plunge in Mar 2020 due to the health pandemic, its share price is range bound between $1.20 and $1.50 for the past many years.
2. Market Performance
Despite its reduced volatility and popularity compared to the likes of Ascendas Reit and Mapletree Industrial Trust, this small and quiet animal has managed to provide more than 26% returns over the past year, exceeding the average 2.4% returns by all the SG Reits and the average 17% returns by the Straits Times Index.
3. Dividend Yield
Based in its past annual dividend of $0.85, even at the yearly all-time high share price of $1.54, the yield is 5.5% which is very attractive in the current low interest rate climate. This yield is relatively higher than other SG Reits and stocks that pay dividends. However, we have to note that high returns come at high risks. The DPU of AA Reit has been declining over the past 10 years from the highs of annual DPU of $0.10 and profit margins have not been growing. Its return on Equity is 4.8% which is relatively low.
4. Payout Ratio
The current payout ratio of AA Reit is at around 78%, which is well covered by its net property income. Its future dividends in 3 years are also projected to be well covered by its net property income.
5. Strong Management
The tenure of its current management team is 5.8 years, with its CEO, Koh Wee Lih helming the Reit for 7.5 years already. I have attended the AGM of AA Reit a few times in the past and was convinced by the clear plans and objectives projected by this management. They have been always been putting the interests of shareholders ahead with yield accretive acquisitions funded by debt and there were very few equity fund raisings (2 in past 10 years) for acquisitions.
6. Long Weighted Average Lease Expiry
AA Reit has a healthy portfolio WALE of 3.95 years, which is relatively longer than 3.3 years WALE by its peers in the mid-cap industrial Reit segment. AA Reit has embarked on its first greenfield build-to-suit project at 51 Marsiling Road for Beyonics and they have continue to lookfor build-to-suit opportunities with solid tenant credit and longer WALE profiles, and asset-enhancement initiatives for organic growth.
The recent $129.6m acquisition of a ramp-up logistics warehouse at 7 Bulim Street, located within the Jurong Innovation District, is near to the future Tuas Mega Port and is fully leased at master tenancy to a major Japanese freight forwarding and logistics company KWE-Kintetsu World Express for 10 years, with option to renew for 5 years. This is strong testament by the manager to AA Reit to enhance stability of DPU to shareholders through achieving longer WALE of its properties.
7. Growth Potential Unlocked - Data Centres!
Even with limited growth and absence of huge potential in the past, AA Reit has been well managed and stronger compared to other midget Industrial Reits such as ARA LOGOS, ESR, Sabana. According to DBS Research, with 502,707 sqft of untapped Gross Floor Area, AA Reit is like a "goldmine" of valuable land bank to extract value. There is a potential to convert several assets into data centres once the moratorium is lifted, which they believe will be value-enhancing for the Reit. When this happens, their WALE of the properties will be even longer and it will be traded at price/book values, closer to the likes of Keppel DC Reit, which will be closer to $2!
8. Potential Acquisition Target
AA Reit has always been a potential acquisition target for takeover by ESR Cayman and possibly other giants like Mapletree for reasons due to its fragmented shareholding structure and access to untapped gross floor area. Though this could be good news but I hope it does not happen as shareholders of AA Reit, including myself would then lose a stable and reliable source of passive income. Otherwise, shareholders would encounter an en-bloc decision, which is a rich man problem.
9. Demand for Logistics and Warehouses
This health pandemic has driven up the demand for stockpiling of goods supplies and inventory by many companies, causing increase in demand for logistics and warehousing space. This helped AA Reit to achieve positive rental reversions from a few recently renewed leases. AA Reit has 24% of leases expiring in FY22 and this demand will bode good for them.
10. Undervalued
At a book value of $1.36, AA Reit is merely traded at 1.13 times book value even at its one-year high of $1.54. Ascendas Reit and Mapletree Industrial Reit are trading at around 1.3 times and 1.6 times to book value respectively. If AA Reit is revaluated at 1.2 times book value, it should be traded at $1.63, which close to the target price of $1.61 quoted by DBS.
According to the valuation by Simply Wall Street based on a discount rate (cost of equity) of 6.7%, perpertual growth rate of 1.9% derived from 5-Year average of SG Long-term Govt Bond Rate. equity risk premium of 4.7% derived from S&P Global, Reits unlevered beta of 0.67, Re-levered and levered beta of 1.013, the intrinsic value for AA Reit is arrived at by discounting future cash flows to their present value using the 2 stage method - analyst's estimation of cash flows next 10 years for the 1st stage and a stable growth rate into perpetuity after that.
Second stage terminal value:
The intrinsic value of AA Reit is $2.64, representing 41.6% undervalued from its current share price. However, it does not guarantee that the share price of AA Reit will rise to $2.64 but does indicate the potential headroom of AA Reit's share price. By the way, Keppel DC Reit is trading at more than 2x book value, which is at $1.20 only, lower than the book value of AA Reit! The largest DC Reit in the world, Equinix is trading at more than 6x book value with yields compressed to lower than 2%! The sky is the limit because data centre assets are a niche property class with ultra long WALE and stability compared to hotels, retail or commercial properties.
I hope that the data centre potential of AA Reit materialise in the short future and there will be more yield accretive acquisitions using cheap debt and equity fund raising which give shareholders opportunities to ride on the growth of AA Reit. Let the true value of AA Reit be unlocked like "crouching tiger hidden dragon"!
Thanks for reading. As always, stay safe and remain strong.
With love & peace,
Qiongster
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