Tuesday, January 1, 2019

Ascendas India Trust (SGX:CY6U)



Ascendas India Trust (AIT) is an underrated gem in the Singapore REIT space. While I understand that certain investors might have some apprehension about having Indian exposure, due in part to the volatile and constantly depreciating currency, the bright growth prospects and strong sponsor has been more than enough to offset these risks. Although this REIT tends to draw less attention than the blue-chip REITs under the Mapletree and Capitaland stables, I personally feel that this REIT deserves a place alongside them.


Summary of Investment Thesis

Strengths
  1. Bright growth prospects driven by favourable Indian demographics and global offshoring trends
  2. Strong sponsor support - Ascendas-Singbridge is backed by Temasek and JTC
  3. Clear pipeline of assets under development - Strong earnings growth visbility thanks to robust pipeline of buildings under development
Risks
  1. Structural Indian Current Account Deficit - This causes the INR to be on a persistent and long-term depreciating pathway against major currencies, which erodes DPU growth in SGD terms. In years of severe depreciation, DPU in SGD terms may fall

What does AIT do?

AIT is a real estate investment trust (REIT) that holds 7 IT Parks and 6 warehouses across India. This REIT is a play on India's growing role as a Global IT center and leading offshoring hub for service. For example, AIT announced in May 2018 the acquisition of a building in Hyderabad, aVance 6 that is 98% leased to Amazon. The REIT has a strong growth pipeline, as it has properties under construction that will contribute to the REIT's NPI upon completion over the next few years.

 


Macroeconomic Analysis

Steady and bright growth outlook. In a world of slowing economic growth, India stands out as an increasingly important growth driver. While China will continue to grow, its best years of breakneck economic growth is likely behind it. Also, India's demographic profile is considerably more favourable than China, which points to decades of strong growth ahead. In comparison, the full impact of China's One Child Policy enacted decades ago will weigh on economic growth in the coming decades. Also, given the relative isolation of the Indian economy (being less integrated into the global economy as compared to the heavily export-oriented nations of the Far East), this growth is less likely to be affected by global economic disruptions. 


Strong economic growth usually translates into rising demand for commercial real estate, which in turn pushes valuations up and drives positive rental reversion. Also, it implies a growing pie, which is beneficial for all players involved, lowering the degree of competition in the market. India's strong economic outlook bodes well for AIT which is well positioned to benefit with its long pipeline of assets to be added.

Offshoring of global IT services to India. India has positioned itself as an offshore hub for IT services. The primary driver behind this offshoring trend is the large supply and lower wages of IT personnel in India. According to PayScale, the average IT programmer commands an annual salary of USD 6,215, compared to USD 6,813 in the Philippines and USD 61,176 in the US. As indicated by the pie chart below, American corporations dominate with a 59% share of AIT's rental income, followed by French corporates at 9%. Local corporations account for less than a quarter of AIT's rental income.



While there has been strong push-back in the US against the offshoring of manufacturing to the Far East, there has been virtually zero political backlash against the offshoring of services to Asia. This is likely because the segment of labour being displaced is more mobile (educated/skilled) and less likely to demand for populist measures at the ballot box. As such, there is unlikely to be any political impediment towards this trend of American and European based corporations shifting their IT operations to India.

Structural Current Account Deficit. Lacking a strong manufacturing base, India has been running a Current Account Deficit for decades as a result of its imports far exceeding its exports. In the long run, this structural current account deficit has resulted in a persistent depreciation of the Indian Rupee (INR). The chart below demonstrates the relationship between the Current Account Deficit and the INR. It can be seen that when the Current Account Deficit widens, the INR tends to weaken and stabilizes during periods when the Current Account Deficit improves.

Between 2009 and 2013, when the Current Account Deficit worsened sharply, the INR depreciated in line. This impacted AIT's earnings during those years, though the strong rental income growth offset the weaker INR. Since 2013, the Indian government has taken steps to curb the Current Account Deficit, such as raising import duty on gold, a major source of the Current Account Deficit. While the Indian government has had some success in reducing the Current Account Deficit, I do not expect it to be eliminated in the next few years. This implies that the INR is expected to continue depreciating gradually, though nowhere nearly as severe as experienced in 2009-2013.

This factor is arguably the largest headwind for AIT since its income is 100% denominated in INR while all distributions are repatriated to unitholders in Singapore Dollars (SGD), and is likely a reason for many potential investors to gloss over this name. From a macroeconomic perspective, investing into AIT is a wager that the rental income growth (in INR terms) will significantly outpace the expected FX losses due to INR depreciation.

Company Analysis

Sponsor (Ascendas-Singbridge Group)

Ascendas-Singbridge is jointly owned by Temasek Holdings and JTC Corporation. Both entities are wholly-owned by the Government of Singapore and their REITs have been well managed over the years. Among the chief concerns plaguing S-REITs have been management pursuing Mergers & Acquisitions (M&A) deals that have been non-accretive to REIT unitholders, or at worst, dilutive to investors. While some IPOs in recent years have been attempting to discourage such behaviour by aligning the interest of unitholders and REIT managers, I am of the view that the character of the Sponsor is key in preventing such behaviour. 

While AIT's incentive structure for management is not quite aligned with unitholders (discussed further below), the management has not undertaken any DPU dilutive deals since their IPO in 2007. I personally feel that having a strong sponsor is a vital ingredient in sustaining growth in the long-term.

Growth Outlook

AIT has grown steadily, in terms of property acquired/constructed since its IPO. As of September 2018, the REIT has a total commercial space of 12.6 mil square feet, and is poised to rise to 20.1 mil square feet over the next few years. This points to a strong NPI and DPU growth outlook over the next few years.




AIT has sufficient debt headroom to finance this gradual expansion. Its gearing ratio stands at 32% presently, quite comfortably below the 45% limit set by the Monetary Authority of Singapore (MAS). The REIT has an average debt cost of 6.1%, based on borrowing ratio of 62% in INR and 38% in SGD as at 30 September 2018. As Indian interest rates are expected to decline as the economy develops gradually, AIT's borrowing costs can be expected to gradually fall in the long run.



Income Analysis

AIT has demonstrated a strong track record in terms of generating Net Property Income, particularly in INR terms (red bars below). In SGD terms, the REIT's NPI has been somewhat less impressive particularly through the years of 2008 and 2012. This is largely due to the reasons mentioned above regarding the macroeconomic environment driving the SGD/INR, and not factors specific to the REIT.



In terms of distributable income, AIT fared poorly through the period of 2008-2012 due to a combination of higher interest costs, higher dividend distribution taxes. However, distributable income has shown steady recovery since 2013 as the negative factors that weighed on the REIT in the earlier years receded. Also, the REIT reduced its distribution from 100% to 90% since 2013, which allows the REIT to gradually strengthen its balance sheet via income retention. 



REIT Management Fee Structure
  1. Management Fee-
    • Base Fee: 0.5% p.a. trust property value
    • Performance Fee: 4% p.a. of trust's net property income 
  2. Acquisition Fee - 1.0% of the value of real estate investment purchased or acquisition price 
  3. Divestment Fee - 0.5% of the value of real estate or sale price 
  4. Trustee Fee - 0.02% p.a. of trust property value 

AIT's management fee structure does not align the interest of unitholders and that of the REIT management because the management incentive fee is based on NPI growth, rather than DPU growth. Under some circumstances, such as an absence of accretive opportunities, the management may be tempted to undertake DPU dilutive acquisitions just to boost DPU at the expense of unitholders. As India's property yields remain high by global standards, the risk of AIT's management undertaking dilutive acquisitions is low for the forseeable future.

Conclusion

AIT is a play on several very positive long-term growth drivers, notably India's bright growth prospects, and the offshoring of IT services by MNCs. However, the risks include India's persistent Current Account Deficit, which has led to a long-term depreciation pathway for the INR and higher interest rates. In years of particularly severe depreciation such as in 2012, the depreciation may outweigh NPI growth, leading to lower DPU in SGD terms. On the other hand, having a strong sponsor with a solid track record helps to mitigate the challenges of operating in an Emerging Market like India.


For market data on this REIT and comparison against the market, please refer to my compilation of REITs here.

Disclosure: At the point of writing, I am long AIT. I intend to hold this position for the long-term.
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