I am even more cautious with AA Reit now

The deal looks done – AIMS APAC Reit announced that it had entered into a contract for sale agreement to acquire Woolworths Headquarters. The purchase consideration was S$454 mil and the site is fully leased to Woolworths Group Limited. The Initial Net Property Income (NPI) yield is 5.17%.

I spoke about this possible acquisition in my last blog on AA reit – I would be cautious on AA REIT and the reason why I would be careful in trading AA reit shares. Following this latest update, I am even more cautious of it now as this deal increases the risks of investing in AA Reit.

However, I want to mention that it does not by itself, mean that the deal is bad. It just means that when we invest in AA Reit, we have to be more careful and aware of the risks that we have taken on. If we are not comfortable, we may want to pare down our holding in AA Reit and diversify.

Let me share those heightened risks with you as follows:

1 Customer Concentration Risk

After this deal, about 20% of AA Reit NPI would rely on a single customer – Woolworth. While it is unlikely to think Woolworth would collapse or relocate from the site fully, there is no guarantee that the chance is zero. Putting many of your eggs in one basket can be risky.

2. Increased Currency Exposure

For many of us who invest in AA Reit using SGD $, a depreciation of Aust $ against SGD $ would reduce the income that we get from the Australian properties assuming all else constant. With this latest deal, the percentage of NPI that AA Reit would get from Australia (particularly from Woolworth and Optus) will rise to about 30%. This inevitably increases our currency exposure.

3. High Leverage Ratio

The financing plan for this acquisition as shared in the powerpoint slides released by AA Reit with this announcement was debt (56% – $254 Mil) and perpetual securities PS (44% – $200 Mil).

According to its 2020 Annual Report, AA Reit total borrowing was S$594 Mil and the leverage ratio was 34%. Taking on another $254 Mil debt would increase its leverage ratio to 39%. And one has to note that the leverage ratio excludes perpetual securities (PS) which can also be seen as a form of “debt” as AA Reit would have the obligation to pay interests to PS holders before paying dividends to shareholders. In their latest PS of $250 Mil, the interest rate is 5.375%, which in my opinion is high. AA Reit cost of debt in 2020 was only 3.0%.

On its book (2020), AA Reit already has $125 Mil of PS. This deal would increase its PS to $335 Mil. So, if we add PS + Debt together, that ratio over asset would become almost 54%. Some of us may find this “debt” level too high for comfort.

Furthermore, there is a high likelihood that interest rate would increase in the coming months or years. Hence, high debt obligation is a concern.

4. Rights Issue

Although the announcement did not mention about raising money from equity to fund this acquisition, I believe AA would consider this option.

If done well and investors are cash rich, then investors would be neutral or in some case, better off if they are given a chance to participate in the right issues. This reduces the debt level of the company (less stress for management 🙂 and more headroom for acquisition) and allow shareholders to be more invested in the company.

However, if you are not cash rich and do not want to participate in the rights issue, then you would have to be prepared to get your stakes diluted by increase number of shares. Your yield from your AA Reit investment would come down.

5. Current Share Price

In my view (see previous AA Reit blog post), the current share price is trading on the higher side relative to historical performance.

With the increased risk as mentioned above, we would have to judge if we would still like to pay premium for AA Reit shares. If many people share this same feeling, then AA reit share price will decline. If you are holding a lot of AA Reit shares, you may want to consider spreading your investment a bit and diversify more.

I hope AA reit would get it well. I am still afterall a loyal shareholder of AA reit for years though I am becoming increasingly uneasy with my holding.

I hope you find the above useful.

Have a great investment week ahead.

Regards,

Warriortan

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