Supply-led rental weakness and longer gestation period
We visited PCRT’s malls recently and came back feeling less sanguine about its outlook. Occupancy rates arehealthy butat the expense of lower rental. We expect the rise in retail mall supply longer gestation periodto curb rental growth in the near-to mid-term.
We factor in weaker rents and longer gestation period in our model, slightly offset by the Beijing development and higher occupancy. DPU for FY13/14 remains largely unchanged due to the earn-out funds but RNAV and target price drops by 17%. Downgrade to Neutral from Outperform with lower RNAV-based target price of S$0.57 (discounted by 20%).
Supply-led rental weakness
Rising supply of retail space in selected cities has caused pressure on both tenant sales and rent. Higher occupancy in operational malls came at the expense of lower rents.
Majority of PCRT’s rental structure has a gross turnover (GTO) component, where tenants pay the higher of a fixed rent or percentage of tenant sales. Fixed rent is lower, as more retail space means greater competition in attracting quality tenants. While crowd was observed at the Shenyang Longemont Mall, few of them were holding shopping bags, signalling weak tenant sales. We expect rental upside from GTO component to be slow and stabilise in FY15/16 after a rental cycle.
Longer gestation period
We expect longer gestation period as immediate catchment areas near selected malls take time to mature. We noticed that residential and office units near the Foshan Jihua mall and Chengdu Qingyang mall are largely unoccupied. Nearby residential and office crowds are the main target of selected malls and high vacancy rates near the malls is likely to translate into longer gestation period.
Potential in Chengdu Dongzhan and Beijing
We see potential in Chengdu Dongzhan and Beijing Tongzhou developments on the back of high people pass-through and attractive breakeven price respectively. However, near- to mid-term
1.1 Operating portfolio assets at 58%
We visited the PCRT’s malls during the Golden Week after the opening of Perennial Jihua Mall in Foshan. To date, c.58% of its portfolio assets (by GFA, adjusted for PCRT’s stake) are operational. Operational assets are expected to increase to c.97% by 2014 with the completion of Perennial Qingyang Mall and Perennial Dongzhan Mall in Chengdu.
1.2 Higher occupancyratesbut lower rentals
As most of the malls are in their first or second year of operations, management is currently focusing its efforts on securing high occupancy and quality tenants to garner traction among shoppers. This includes rent-free periods, master leases and anchor tenants at attractive rentals, which are not uncommon practices among peers, but are likely to translate into lower rentals for the PCRT.
2. SUPPLY-LED RENTAL WEAKNESS
2.1 Shenyang faces supply pressure
According to Savills, Shenyang’s mid- to high-end retail market is expected to experience an average supply of 718,000 sq m per annum between 2012 and 2014, increasing its total stock by 54%. The supply pressure has translated into higher vacancy and weaker rental income.
2.2 Shenyang furniture a victim of rental pressure
Aside from supply-led pressure on rents, the Shenyang Red Star Macalline Furniture Mall was also affected by uncertainty in the property market as households delay bulk furniture purchases. To improve occupancy, management has master-leased the mall but had to sacrifice in terms of rental income. Although the rental structure has a GTO component, existing tenant sales needs to almost double for the effect to kick in. Judging from available data on how tenant sales grow as malls mature, we expect the effect of the GTO component to be slow and start in FY15/16 after one rental cycle.
2.3 Shenyang Longemont Mall affected, but mitigating factors exist
Shopper traffic at the Shenyang Longemont Mall is healthy during our visit given the holiday and opening events that were happening. We noticed that despite the large crowds, few were holding shopping bags, signalling weak tenant sales. Management mentioned that the existing rental income is largely from the fixed rent, but the GTO component has yet to kick in. However, the spillover from the nearby wholesale centre which gains 40,000 footfalls per day, the opening of the Longemont Hotel, nearby residents moving in and the ramping up of the Longemont office blocks may serve to attract more shoppers.
2.4 Positive GTO effect onrents to come after a rental cycle
We used Shenyang Longemont Mall, the largest operating mall by valuation, as a benchmark to gauge how the GTO component will affect rental income. More than 80% of the mall’s tenants have the GTO component in their rental structure. This aligns with the interests of the management and tenants in driving shopper traffic and spending, but is expected to result in weaker interim rentals as the mall ramps up its operations. Management mentioned that existing rental income are largely from the fixed rent but expects GTO components to kick in by FY14.
Looking at CapitaMalls Asia’s China assets, it typically takes a rental cycle of 3-5 years for new malls to double in GTO and stabilise at growth of 6-7%. Therefore, we expect weak interim rental as the GTO component kicks in gradually and stabilises after a rental cycle in FY15/16.
2.5 Foshannot spared fromsupply pressure
Approximately 1.3m sq m of retail space is being planned for next 2 years, with Wangda and Wangfujing expected to open next year. We noted light footfall at this mall which we believe can be attributed to supply pressure as well.
3. LONGER GESTATION PERIOD –DEVELOPING CATCHMENT AREAS
3.1 Low occupancy in residential clusters near Foshan mall
Footfall was light at Perennial Jihua Mall as it had opened less than three months ago and more locals travel out of the city during Golden Week. Given that it is positioned as a suburban mall, residential catchment in the vicinity is important in gaining shoppers traffic and rental pricing power. There are approximately 4000 residential units being built in the area, and we noticed that most of the units remain unoccupied. While the mall is directly connected to the subway station, which is expected to serve as an interchange for the future Lines 4 and 6, the subway is only expected to be operational around 2020. Given low occupancy in nearby residential clusters and lag time before subway opening, we expect shopper traffic and tenant sales to be impacted negatively in the short to mid-term.
One mitigating factor is that both the management and tenants are seeking to ramp up tenant sales. As most of the rental structures have a GTO component where the rent will be whichever is higher - the fixed component or a percentage of the GTO – the interests of management and the tenants are aligned. We also noticed marketing campaigns such as lucky draws and free gifts at the mall. Management conducts on-the-ground surveys of the effectiveness of its marketing campaigns and aims to be flexible in adjusting to local preferences. We expect shopper traffic and tenant sales to be weak in the short- to mid-term, but to pick up in FY15 after the mall’s 3-4 year gestation period and as the residential occupancy in the vicinity improves.
3.2 Low office and residential occupancy around Chengdu Qingyang Mall
The Perennial Qingyang Mall is located near the Third Ring Road in Chengdu and is positioned as a suburban mall. It is the only mall within a 5km radius, and targets the residential and office crowds in the vicinity. We noticed that the office blocks directly beside the mall are still being developed and the residential units appear unoccupied judging from the unopened windows and bare fittings. Although the mall is targeted to open in 1Q14 or 2Q14, we expect a longer gestation period given the low occupancy in the immediate catchment area.
4. POTENTIAL IN THE BEIJING AND CHENGDU DONGZHAN DEVELOPMENTS
4.1 High footfall in Chengdu Dongzhan vicinity
We noticed high people pass-through around the Perennial Dongzhan Mall in Chengdu. The mall makes up 31% of the PCRT’s portfolio assets by valuation (targeted completion in 4Q14) and is strategically located with connectivity to a subway station, high-speed rail station and long- and short-distance bus interchanges. The high pass-through was observed despite the fact that one out of the two subway lines is in the development phase and some bus lines have yet to shift over from their existing locations. The government guided that the people pass-through for the transportation hub is 200,000 per day and it targets to reach 500,000 when all the lines are operational. We see potential in terms of shopper traffic but expect rental contributions to have a significant impact only after FY15/16.
4.2 Monetisation opportunity in Beijing development, but impact limited by the small stake
The Tongzhou District is 13km from Beijing’s city centre and has been earmarked by the Beijing government as a new central business district (CBD). The site is close to the Grand Canal and will be positioned as a waterfront mixed development. Across the Grand Canal we could hear a concert being held for the Music Festival and saw residential developments which have been largely sold. The environment differed remarkably from the existing CBD with traffic congestion and crowds. Consequentially, we expect a considerable length of time before the nearby developments are completed and the office crowds shift to the new CBD area. The CBD is targeted to be completed in 2016, and we expect little income contribution from the mall in the interim.
However, monetisation opportunities exist for the road facing the retail units. We note that the Wanda Tongzhou development has been strata selling its road-facing units at Rmb80,000-90,000 psm GFA, which is about five times the breakeven price on a completed basis of Rmb15,800 psm GFA. Three land sales 3-12km away from the mall at end-2012 were transacted at Rmb12,896 psm GFA, which is only 20% below the breakeven price of development. We view this development favourably, but the impact on its valuation is limited as it is less than 5% of the portfolio value based on the transaction costs.
5. VALUATION & RECOMMENDATION
5.1 Downgrade to Neutral
We adjust our estimates for the lower stabilised rents and longer gestation period, which are slightly offset by the higher occupancy and factoring in the Beijing Tongzhou development. We maintain a 20% discount in deriving our RNAV-based target price to factor in the higher uncertainty for newer malls. Our RNAV-based target price drops by 17% and we downgrade PCRT to a Neutral due to the supply-led rental pressure and longer gestation period as a result of the slower development of the nearby catchment area. Catalysts for the stock include the acquisition of pipeline assets at attractive prices and stronger-than-expected tenant sales.
Publish date: 09/10/13