REIT analysis: Why I invested in Parkway Life REIT (SGX: C2PU)

Since its IPO in 2007, ParkwayLife REIT (PLife REIT) has consistently increased its DPU every year. In terms of share price, it has also gained more than 150% from its IPO price.

Given its impressive performance so far, I thus decided to do an analysis on PLife REIT, which subsequently led me to invest in it during the March 2020 market correction.

As such, for this post, I will be sharing both my analysis of PLife REIT and reasons for investing in it.

Note: For this analysis, I will be using updated data from PLife REIT’s unaudited full-year 2020 financial statement and results, and annual reports from the earlier years.

Disclaimer: This post should not be used as a recommendation to buy or sell units of PLife REIT. Rather its intended purpose is to be a source of insight and education. Any decision to buy or sell units of PLife REIT should be taken on the personal accord of the reader. As such, I take no responsibility for any future loss or gain amounting from the trading of units of PLife REIT. Lastly, I am also currently vested in PLife REIT.

Business overview

As of FY2020, PLife REIT has a total of 54 properties in its portfolio, amounting to a value of S$2.02 billion. A summary of its portfolio can be seen below.

On a side note, PLife REIT will be selling P-Life Matsudo, the only pharmaceutical product facility in its portfolio.

In terms of PLife REIT’s total gross revenue, much of it comes from its hospitals/medical centre segment.

As seen, around 57.7% of FY2020 total gross revenue came from hospitals/medical centres. Nursing homes took up the next considerable revenue contributor, contributing close to 41% of total gross revenue.

Given that hospitals/medical centres are the main revenue contributors of PLife REIT’s revenue, it is thus not surprising that Singapore is also the main country in which revenue is derived from.

As of FY2020, around 57.5% of total revenue comes from Singapore. This is due to the fact that three out of four of PLife REIT’s hospitals/medical centre are located in Singapore.

Japan is the next majority country as all of PLife REIT’s nursing homes are currently located there.

In terms of performance over the years, both PLife REIT’s hospitals/medical centre and nursing homes have grown over the years.

By briefing looking at PLife REIT’s business segments, we can see that nursing homes have been the main revenue growth catalyst for the past 5 years. Moving forth in the years to come, I expect this trend to continue given the stable and defensive nature of nursing homes.

Lease structure

Before analysing the financial results of PLife REIT, it is important to first know how it derives its revenue. Unlike traditional REITs where revenue is derived from the active leasing and management of rental space, a huge majority of PLife REIT’s revenue comes from master lease agreements.

Under these agreements, third party companies are engaged to manage and operate the properties on behalf of PLife REIT. For instance, PLife REIT’s hospitals are all managed and run by one company, Parkway Hospitals Singapore Pte Ltd.

Currently, the three hospitals are on triple-net lease agreements till August 2022, with an option of a 15 years extension. This benefits PLife REIT greatly as it need not deal with the hospitals’ property tax, insurance, and operating expenses.

As compared to the hospitals/medical centre, the nursing homes in Japan are run and operated by various different companies and operators. The property-related expenses are however footed by PLife REIT.

The only property which PLife REIT actively manages is its partially owned medical centre in Malaysia, where it owns various strata units, carpark lots and auditorium space.

To assess if PLife REIT’s lease structure has worked in its favour, I will thus be looking at its financial performance over the years.

What I like about ParkwayLife REIT

For this section of the post, I will be highlighting what I like about PLife REIT and its financial performance over the past 5 years.

Built-in revenue protection and growth

The main benefit of PLife REIT’s lease agreements is the way such agreements are negotiated and structured.

Currently, PLife REIT has 4 lease agreements (3 in Singapore, 1 in Japan) with built-in rental escalation. This rental escalation can be a result of higher variable rent or pegged to a country’s Consumer Price Index (CPI). CPI is also commonly known as the core inflation rate.

The rental escalation for the Singapore hospitals can be summarised with the image below.

Basically, the rental escalation for the Singapore hospitals is based upon the higher value of either the CPI formula or base and variable rent formula. Variable rent for the current lease agreement is set at 3.8% of the hospitals’ annual adjusted revenue. The CPI formula on the other hand is based on the prevailing CPI +1%, where the CPI is deemed to be 0% in the case it is negative.

This is slightly different to the Japan property where the rental escalation is set to Japan’s CPI itself, with no rental escalation should CPI be negative.

Besides lease agreements with rental escalation, PLife REIT also has lease agreements with either fixed rental rates or rental reviews after a couple of years.

As seen, a large portion of the lease agreements in Japan has rental reviews with downside protection. This means that rental rates can only either remain constant or increase during the term of the lease agreement.

As a whole, PLife REIT’s lease agreement structure provides both income stability and opportunities for organic growth. This bodes well for investors as revenue should likely remain stable or increase steadily over time given the long nature of such lease agreements.

Steady top and bottom line growth

As seen, there has been a steady growth in both PLife REIT’s top and bottom line. Do note that in calculating the operational distributable income, I did not account for any form of divestment gains. This means that PLife REIT’s growth in its top and bottom line is purely a result of operational performance.

While net profit recorded a negative growth rate over the years, I am not too concerned given that the decrease is due to a lower net positive fair value gain on PLife REIT’s investment properties.

Although CAGR was at a single-digit growth, I am quite fine with it given that this growth is stable and recurring in nature. Furthermore, due to the nature of PLife REIT’s lease agreements as mentioned earlier, I expect steady and positive growth to continue for the next few years.

Healthy returns to unitholders

The steady positive performance in PLife REIT’s top and bottom line over the years has also resulted in positive returns for investors.

As seen, there has been positive growth in both NAV, DPU, and AFFO per unit. It is quite admirable that both NAV and DPU were able to achieve year-on-year growth for the past few years.

DPU wise, I chose to compare DPU as a result of PLife REIT operations instead of total DPU as doing so excludes one-off divestment distributions. Thus, this allows me to see if the DPU growth is sustainable or not.

Given the steady DPU growth net of divestment distributions, we can conclude that PLife REIT’s DPU growth over the years was due to acquisitions and rental escalations. In the long run, this is a more sustainable way to grow a REIT’s DPU instead of depending on divestments.

Furthermore, a positive CAGR in PLife REIT’s AFFO per unit also shows that more cash is being generated from PLife REIT’s businesses.

Bar any exceptional circumstances or black swan events, I expect PLife REIT to continue delivering value to its unitholders.

Low debt cost

Besides performing well for unitholders over the years, PLife REIT has also done good work on the debt front.

PLife REIT’s weighted average debt cost of 0.53% per annum is one of the lowest in the entire S-REITs market. Such a low debt cost has also translated to an enormously high interest coverage ratio.

In addition, the steady decline in average debt cost over the years also highlights the good work that PLife REIT’s management is doing in managing its debt profile. With about 87% of its interest rate exposure hedged, PLife REIT can certainly maintain its low cost of debt in the years to come.

With a low debt cost and high interest coverage, PLife REIT should have no concerns in paying off its near-term debt interest costs. This removes potential worries that investors might have due to the current economic climate.

Long WALE

The last aspect of PLife REIT which I really like is its long WALE for its property lease agreements.

As seen, PLife REIT overall portfolio WALE stands at 5.74 years. Its WALE for the Japan properties is also relatively high at 11.29 years.

While overall WALE has been decreasing over the years, it is mainly due to the 3 Singapore hospitals approaching lease renewal in 2022. Nevertheless, an overall WALE of 5.74 years is still pretty high by any REIT standards.

Looking at PLife REIT’s lease expiry profile, there are also no major concerns at least till 2022.

Source: PLife REIT FY2019 annual report

While there might be a risk that PLife REIT would not be able to renew its leases for the 3 hospitals, I highly doubt that would be the case. This is mainly due to the prominence of the 3 hospitals for both PLife REIT and its sponsor.

As a whole, a long WALE for PLife REIT properties, coupled with the earlier mentioned factors, would only add to the overall income stability and growth of the REIT.

Points to consider

While there were many aspects of PLife REIT to like, there were also other ‘not so good’ aspects I feel investors should note. I will thus be using this section of the post to elaborate on some of them.

Debt concerns

Although PLife REIT has managed to maintain a low cost of debt over the past years, it still does have some near-term debt risk.

As seen, PLife REIT’s gearing ratio has been slowly inching up over the past years. Much of this increase is due to the use of pure debt to finance acquisitions over the years. Indeed, there has not been a single rights issue since PLife REIT’s IPO.

With that said, PLife REIT’s current gearing ratio of 38.5% is not too big a concern as there is ample debt headroom before hitting the regulatory limit.

While there is a small possibility that PLife REIT might face a gearing issue should the value of its investment properties drop, I do not foresee the impact to be as catastrophic as that witnessed by the dilutive rights issue taken by First REIT. This is mainly due to the nature and quality of PLife REIT’s properties.

However, investors should still be fully aware that PLife REIT does have some short-term debt refinancing risk.

As seen, close to 33% of PLife REIT’s total debt would be up for refinancing by the end of 2022. This is on top of the renewal of lease agreements for its 3 hospitals in 2022, which I will touch on more about later in the post.

On the bright side, PLife REIT has managed to refinance or extend all of its debt which is maturing in 2021. This provides some financial clarity moving forth.

For the maturing debt in 2022, PLife REIT should have no issues refinancing it with its operational performance and financial standing. Nevertheless, I will still keep an eye out for future business updates with regards to PLife REIT’s refinancing plans.

High dividend payout percentage

Besides some short-term debt concerns, PLife REIT’s high dividend payout percentage is another area to note.

As seen, much of PLife REIT’s AFFO is being paid out as dividends. This is largely due to PLife REIT paying out 100% of its distributable income over the years.

Generally, as a rule of thumb, REITs should not be paying out a high percentage of its AFFO as dividends. This is because any drop in operational performance would mean that the dividend would need to be sustained with either debt or the REIT’s own available cash instruments. This would in turn hurt the REIT’s long-term growth prospects.

However, I think that it is a slightly different case for PLife REIT.

As mentioned earlier, PLife REIT’s lease agreements are long-term in nature. This means that PLife REIT’s rental revenue is kind of predictable and stable during the lease period. Furthermore, with backup operators for its nursing homes and a lease agreement till 2022 for its hospitals, much of the downside risk to PLife REIT’s rental revenue is mitigated.

This consequently means that dividends paid out should be able to be sustained in the years to come.

Nevertheless, I would definitely be more comfortable if PLife REIT did not pay out 100% of its distributable income every year. This would give PLife REIT a larger cash pool, which in turn provides more financial leeway for growth and sustenance.

Lease renewal

As mentioned a few times earlier, PLife REIT’s lease agreement for the three local hospitals would be up for renewal in 2022.

Although there is an option to extend the lease agreement for another 15 years based on the current terms, I am not sure if the option would be exercised. This is mainly due to the impact of the Covid-19 pandemic on medical tourism.

While we do not know the exact proportion of revenue contribution from medical tourism for the 3 hospitals, it can be assumed to be quite significant given the prevalence of medical tourism to private hospitals. Hence, with travel restrictions in place, revenue from medical tourism would definitely be negatively affected. It is just a matter of how big the drop would be.

Having said that, the impact might be partially mitigated by the rollout of Covid-19 vaccines. This can then subsequently lead to an easing of border restrictions. Furthermore, with the lease renewal only happening in 3Q 2022, there is still time for a recovery in medical tourism to happen.

Either way, I would definitely be looking at the gross revenue figures of the hospitals in PLife REIT’s FY2020 annual report to see how much of an impact Covid-19 had. However, even with this information, it would still be quite hard to predict how the lease renewal would play out.

Thus, I think we can only adopt a wait and see approach when it comes to the lease renewal for the three hospitals. Who knows this concern might become irrelevant if the lease agreement is extended for another 15 years.

Concentration risk

With a huge majority of revenue coming from the three hospitals, it is no surprise that PLife REIT’s tenant profile is not well spread out at all.

Source: PLife REIT FY2019 annual report

As seen, Parkway Hospitals contributed more than 50% of PLife REIT’s total revenue. In addition, the other top 9 tenants contributed to around 26.8%. As a whole, PLife REIT’s top 10 tenants contributed to 85.2% of total gross revenue in FY2019.

If one was to breakdown the network of PLife REIT’s nursing home operators, 51% of the rental from nursing homes were contributed by five operators in FY2020.

While PLife REIT has a concentrated tenant profile, I feel it is not too big a worry. This is down to the presence of contingency plans such as back-up operators for PLife REIT’s nursing home operators. Furthermore, I also fully expect Parkway Hospitals Singapore to renew its lease agreement with PLife REIT.

With that said, PLife REIT has not been resting on their laurels and has taken steps to diversify its rental sources over the years. This is evidenced in the declining percentage of Parkway Hospitals Singapore contribution to PLife REIT’s gross revenue over the years.

With PLife REIT continuing its growth strategy in nursing homes, I fully expect rental diversification to continue in the years to come.

Manager’s fee structure

While not necessarily a significant cause of worry, PLife REIT’s manager’s fee structure kind of works to the management’s advantage.

Source: PLife REIT FY2019 annual report

As seen, PLife REIT’s management fees are based upon two main aspects, the REIT’s assets value and net property income. These two metrics are easily achievable with acquisitions, be it whether they are dilutive or accretive to unitholders.

In that sense, PLife REIT’s management would always be making money as long as the REIT is growing in size, regardless of its performance to unitholders. This is also made easier with the built-in rental escalations of PLife REIT’s lease agreements.

In addition, PLife REIT’s management fees are also currently paid fully in cash instead of units. Some might argue that by doing so, the management is not really aligned with the interests of its unitholders. However, I beg to differ.

Throughout PLife REIT’s growth over the years, it has been done in a way that provides value to its unitholders. This is evidenced in the growth of its underlying DPU and NAV as mentioned in earlier parts of this post. Furthermore, this has also been achieved on the back of steadily positive financial performance.

While there might be a possibility that DPU could be higher if PLife REIT management elects to be paid in the form of units, I also feel that a management team should be properly incentivised for good performance over the years. This is fundamentally a chicken and egg situation.

At the end of the day, as long as a REIT is growing sustainably and providing good returns, I am not really bothered with how the management is being paid.

Valuation

Having gone through both the positive and negative aspects of PLife REIT, I will now look at its current market valuation. This determines a suitable entry point should one decide to invest in PLife REIT.

PB ratio

At its current market price, PLife REIT has a price-to-book ratio of 2.07. This is rather overvalued if we are to look at its historical PB ratio.

As seen, PLife REIT’s 5-year PB ratio stands at around 1.64. Based on this ratio, the market price of PLife REIT has to drop to $3.21 for it to be at a ‘fair’ price. This represents a 20.7% drop in its current market price.

Safe to say, such a drastic drop would only happen during the next market correction.

AFFO yield

Besides determining the valuation of PLife REIT using the PB ratio, the AFFO yield method can also be used. Generally, I use this method to determine a REIT’s valuation based on its current growth trajectory.

For its current market price, PLife REIT spots an AFFO yield of 3.47%. As a comparison, PLife REIT’s basic internal AFFO yield (AFFO/value of investment properties) was around 4.28%.

Based on these two figures alone, we can say that PLife REIT’s current market price is slightly overvalued. A fair market price would be around $3.29. This is quite similar to the price based on its historical 5 year PB ratio.

Given that the above figures were based on current year results, I wanted to incorporate PLife REIT’s future AFFO growth in to the equation.

With a modest growth rate of 2%, the fair price of PLife REIT, based upon AFFO yield, would be $3.36.

Taking into account both the PB ratio and AFFO yield, PLife REIT fair price would range from $3.21 to $3.36.

However, as I like to have a margin of safety of at least 1 basis point, I would instead invest in PLife REIT when its price ranges between $2.81 to $3.02. Entering at this price range would also net a dividend yield of between 4.57% to 4.91%.

Why I invested

Having analysed PLife REIT’s financial performance and its valuation, I would close off this post with my reasons for investing in PLife REIT.

Resilient revenue

When it comes to investing in REITs, I am always a sucker for REITs with high WALE. The reason for this is that there will be lesser volatility in the REIT’s future earnings.

PLife REIT ticks this box perfectly with its long lease agreements and built-in rental escalation. This allows for stable, recurring and organic growth in rental revenue throughout the period of the lease agreements.

Furthermore, as PLife REIT invests in hospitals/medical centre and nursing homes, it would not be that adversely affected by economic downturns. Yes, with the current Covid-19 pandemic, revenue from hospitals/medical centre might be adversely affected, with medical tourism almost non-existent. However, over the long run, medical tourism should recover once the pandemic dies down.

Even if revenue from hospitals/medical centre takes a hit, PLife REIT would not be affected much due to the way the lease agreement is structured. In addition, revenue from the nursing homes should be able to make up from the loss. After all, be it a pandemic or economic recession, nursing homes would still be required to operate as per normal.

Room for growth

With the global population ageing rapidly, there would be increased demand for healthcare and aged care needs. This is even more prevalent in the two major countries that PLife REIT operates in, Singapore and Japan.

According to data from The World Bank, population aged 65 and above for both Japan and Singapore have almost doubled from figures at the start of the millennium. This trend is set to continue with individuals now having longer life expectancy than before. Indeed, 40% of Japan’s total population is projected to be above the age of 65 by 2060.

This would be a growth catalyst for PLife REIT as it looks to continue expanding its nursing homes segment.

In addition, with a relative high share price and low cost of debt, PLife REIT is also nicely poised for inorganic growth, be it via equity funding or debt.

Taking these factors into account, coupled with organic growth via its lease agreements, I am optimistic that PLife REIT can continue on its steady growth trajectory witnessed in the past few years.

Proven track record

Lastly, one of the reasons that I invested in PLife REIT was also due to its DPU track record. Let’s face it, a year-on-year increase in operational DPU since IPO is literally a dream for any REIT investor.

The fact that PLife REIT has managed to achieve it places the REIT in high regard amongst my REIT checklist. It was also the main reason why it attracted me to analyse PLife REIT too.

Yes, I get that past performance might not be indicative of future performance. However, I feel that this growth trend can continue if PLife REIT continues growing sustainably and renew its expiring lease agreement in 2022.

As such, if there are no adverse changes, you can bet that I will be holding on to my PLife REIT units for the long-term! I will also look to slowly add to what I have once the price comes down a bit. PLife REIT shares are definitely a tad expensive for me now.

Do you agree with my analysis? Or feel that I overlook some aspects? Let me know in the comments below! I am always open to discussion.

Now on to the next REIT to analyse…

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