News and commentary

Real estate realism

By Vivian Lewis
Updated: Monday, November 03 2008 04:11:PM

     Your editor made a mistake in her blog last week about the rash of new unsponsored OTC American Depositary Receipts which are being created by banks. Under the terms of a new Securities and Exchange Commission ruling, companies reporting to a foreign regulator in according with International Accounting Standards no longer have to re-calculate their accounts into U.S. Generally Accepted Accounting Principles (GAAP).

     As a result, listed companies from respectable markets around the world now have new ADRs. But there are not only 200 of them, as reported last week. I am still inputting the data from the various depositary banks, a truly boring job, but the number of new ADRs is well over 290 as of this writing. And the trend will pick up.

      With unsponsored ADRs, the banks can charge fees when they hand you your dividend. They can charge fees when they calculate your taxes to the foreign country where the stock has its primary listing. They can charge fees when there is a corporate action like a stock split or rights issue or takeover. So they utterly love unsponsored ADRs.

      But since this gives us more opportunities to diversify our investments, we love them too. Subscribers who have access to our website can view the newly arrived ADRs on our ADRGuide site. I am about halfway through the process of inputting the data.

      I retain a fondness for real estate investing, in part because of a mistaken belief that it does not correlate with stock markets. Since our London pied-a-terre is near the new financial center at Canary Wharf, it certainly has not escaped unscathed by the crisis. Nor has the fallback of sterling against the dollar made our investment very lucrative.

     But I comfort myself that in developing countries, sound property investments should do better. So were have two plays on emerging Asian property in our portfolio, for China and India, the subject of our subscriber letter today.
 
     *Start with beaten down Xinyuan, NYSE-XIN, a property developer in China. The combination of two recent bubbles bursting is enough to explain why the stock is down, but it did not help that XIN warned that there would be a falloff in sales in H2 this year.
 
     Moreover, there is plenty of news and pseudo-analysis about on how Chinese real estate is proving to be a bubble, the most recent a report from Citigroup. They wrote up areas near where their China team is based in easy reach of Hong Kong like Shenzhen and Guangzhou. The Pearl River Delta, home of the export industries feeding into the WalMarts of the world, is indeed feeling the pinch.
 

     However, my mood is less gloomy looking at the XIN portfolio of sites and existing gated complexes. XIN, a Cayman Islands company, yesterday announced that it was buying back its shares, another reason for optimism.

     XIN operates in second-tier inland cities most of us have never heard of or visited. Even your intrepid editor only managed to visit two of them in her 3 weeks in China earlier this year, Suzhou, on the bullet train between Shanghai and Wuxi; and Chengdu in Sechuan Province on the Yangtze River.  

     Both are interior industrial cities drawing in new residents from the surrounding countryside. Suzhou is a traditional silk clothing center, and very beautiful with canals; Chengdu is a river transport center attracting farmers and workers displaced by the Three Gorges Dam (and the later earthquakes). It is very hot. They have higher than average per capita incomes because they are not overwhelmed with unskilled workers producing cheap goods for foreign markets like the Pearl River Delta.
 
     And in fact, the four other cities where XIN is building its compounds also are major trading hubs. Jinan, in Shandong Province, inland but between Shanghai and Beijing waterfront cities, is famous for its springs and railroad junction; down the tracks a few miles is the famous Qingdao (Tsingtao), whence China’s best-known beer. Another XIN development city is Zhengzhou, in Henan Province, surprise, surpsie, a railroad hub.
 
     The canny family controlling Xinyuan are making their buyback now because of market malaise. Presumably they think the new Chinese interest rate cuts and preograms to build up the domestic economy will result in disposable cash in the hands of potential buyers of XIN apartments. I tend to agree.
  
     *Our other Asian real estate pick is a different play. Ascendas (ACNDF.PK, AiTrust, or AINT.SI) is a Singapore-listed real estate investment trust building and operating office and industrial properties in India. It mostly builds office towers but does a small amount of commercial property as well, like shopping malls for the people working in the towers.
 
     Again it helps to know where they are at. Currently the sites are in Bangalore, India’s IT capital, Hyderabad, and Chennai (formerly Madras). It is moving into Coimbatore, Pune (formerly Poona), and Gurgaon. Again these are famous old rail centers, because investment follows the train.
 
     Do not imagine that Ascendas’ tenants are merely the Indian IT companies. To be sure, it did a sale-leaseback deal for Tata Consulting Services this summer which we reported on, freeing up cash for the Indian IT firm to help it survive the crisis. Unlike Tata, ACNDF was able to fund the building at 70 basis points over the swap offer rate, so that its lease will produce excellent profits.
 
      Some 63% of the REIT’s lets are to IT companies mainly because that is where the money is in India. But most of its tenants are global companies: GM, Pfizer, Merrill Lynch, Applied Materials, Cognizant. The top 10 lets account for only 29% of total area leased by Ascendas, and non accounts for more than 4% of the total. That spreads the risk even though I worry about GM.
 
     Because its investors are in Singapore, Ascendas has hedged its repatriation flows from rupees to Singapore dollars through to the hend of H1 2009 (a year from now more or less). It produced an income per unit of S1.82 cents. That was up 23% from last year’s Q2, and up sequentially by 10%. At end Sept., NAV was S$750 mn or 99 cents (Singapore)/sh.
 
     Based on its H1 distribution, it pays off to the tune of 16.2% as of the price at which it entered the model portfolio. So the obvious question to ask is can they keep it up?
 
     Having been rude about Citi's Asia hands, I must admit they are right about Ascendas which they call a buy with an attractive 15.9% yield (they wrote their piece after we had already bought in. We paid 28 cents U.S. per share and they are writing with the share 33 U.S. cents.) Citi wrote:
 
     “In current volatile times, we see aiTrust as a defensive Indian property play. While stock is down 42%, it's outperformed Indian property stocks by 52% over last 3 months. Its attractive yield of 15.9% for FY09E is ahead of peers and good support. We reiterate Buy (1M).”
 
     (1M means best buy, moderate risk. Citi lowered its target price to S$0.79 citing currencyy risks despite the hedging we reported above. This may be because Citi thinks the costs of hedging beyond Sept. 2009 will go up.)
 
     For Q2, Citi analysts noted “a one-time income of S$2.7m from extra power supply. Net property income was up 2% largely due to higher operating, and utility costs given a larger portfolio” It added: “we expect [a] stronger 2H” from higher areas available for lets.
 
     Citi cited some risks: like a depreciating rupee in S$ (and US$) and any global slowdown in IT demand feeding into closing offices or bankruptcies. I think this is pretty remote. But obviously, if GM goes bust, this will have an impact.

 

      Note: Results and DPU for Q1 and Q2 FY 2007-8 were reported together after the listing of Ascendas, at S$ 2.95 cents. Had the DPU been equal and hence 1.475 Singapore cents for each quarter, 2Q FY 08/09 would have been 23% higher.

      *DryShips reported in excellent Q3 for the first time consolidating its Ocean Rig Ultra-deep-water drilling rigs with its dry bulk carrier fleet. DRYS.Q net profits came in at $180 mn vs $105 mn a year ago, or $4.21/sh vs $2.97. Note that these figures are after extraordinary gains and losses from ship sales and from swaps of +$1.54 and -0.86/share respectively.

      This was impressive given the mess in the Baltic Dry Index which sets the price for dry bulk ship charters. Yet DRYS did not beat analyst estimates. To quote CEO George Economou in his Q & A with analysts, "it is not easy to prepare for the atom bomb."

      Having begun to diversify away from day charters and away from bulk carriers altogether, the financial crisis intervened and Mr. Economou could nto complete the task. Yet he managed to get 55% by volume of the ship fleet (25 of its 39 vessels) to long-term contracts, for an average of 5 years to avoid the wipe-out in day rates. CRYS is taking in $50,000/day/vessel in today's market (on average) according to the company.

       And unlike the situation in the fleet, oil dirlling rigs able to handle the briny deep where wells are now being drilled are in short supply, and command a premium rate. DRYS signed a rental deal with Tullow Oil for one of its two existin rigs at $637,000 per day, which is comforting.

      Mr. Economou made another remark which resonated with me and with the market, which saw a 20% rise in DRYS.Q stock price today. He said: "the balance sheet is in good shape, at a level we are very comfortable with. Here is why: firm EBITDA levels for 2009 to 2011 from actual contracts signed in millions of dollars:

                          2009       2010      2011

Ocean Rig                 $235        281       264

fixed dry bulk charters    419        443       694

         source: Dry Ships

      Also reassuring were the balance sheet data on cash at $456 mn. The company has debt of $2.899 bn of which $1.224 bn has not been drawn down. While we wait for the iron ore business between Brazil and China to resume (they are in tough negotiation now), while we wait for the blocked letters of credit financing the export trade to become liquid again, we are prepared to put up with a certain amount of self-dealing and insiderism from Mr. Economou. These factors keep the price of DRYS down and produce a nice yield and a P/E ratio insingle digits.

     At some point, the oversupply of bulk carriers will be resolved. Either China will stop growing, which is unlikely, or the ships on order will never be built and the pace of scrapping of old ships will pick up. While we wait we get to cash our dividend checks.

     The spinoff of Ocean Rig UDW Inc. is scheduled for late this year or early next. The latest scoop from Mr. Economou (when questioned by Natasha Boyden of Cantor Fitzgerald) is that some of the DRYS debt may be attributed to the new entity. We will let you know when we know more.

      *Last week your editor met with John Coustas, CEO of Danaos (DAC); Ted Petrone, president of Navios (NM); and Harry Kosmatos, senrior manager of Tsakos Energy Navigation (TNP). But I decided that I like George Economou's strategic thinking best. It would help if he was more trustworthy with his shareholders but then his stock would be pricier. 

      *Western Asset Emerging Markets Floating Rate Fund now has a new ticker symbol, EMD (in place of EFL). The proposed merger with another Legg Mason closed-end fund investing in emerging market bonds, Western assets Emergin Markets Debt Fund, has been put on hold because the share price of our EMD is so high compared to that of the merger partner. (This is mainly because floating rate debt commands a nifty premium to net asset value in today';s troubled markets.) The managers are monitoring the situation. The merger would enable our fund to cut its relatively high per share expenses.