Sold out: Ho Bee Land Ltd (too much debt)

 I liquidated my Ho Bee Land (SGX:H13) position on 18 Apr 2023 for SGD 2.21, realizing a loss of ~20%, including dividends received. Considering the rising interest rates, I fear Ho Bee Land's debt is too high. 

Ho Bee Land is almost a REIT considering the high amount of investment properties compared to the projects they still have in development. Like a REIT, its net debt level is also relatively high at almost 13 times EBITDA. The interest coverage rate is 2.9, which is low but not immediately alarming. However, when you flip through the Ho Bee Land 2022 Annual Report, you learn that it was borrowing at rates of only 1.02 - 1.61 % (page 74) in 2021. Already in 2022, this range expanded to 1.05 - 5.05 %. What would eventually happen if all their loans were charged a 5% interest rate or higher? When your finance costs rise fivefold, the lease payments of the tenants will also have to grow five times just to keep the interest rate coverage stable. 

Raising rents fivefold is highly unlikely, even in an inflationary environment. However, Ho Bee Land has another trump card to play: their borrowings are currently hedged with interest rate derivatives. In 2022, we can already see these derivatives creating value (annual report page 75), and they will keep working for them if interest rates stay high. Unfortunately, we must consider what will happen after these hedges expire. All derivatives are tied to specific loans, which mature from 2023 - 2026 (page 74). These loans will have to be refinanced, and obviously, you can not continue to lock in a 1% interest rate with derivatives when the general interest rate environment is already much higher. Thus, Ho Bee Land can only pray that the interest rates will drop again in the coming years. Here, we arrived at the crux of my fear.

Most of Ho Bee Land's investment properties are in the UK. I could not find a reliable source for historic commercial real estate lending rates. The graph shows the historic Bank of England Bank Rates. It is the interest rate that banks receive for holding money with the BOE. This data will also prove my point.

(Source: excel data from https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp)

We can see three different clusters of interest rate levels.

• Fluctuating around 11% from 1973 till 1993

• Fluctuating around 5% from 1993 till 2009

• Near 0.5% from 2009 till 2022

Apart from the transition years (1993 and 2009) and 1978, for some reason, there are no years where the rate significantly differs from the year before or after.

From observing this pattern, the current 5% rate is unlikely to be followed by a reversal back to the 0.5% regime. Apart from another 1978 type of exception, it is likely that we will see the 5% level sustained over a longer term. In other words, it looks like there is a new regime of mid to high interest rates. This is a bit of an engineering type of pattern recognition. If you have strong economic reasons to disagree that interest rates remain elevated for longer, there is no reason to worry about Ho Bee Land. Their balance sheet is quite strong now. They will gracefully survive a short period of high interest rates. However, if you agree that there might be an interest rate regime change, the coming years look bleak for Ho Bee Land. Not only for them but also for many REITs and other real estate holders facing the same issue: lots of debt with low interest rates, locked in for a few years but expiring in a potentially higher interest rate environment.

One remedy for leveraged property owners is to simply sell off properties and repay the debt until it is no longer a burden. But who is going to buy those properties from them? Even if it is a high-quality office in London? Most other real estate investors are also leveraged and facing the same rising interest rate issue. Adding more fuel to the fire, cap rates generally rise together with interest rates, so estimated values of properties will go down. Ho Bee Land actually started selling off some properties in Singapore. However, I wonder if this strategy can reduce the debt burden enough to stop worrying about it. (NB: Ho Bee Land stated that those property sales are unrelated to debt pressures.)

Disclosures: I am not a real estate professional. Nothing written here is investment advice. I sold off Ho Bee Land and all my REITs except Daiwa House Logistics REIT. I will give more details in future blogs.

WALL-E; Industrial S-REIT's dirty little secret

An S-REIT is a REIT listed on the Singaporean stock exchange. This article concerns industrial and logistic REITs listed in Singapore and also owning properties there. Most of such properties are built on land leased from the Singaporean government. These land leases are relatively short, 30 to 60 years, and part of that time has already passed. The remaining time is expressed as the Weighted Average Land Lease Expiry, which I will shorten as WALL-E, like in the namesake movie. 

When the land lease of a particular property has expired, the REIT owning that property has to demolish it and return the land to the government. The REIT may also manage to extend the land lease, but it must pay a large lease payment. It is really a lose-lose dilemma for the REIT. This WALL-E issue does not get much exposure in the media. This may be because the weighted expiry is still 30 years or more in the future, which is an eternity for most of us.

Still, it is the elephant in the room for me. Imagine the worst-case scenario where a REIT can not extend any of its land leases after 30 years. The impact on the REIT valuation is like a discounted cash flow calculation without a terminal value. If you are unfamiliar with these calculations, let me assure you that it dramatically decreases the value. Another way to think about it: you should at least get a 3.33% dividend yield per year just to be compensated for the fact that a year of the properties' earnings potential has been lost. Only the yield above 3.33% is what you truly earn. 

The best Singaporean finance blogger Kyith Ng wrote about this issue in 2011  and concluded:

"It will be prudent to value a REIT as if this is a non-perpetual asset with a finite lifespan and calculate the internal rate of return as accordingly."

As Kyith Ng mentions in this article, the JTC Corporation is responsible for either extending a land lease or terminating it on behalf of the Singaporean government. Looking at historical cases, it seems that JTC will usually renew a land lease, but it might not do so when there are redevelopment plans for the area where an industrial property is located. Thus, JTC's decisions seem to be driven by urban planning motives rather than attempts to maximize profits. It may not be as bad as it looks for the REITs. 

Even so, I am annoyed by the WALL-E issue. I do not feel I really own an asset if it must be returned within 30 years. Funny enough, I don't have this concern when a lease expires in 60 years or more. The expiring land lease issue could get increasing media attention as we get closer to the expiry dates of more and more properties. In a few years, the threat might be felt as more pressing and could influence the share prices of REITs. At least one S-REIT manager seems to share this concern...

5. Rebalancing of portfolio to freehold assets, whilst not compromising on growth:

a. With our Singapore properties, accounting for 60.5% of our portfolio by valuation, held through Jurong Town Corporation (JTC) on a leasehold basis, it is prudent that we progressively rebalance AA REIT’s portfolio to longer tenure or freehold properties to minimise the future impact of a shortening land tenure.

(AIMS APAC REIT, Annual Report 2022, page 8)

The WALL-E issue affects S-REITs with industrial properties in Singapore, like ESR-LOGOS REIT, AIMS APAC REIT, and Sabana REIT. It is much lesser an issue for S-REITS with offices, hotels, and malls, which are sectors where land leases tend to be much longer. It is also not an issue for industrial S-REITs like Daiwa House Logistics (Japan) and Frasers L&C (Australia, Europe), which, although listed in Singapore, are active in countries where land lease expiry is very long or properties are typically on freehold land. That said,  there are other countries, such as Vietnam and China, where land leases are also relatively short. S-REITs like CapitaLand China Trust and EC World REIT may be impacted in these cases. 

In my portfolio, the WALL-E issue concerns ESR-LOGOS REIT, AIMS APAC REIT, Sabana REIT, CapitaLand China Trust and China Merchants REIT in Hong Kong. I sold all of these.

Sold out: Able Global Berhad (KLS:7167)

Able Global Berhad sells milk under the brand names Able Farm and Tarik Tarik. I had purchased a 0.5% position to feel out this stock. My rule is to double the starting position or sell it off when I don't feel confident about the company's prospects. The company has low debt, a good ROE, and a decent dividend yield. The stock price seems low compared to these fundamentals. So, why do I not feel confident?

Able Global is expanding its dairy business into Mexico. Analysts applaud their spirit of entrepreneurship, but I am confused about the reason for choosing this particular country. I have reviewed the company's publications but did not find any rationale for this choice. When a company expands its operations, it is typically done at the edge of its circle of competence. It would, for example, expand into a neighbouring country or a product line that supplements the current products. It is unclear why a company would jump from Malaysia into Mexico. Able Global increased its debt burden to support this effort, raising the stakes even higher.  

My second area of doubt concerns Able Global's digital brand strategy. There is no active presence of Able Farm on Instagram, TikTok, Twitter, or Facebook. But even worse, a search on Shopee does not even yield 25 listings of their products. You may argue that offering milk on a trading platform makes no sense because it would get spoilt during shipping. Let's clarify here that Able Farm offers condensed, evaporated and UHT milk variations, which you don't have to refrigerate. F&N and Dutch Lady provide similar products in the Malaysian market. Searching these brand names lists hundreds of results on both Shopee and Lazada. Where are the Able Farm products? Let me be clear that the products do exist. I have seen those used in various street food hawker stalls for which Malaysia is famous. There is likely a long-time functioning supply chain behind these products, possibly with third-party wholesalers. They might not see the need to advertise to the ultimate consumer. 

For my portfolio, I am looking for consumer staples where the brand name is the moat. Brand names must be supported by modern advertisements and other marketing efforts. The absence of modern marketing efforts for Able Farm and my reservations about the future Mexican operation made me conclude that the stock does not fit my requirements. I should have caught these objections because both already existed when I bought the stock. My lack of research and reflection was a mistake. By the way, selling the stock may also be a mistake when the Mexican operations take off successfully. I will be keeping an eye on the developments. Sold Able Global at 1.29 RM.

Disclosure: Long Fraser and Neave (F99 in Singapore)