Monday, September 16, 2013

Religare Health Trust : Rupee concerns priced in – acquisition opportunity exists (CIMB)

Religare Health Trust
Current S$0.76
Target S$0.93
Rupee concerns priced in – acquisition opportunity exists

 RHT was sold down on softer rupee and rising interest rates. Current share price implies a further rupee depreciation of 35%. We also see acquisition opportunity given the weak rupee and RHT’s low debt.

We trim our estimates to factor in higher interest cost and weaker rupee. Our DDM-based target price drops 13%. Maintain Outperform with acquisition acting as catalyst.

Addressing FX concerns
The rupee has declined 10% YTD. It is true that a falling rupee is negative for RHT, but there are mitigations. We estimate that every 10% fall in the rupee will cause DPU to fall by 10.4%. The fall is mainly due to the translation effect and slightly augmented by a small amount of S$ debt. Also, the negative effect is lagged as RHT has a policy of hedging two distributions on a 6-month rolling basis. We have revised our S$/Rs assumptions to 51, from 47.8. FY15 yield currently stands at 10.6% and will compress further to 9.5% if the rupee falls by another 10%. RHT listed at 6.42% forward yields, which implies that current share price has already factored in a further decline of rupee by > 35%.

Limited impact from rising interest rates
Impact of rising interest rates is limited given RHT has the one of the lowest debt ratios (7.3%) among its peers. There are valid concerns of debt mismatch though. The bulk of this debt (~90%) is denominated in S$, but it is not a big quantum. Current debt is locked at 2%+SOR for three years, but additional debt will come at a funding cost of 4.5-5%. The quantum of additional debt is mitigated by the fact that 25% of RHT’s future planned capex will receive interest-free commitment funding from Fortis Operating Co.

Depreciating rupee an avenue for acquisitions
RHT’s low debt ratio and ability to finance in S$, puts them in a sweet spot for Indian acquisitions, as rupee falls. RHT has ample debt headroom, at S$290m to carry out proposed capex and engage in acquisition. Even if total assets fall by 20% due to translation loss, debt headroom remains healthy at S$210m. Fortis, its sponsor, has been divesting its overseas assets. The top two Fortis hospitals by revenue, FEHI and Mohali, make good candidates given their higher average occupancy and ARPOB. Assets cost around S$100m.

1. Concerns on RHT’s rupee position could be overdone
1.1 Depreciating rupee has hit Indian and Indo REITs
Macroeconomic stress and Fed’s statements on unwinding of QE triggered sharp depreciation of emerging country currencies such as rupee and IDR. rupee and IDR depreciated by 8% against S$ in August alone. While REITs as a sector fell in August, REITs and business trusts (BTs) with exposure in India and Indonesia fell by almost twice the amount, reflecting investors’ concerns on both their country and currency exposure. We think share price retracement has reflected a lot of the concerns of currency deprecation.

1.2 Sensitivity of DPU to further rupee falls
The concerns on rupee are certainly justified. While it is difficult to predict if the rupee will floor at current levels, our sensitivity analysis of RHT DPU vs. further rupee movements suggests that one can still get 7.3% dividend yields at current price, even if the rupee falls a further 30%. RHT was listed at forward yields of 6.42%. Our base assumption of S$/Rs is now pegged at 51. Assuming that 6.42% yield is fair market pricing for RHT. It would mean that current share price reflects market expectations of a further >35% decline in the rupee.

All of RHT’s revenue and costs are based in rupee, with the exception of interest expense, management fee and trustee expense. Our sensitivity analysis shows that a 10% depreciation of rupee will cause 10% drop in revenue and costs excluding interest and fee expenses. Interest and fee expenses, on the other hand, are less sensitive to exchange rate movements as majority of the existing debt (~90%) and all fee expenses are S$-denominated. Specifically, a 10% depreciation of rupee only results in 8% drop in interest and fee expenses. This means that when rupee depreciate and hit the top-line, costs decline by a smaller degree, resulting in greater impact on net and distributable income. The effect of that however, is mitigated, as interest and fee expenses are small proportion of total costs. Overall, a 10%/20%/30% depreciation of the rupee will result in 10.4%/20.7%/31.1% decline in DPU.

1.3 Impact of falling rupee is delayed by currency hedging
RHT has hedged its next two distributions and is expected to continue hedging its obligations on a 6 month rolling basis. This means that current FY14 yields of 10.7% is largely safe. Nonetheless, having one year of secured dividends is clearly not good enough when investors know that DPU will fall in FY15 from the currency effect. We have examined the effects of DPU impairment by analysing the sensitivity of DPU to further rupee depreciation. The other impact is to gearing levels, if asset values falls on rupee translation losses, while debt levels (in S$ terms) stays the same.

2. Rising rates concerns negative for REITs in general
2.1 Rising interest costs
With rising expectations surrounding the tapering of the QE, the US 10-year government bond yield rose more than 80bps since June. The US Fed is widely expected to scale back QE by 4Q13, which is likely to lead to rising financing costs and hurt S-REITs prices. Since the 07/08 financial crisis, most REITs have spread out their debt maturity. Additionally, they typically have a higher portion of fixed-rate than floating-rate debt. Therefore, we foresee rising interest to take effect on the P&L gradually over the coming years as debt matures and think refinancing issues of 07/08 are unlikely to resurface. We think that the market could be more concerned about the narrowing yield spreads over 10-year S$ yield. (We have addressed this issue in our recent report - “Taking stock of yield spreads”)

2.2 RHT does not have worries on its level of gearing
On average, debt ratios of S-REITs are currently at around 36%, while RHT is at 7.3%. It is also considerably lower as compared to other healthcare REITs such as First REIT and Parkway Life REIT. The risks for RHT is: 1) its gearing level could increase if the value of its rupee-denominated asset falls in S$ terms; and 2) banks could increase their lending rates to RHTs, due to the higher perceived risks emanating from its Indian exposure.

We note that RHT does not hedge its balance sheet and finances mainly in S$ - which is a key concern. This is however, mitigated by a low debt ratio, which allows room for potential falls in asset values due to translation loss. In our sensitivity study, a 10% translation loss on the total assets only increases its debt ratio to 8.1% – not a major concern.

2.3 Future capex is the concern, though there are some mitigating factors
Current debt cost is SOR+2.0% or around 2.5%, funded by DBS. SOR should not rise with US Fed tapering, and will hike up only if the US Fed raises US Fed fund rates. Obviously, beyond the period, one should expect debt financing costs to rise but that is a common problem for all REITs. For RHT in particular, any additional debt will likely attract funding cost of 4.5-5%. So, the impact is more on future capex and/or acquisition. Planned capex amounts to rupee 7,132m (approx. S$140m) for AEI and Greenfield developments. The mitigation for these new capex is that 25% of the estimated costs will be funded by an interest-free refundable commitment deposit from Fortis Operating Company, the company operating the hospitals. We think this could soften the impact of rising interest rates.

3. Depreciating rupee a boon for Indian acquisitions
3.1 Opportunity for India ROFR acquisition
RHT Management has highlighted their preference for India right of first refusal (ROFR) assets and S$ denominated debt. Debt ratio and headroom, as mentioned previously, is healthy and provides ample room for acquisition. This makes the current situation of low debt and depreciating rupee potentially an acquisition opportunity for RHT, at attractive prices.

Fortis has highlighted its intention to lower its debt ratios and adopt an asset-light model, which was one of the main reasons for setting up RHT. Fortis has been divesting overseas operations and increasingly shifting its focus to the high growth market in India. Aside from listing of RHT and divestment of Dental Corporation in Australia, Fortis recently announced its divestment of Fortis Hoan in Australia. Post divestment, debt to equity is expected to stand at around 0.6x, considerably lower than pre-RHT ratio of 1.6x. To reach its target net debt to equity ratio of < 0.5x, we think that Fortis may engage in further divestments.

Moreover, there is more than S$200m of debt headroom for RHT as long as translation loss does not exceed more than 20% of total assets (at 40% target debt ratio). RHT has voluntarily adopted gearing limit of 60% and has a target gearing policy of 30-40%.

3.2 A closer look at potential assets
Given RHT’s preference for India assets, we take a closer look at Fortis’ India hospitals. Fortis currently owns and manages 51 hospitals in India, out of which 17 was acquired by RHT. Among Fortis’ top 10 hospitals by revenue, we focus on Fortis Escorts Heart Institute (FEHI) and Fortis Hospital, Mohali (Mohali). They are the top 2 hospitals in terms of revenue, and both are matured assets with more than 200 beds each.

FEHI is a 25 year old hospital with 310 beds and revenue of 3,570m rupee (approx. S$70m). It is JCI certified and NABH accredited cardiology care hospital. FEHI is operated and 100% owned by Fortis.

Mohali is a 12 year old hospital with 300 beds and revenue of 2,500m rupee (approx. S$48m). It recently received its JCI re-accreditation for the second time in succession. Mohali is operated by Fortis but owned by a third party.
Due to the lack of public transaction data for clinical establishments and the unique nature of the agreements between Hospital Operating Company and Hospital Service Company, we estimated the value of FEHI and Mohali based on multiples obtained from Cushman & Wakefield’s (C&W) valuation found on RHT’s prospectus. Specifically, we identified hospitals with similar location and maturity profile that has been valued by C&W, obtained revenue multiples and applied them to the FY13 revenues of FEHI and Mohali.

We feel that both hospitals are likely acquisition targets for RHT because 1) they are matured assets with occupancy and average revenue per operating bed (ARPOB) above that of average RHT assets, 2) they are operated by Fortis and 3) their estimated value is approximately S$100+m, acceptable given RHT’s debt headroom.

3.3 Timing and price of acquisition is the key
The effect of RHT's potential acquisitions in the future are likely to be determined by the price and timing. While the weakening rupee allows RHT to finance in S$ and purchase asset as favourable prices, potential further weakening can weaken its balance sheet position and increase the proportion of interest payments to its top line. That being said, RHT’s ability to obtain interest-free commitment fund for its planned capex will reduce the amount of S$ debt required. Also, debt headroom remains above S$210m even if RHT’s assets suffer from translation loss of 20%.

4. Valuation and Recommendation
4.1 Maintain Outperform
Rupee concerns remain an overhang but RHT’s current share price appears to have fully factored in such concerns. Assuming IPO yield of 6.42% is fair yield, current share price has priced in a further 35% depreciation of the rupee rupee . The rupee has depreciated 4.9% in 2010, 14.9% 2011 and 9.1% 2012. It has fallen 10.1% YTD. We adjust for currency and interest costs, trimming our FY13/FY14/FY15 DPU to 8.05/7.98/8.24 cents. Our current base case S$-Rs assumption in our model is 51. Our DDM-based (3% terminal growth, 11.7% discount rate) target price drops by 12.8% after our earnings adjustments. We understand that there are concerns surrounding an India-related stock given current market sentiment, but reckon that current share price has factored in a lot of that risk. Maintain Outperform.

Source/Extract/Excerpts/来源/转贴/摘录: CIMB-Research,
Publish date: 13/09/13

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