• Sponsor’s liquidity still tight
• Reasons for LK to retain substantial stake
• Unchanged FV of S$1.48

Lingering Issues Over at the Sponsor

S&P has downgraded the credit rating of First REIT’s (FREIT) sponsor, PT Lippo Karawaci (LK), to ‘B-’ with negative outlook, citing concerns about the company’s thin liquidity buffer, especially in the face of substantial interest servicing needs. FREIT’s recent results have also given us a glimpse of the downstream implication, as the level of receivables has been rising over the last few quarters, though this has not impacted FREIT’s ability to pay out regular DPUs as required.

Significant Divestment by LK Unlikely

While there remains a possibility of LK trimming its 28.1% stake in FREIT, which in itself is already a reduced stake from its 30.94% ownership back in end-FY17, we think that this is unlikely to go below 25% for two reasons. Firstly, not only would this breach loan covenants, it would also create challenging conditions for both LK and its subsidiary, Siloam Hospitals (Siloam), to conduct future sale of hospital assets to FREIT.

Up till 1Q18, Siloam has been highlighting LK’s cross-border asset-light strategy, and we think that it would be myopic to alter this structure significantly in order to meet short-term funding needs. Secondly, we believe that LK could be exploring more meaningful ways to improve its liquidity position, which, in S&P’s view, should involve asset sales exceeding IDR 3t to provide for ~2 years of cash flow requirements.

Such levers could be in the form of a sale of Puri Mall for instance, which S&P estimates to be ~IDR 5- 6t, though this might take some time. For perspective, LK’s stake in FREIT is ~IDR 3.2t.

Cautiously Optimistic

FREIT has recently successfully entered into a S$100m unsecured term loan at <4% cost of debt for six months, with an option to extend for another six months. This facility is intended to refinance its S$100m 4.125% Fixed Rate Notes due on 22 May 2018.

We believe management has taken this approach to give sufficient time for uncertainties to clear up before dipping back into the bond market again. On balance, we remain cautiously optimistic that the balance of probabilities should remain in FREIT’s favour, and thus retain our fair value estimate of S$1.48.

Source: OCBC Research - 25 May 2018