• CapitaLand Retail China Trust’s operating metrics turned positive in August 2020; better times expected.
• Close to S$33bn of pipeline available for injection implies an expansion in AUM of more than 10x.
• New asset classes of business parks to “future-proof” its earnings profile against future pandemics.
• Compelling value at 0.8x P/NAV, BUY!

Green Shoots Emerge Within China Retail

China retail sales reversed decline trend in August.

• China’s retail sales index turned positive for the first time this year in August 2020 as retail sales rose 0.5% y-o-y. This contrasts against a trough in January and February (both -20.5% y-o-y), which coincides with the pandemic peak in China where malls were primarily shut in accordance to provincial regulations and Chinese New Year holidays were extended by about 10 days.
• Similarly, CapitaLand Retail China Trust (SGX:AU8U)’s malls underwent directed closures or shorter operating hours during the period and have all since reopened from 2 April. Government support packages were directly channeled towards tenants in the form of preferential electricity tariffs, lower borrowing costs for business and tax subsidies. Tenant relief of about one month’s rent was offered by CapitaLand Retail China Trust to tenants on a blended basis to tide over the trough period.

CapitaLand Retail China Trust’s shopper traffic and tenant sales recovered beyond pre-COVID levels in August.

• Similar to the broader retail sales trend, CapitaLand Retail China Trust’s shopper traffic and tenant sales have recovered to 103.4% and 102.1% of pre-COVID levels for the enlarged portfolio. A second lockdown in Beijing resulted in a kink in the recovery curve in June, which has eased since July. On the same mall basis, traffic and sales recovered to 76% and 78% of pre-COVID levels respectively, with CapitaLand Retail China Trust’s portfolio reconstitution coming into play here.
• With green shoots emerging within the broader market, we continue to hold our belief that China will set the stage for a retail recovery globally. CapitaLand Retail China Trust continues to be one step ahead of Singapore peers, especially the ones focused in the suburban space. With many opportunities to spend and fatter-than-normal wallets for the Chinese consumer, we think CapitaLand Retail China Trust’s upcoming results may spring a further surprise in terms of operational performance.

Upward trajectory may likely continue towards year-end as the peak season approaches.

• Retail sales grew 8.0% y-o-y in China last year, in comparison to an average 8.7% decline for 8M20, which may indicate further room for ‘normalisation’. Moreover, the fourth quarter will see a slew of shopping events that are historically spending peaks for the Chinese. This includes the greatly popular Singles’ Day shopping event hosted by e-commerce giant Alibaba, which has been setting new record sales every year, a key event to watch for consumer spending sentiment.

Expansion of Investment Mandate

From “pure retail” to “pure China”.

• CapitaLand Retail China Trust announced the expansion of its investment mandate to include income-producing real estate assets in China, Hong Kong and Macau, that are used primarily for retail, office and industrial purposes. The expanded mandate will encompass business parks, logistics facilities, data centres and integrated developments and in our view, pave the way for CapitaLand Retail China Trust to further tap on sponsor CapitaLand (SGX:C31)’s expertise and network in China.
• We are excited about this expansion in mandate and see this diversification positively as it will bring greater balance and visibility to future distributions. Looking ahead, we believe that CapitaLand Retail China Trust’s new identity as a “pure China” play to be more attractive to investors given its wider investable universe and relevance after the lessons learnt from the COVID-19 pandemic where a pure retail REIT’s operations were more significantly disrupted.
• With the REIT pivoting away from the retail sector over time through the introduction of new asset classes like industrial (especially business parks) and integrated developments, we see less volatility in future earnings and at the same time gaining exposure to future economy sectors like tech, media, etc. While the transaction yields are likely to be higher than retail which lowers the accretion for CapitaLand Retail China Trust to achieve, we do believe that this strategy will further future-proof the REIT’s earnings profile to future pandemics and shifts in consumer behaviour which are inherent trends that the retail sector has to constantly be ahead of.

A sizeable addressable pipeline to grow by 10x; a possible giant in the works.

• The sponsor directly/indirectly owns a total of 25 retail assets, 27 commercial assets and 22 integrated development projects and 10 assets within the logistics and business park space. Based on our estimates, the addressable investable pipeline from the sponsor is estimated to be close to S$33bn (on a 100% basis). This implies an investable pipeline of more than 10x of CapitaLand Retail China Trust’s current asset under management (AUM).
• The estimated S$33bn in pipeline assets is split between Integrated developments (74% of value), retail malls (14%), industrial (5%) and commercial (7%). While integrated developments are sizeable in footprint and value, we see this asset class as more of a medium target given its lower yields, which will make an accretive transaction tough given CapitaLand Retail China Trust’s high cost of capital.

Industrial and commercial pipelines are mainly located in Shanghai.

• The industrial, commercial property pipeline represents a sizeable value of S$4.1bn, which is still significant for CapitaLand Retail China Trust to tap. We note that a majority of these properties came from the merger with Ascendas-Singbridge, which still form a significant opportunity for CapitaLand Retail China Trust to tap.
• Based on our estimates, the industrial and commercial portfolios are substantially located within Tier 1 cities in China with Shanghai, representing 57% of the S$4.1bn value. The rest are located within Guangzhou, Shenzhen, Suzhou and Hangzhou, taking up 40% of value.

Historical Low Price-to-book Sidelined Near-term Growth Potential

Attractive price-to-book at 0.68x.

• CapitaLand Retail China Trust's share price currently trades near a 10-year low price-to-book of 0.68x, below -1 standard deviation level of 0.80x, and at a sharp discount against historical mean. Despite the strong recovery profile that is ahead of Singapore peers, CapitaLand Retail China Trust continues to trade at a discount to peers which average at 0.84x price-to-book (at -1 SD levels).

Forward yield of 8.6% based on estimates with further upside through acquisitions.

• We forecast DPU to be 8.8 Scts and 10.1 Scts for FY20 and FY21 respectively, signalling a decline of 11% and growth of 14% y-o-y. FY20 yields are at 7.5% based on our estimates, at a good 160bps above the sector average of 5.9% while forward yields are also attractive at 8.6%.

Reiterate BUY on CapitaLand Retail China Trust

• Not only is the quantum of rental relief and rebates likely to be lower for CapitaLand Retail China Trust as opposed to Singapore peers which are subjected to at least two months of rental rebates out of pocket, we see lower risk of further rental relief and rebates provided by CapitaLand Retail China Trust as opposed to Singapore retail peers.
• We continue to like CapitaLand Retail China Trust for its smoother recovery profile, attractive yields and near-term acquisition potential which have not been priced in by the market.
• The acquisition play will not only strengthen CapitaLand Retail China Trust’s earnings visibility through diversification but also build CapitaLand Retail China Trust into a China behemoth with CapitaLand (SGX:C31)’s strong line-up of quality assets, which should bode well with investors.

Source: DBS Research - 8 Oct 2020