The business models of CapitaLand Investment (CLI) and City Developments (CDL) may have diverged. However, both depend on the interest rate cycle but for different reasons.
CLI’s stated strategy is to lighten its balance sheet and raise its income to the extent that its ROE gets to 10%. Based on a theoretical equity base of $10 billion, CLI’s net profit after tax and minority interest (patmi) has to get to $1 billion for an ROE of 10%. CLI also has a target for assets under management (AUM) target of $200 billion by 2026, which is about double its current AUM.
To recap, CLI has two main sources of income: fee-income related business (FRB) and real estate investment business (REIB). FRB comprises fee income from listed REITs, private funds, commercial (previously property) management, and lodging management. REIB comprises income from CLI’s sponsor stakes in listed funds, its stakes as a general partner in private funds, and its effective stakes in on-balance sheet assets.
At $200 billion in AUM and with greater efficiency in the FRB and REIB businesses, analysts believe CLI can get to its double-digit ROE target. In 1HFY2024 ended June, CLI reported a patmi of $331 million, down 6% y-o-y, suggesting that CLI has some way to go before hitting the magic $1 billion patmi number.
A JP Morgan report following CLI’s results briefing on Aug 14 says: “Historically, CLI has achieved $800 million to $1 billion in profits (annualised 1H2024 patmi is equivalent to $662 million) and with current $14 billion equity basis, mathematically for CLI to hit a double-digit ROE would entail shrinking the equity basis by $4 billion. Feedback from some investors is how quickly CLI could return $4 billion of capital to shareholders and willingness for management to give up such financial flexibility.”
CDL does not have a patmi target but has a divestment target of $1 billion. In 1HFY2024 ended June, its patmi rose 32% y-o-y to $87.8 million. CDL has been taking on assets, causing its gearing to rise. CDL has changed how it reports its gearing ratio, focusing on gearing based on the fair value of its investment properties.
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As at end June, CDL’s gearing stands at 116% based on historical cost accounting. Including the fair value of investment properties, gearing is at 69%. In comparison, CLI’s gearing as at end 1HFY2024 stood at 0.59 times (59%) and its interest coverage ratio was at 3.5 times. CDL’s ICR stood at two times.
Part of CDL’s strategy is to wait for the Federal Reserve to start its rate-cutting cycle as its fixed-rate debt is around 40%. CLI’s fixed-rate debt is at 61%. One of the reasons for CDL’s lower fixed rate debt and its higher average cost of debt of 4.5% is that the property group took on debt to acquire St Katharine’s Dock in London last year and a hotel in Paris this year. In addition, CDL has been acquiring assets in the private rental sector (PRS) and purpose-built student accommodation sector (PBSA), and it has landbanked in Singapore.
Challenging first half
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Sherman Kwek, group CEO of CDL, says: “We had some delays and we didn’t recognise as much profit as we had hoped. In terms of metrics, our share price hasn’t performed, and on May 31, we suffered from a deletion in the MSCI Singapore Index. It doesn’t mean we can’t get back in.”
“Our revalued NAV (RNAV) has ticked up to $19.49, and we are trading at a very deep discount, which is why we did share buybacks. Our gearing has gone up, but we need the interest rate environment to be more favourable,” he adds.
In 1H2024, CDL bought back 13.5 million shares at an average price of $5.88 per share. Analysts believed that CDL’s share buybacks during 1H2024 were the group’s attempt to defend the stock from exiting the MSCI Singapore Index.
“Unfortunately, in one specific case, the delay was longer than six months, which is not great. The contractors were cash-strapped, so to move forward, we had to work with them to find ways to facilitate the construction. During the delay, interest expense continued, and we will recognise the profits much later. But aside from that, in terms of actual additional costs, not too much more. It’s more the timing of the profit recognition and handing over units. But the good thing is, we always build buffers when we sign our sales and purchase agreements with our buyers, so we will still be within the time required to hand over units,” says Kwek.
At the start of the year, Kwek had set a divestment target of $1 billion. According to CLSA, the company has divested $271 million of property in the first half.
“Markets are a little tough now. There’s always cautious buying sentiment. It’s about finding the right buyer. There will be more divestments coming in the second half of this year. We could get to $400 million to $500 million of divestments this year, inclusive of the first half,” Kwek says.
Among the properties to be divested are the legacy UK properties acquired 9 or 10 years ago for around $1 billion. These include Teddington Riverside in Richmond, Stag Brewery Mortlake in Richmond, 31&33 Chesham Street in Belgravia, 100 Sydney Street in Chelsea, and Ransome’s Wharf in Battersea.
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“For legacy residential sites, the bigger sites are waiting for planning permission. The rest of the divestments will be at market value; we have to take impairments from time to time,” says Yiong Yim Ming, group CFO of CDL.
When questioned about CDL’s rising debt levels, Yiong explains this is for newly acquired properties and not legacy assets acquired more than 10 years ago.
Fed pivot to bring relief
CLI had a challenging first half as well, but for different reasons, as explained by Andrew Lim, group chief operating officer of CLI.
“We outlined three priorities, and they all concerned capital. The first priority was capital formation. The second priority was capital recycling, and the third priority was capital rebalancing,” Lim says.
Capital raising was the lowest since 2012, according to Lim. Globally, around US$60 billion was raised. Of that, US$5 billion was allocated to Asia. “We’re around 10% of the US$5 billion. We are punching at or slightly above our weight,” Lim says.
The private equity business comprises part of capital formation, where CLI forms new private equity funds and gets capital partners to invest as limited partners (LP).
Of the capital raised this year, 90% went to the living sector and industrials. Of the different strategies, the majority of the capital is going to value-add. “Four of the five funds we raised capital for are in these strategies. We are listening to investors,” Lim continues.
Capital recycling was tough because markets were somewhat frozen for 2022 and much of 2023. With the Fed’s pivot, this part of CLI’s model may be better placed.
In 1HFY2024, among CLI’s contributions to its FRB, commercial management (formerly property management) was the largest contributor and the highest y-o-y growth at 22%. Lodging management was the second-largest contributor with single-digit growth; listed funds management came third. Although the fee income contribution by private funds to FRB was the lowest among the segments, it recorded a 12% y-o-y growth.
“Given where rates are, the challenge is for core product in particular; to formulate capital and go and raise capital and employ,” Lim says. If rates start to moderate, that should open the window for core product, and CLI would be able to “formulate capital again and deploy”.
Regarding capital rebalancing, Lee Chee Koon, group CEO of CLI, says that the portfolio, which remains big on China with 30% exposure, needs to be more balanced and diversified. “To guide the market, we do not envisage any geography should take more than 20% of our capital allocation. We are going to [recalibrate] through active capital recycling and active growth, with proceeds from recycling seeking new opportunities to grow our presence and capabilities in Japan, Korea and Australia,” Lee says. “The idea is to be strong in Asia-Pacific before we look into Europe and the US.”
In addition to dislocations caused by interest rates, 2024 is also an election year in several key countries: India, the UK, France, Indonesia, Mexico, and the upcoming US presidential election.
“Fundraising has been tough and private equity players have trouble finding liquidity,” Lee adds, promising to share more on CLI’s Investor Day in November.
On Aug 13, CLI announced the first close of its sixth onshore renminbi (RMB) fund, China Business Park RMB Fund III (CBPF III), with an initial equity commitment of RMB1.2 billion ($222 million) to invest in the business park sector in China. CLI has secured an onshore major institutional investor as the fund’s anchor investor.
The close-ended fund is expected to add RMB2 billion to CLI’s funds under management (FUM) when fully deployed. CLI will maintain a sponsor stake in CBPF III in line with its asset-light strategy to grow its FUM while keeping strong alignment with its investors and partners. The seed property was Ascendas iHub Suzhou in Suzhou Industrial Park.
CLI’s strategy to recycle assets from its balance sheet into RMB funds is part of its China for China capital management strategy. CBPF III is CLI’s second recapitalisation this year following the divestment of a 95% stake in Capital Square Beijing into a joint venture.
“China is a very big market and there are huge pools of capital in the country. We have raised almost RMB50 billion of capital within China. There is a lot of capability to tap domestic capital for fee income in China and reduce our capital allocation. We are recalibrating our playbook for China and pivoting to China for China and RMB,” Lee explains.
“We need to reduce the capital employed and pivot from USD to RMB and get to a China for China product. This is a delicate dance to accomplish with real estate and our capital partners. We want the CBPF III to serve as a template,” COO Lim says.
JP Morgan agrees that the fundraising environment remains challenging, especially for core and core plus strategies given elevated interest rates. “Nevertheless, interest remains in thematic areas such as value-add, wellness, living, data centres and logistics. CLI is also making efforts to roll over existing funds and attract new capital, especially in China, where the focus is on RMB funds. YTD CLI has raised $1.1 billion in private funds,” JP Morgan says in a post-results report.
JP Morgan has an “overweight” recommendation and a year-end target of $4 for CLI based on a sum-of-parts valuation consisting of 1) 16 times EV/ Ebitda multiple for its asset management business in line with peers; 2) 15 times EV/Ebitda multiple for the lodging business; 3) $7.7 billion for its stakes in various S-REITs, based on JP Morgan’s fair values; 4) $5.5 billion for its stakes in various unlisted funds and 5) $6.2 billion for CLI’s investment portfolio (inclusive of assumed $3 billion asset sales).
